As we already informed you in our newsletter dated 8 November 2023, the Federal Government introduced the draft Growth Opportunities Act to the Bundestag on 30 August 2023. Although the Bundestag passed the Growth Opportunities Act in its session on 17 November 2023, the approval of the Growth Opportunities Act by the Bundesrat, which was scheduled for 24 November 2023, did not take place. The Bundesrat rejected the act and called upon the Mediation Committee. On 21 February 2024, the Mediation Committee was able to agree on a recommendation for a resolution on the Growth Opportunities Act. This recommendation for a resolution was ultimately adopted by the Bundestag on 23 February 2024 and by the Bundesrat on 22 March 2024. The Growth Opportunities Act has therefore finally been passed, and it is expected to be promulgated in the near future.

In particular, the anti-fragmentation rule initially intended to be included in the government draft as part of the interest barrier according to Section 4h of the German Income Tax Act (Einkommensteuergesetz – EStG) was removed, and the introduction of an interest rate cap was replaced by OECD-compliant regulations in the context of transfer pricing. We have summarized these two regulations for you below.

The draft law has not been amended with regard to the regulation to reduce the low tax rate under the CFC rules and the changes to the Investment Tax Act in connection with capital gains from real estate companies and the qualification as a real estate fund. Please refer to our comments in the newsletter from 8 November 2023.¹

Anti-Fragmentation Rule

The anti-fragmentation rule is intended to prevent multiple use of the exemption limit of EUR 3 million by several (special purpose) companies with similar activities by grouping together similar companies or companies that are under a single management for the exemption limit. The regulation would have had a particular impact in the real estate industry, where separate companies are regularly founded for each project or construction project.

The anti-fragmentation rule contained in the government draft was removed from the draft law without replacement.

Interest Rate Cap

The introduction of an interest rate cap in Section 4l of the German Income Tax Act was already criticized in the statement of the Bundesrat, and the implementation via Section 1 of the German Foreign Tax Act (Außensteuergesetz – AStG) was called for instead. The Bundestag has since followed the Bundesrat’s proposal. Section 4l was removed from the draft law and paragraphs 3d and 3e were added to Section 1 of the German Foreign Tax Act.

The two added paragraphs are intended to specify the general arm's length principle with regard to financing issues. While paragraph 3e defines in which cases financing relationships are low-function and low-risk services, paragraph 3d is intended to contain regulations on interest expenses in financing relationships, which, in addition to loan relationships, also include the provision of debt capital and debt-like instruments.

Paragraph 3d is intended to cover cross-border financing relationships where the taxpayer cannot credibly demonstrate that it could have paid the loan interest and repaid the loan from the outset and that it has an economic need for the financing. As a result, loans for which there is no need and which were not intended to be repaid from the start should not result in the deduction of interest expenses as business expenses. Instead, these are hidden deposits.

In addition, interest expenses should not be deductible if the interest rate agreed between related parties exceeds the interest rate at which the company could obtain financing from third parties based on the rating for the group of companies. Only if it can be credibly demonstrated that a higher interest rate is in compliance with the arm's length principle can the interest deduction be allowed on a case by case basis.

By inserting paragraphs 3d and 3e in Section 1 of the German Foreign Tax Act with regard to the level of an appropriate interest rate within the framework of the arm's length principle, the provisions of the double taxation agreements on affiliated companies (Art. 9 of the OECD Model Tax Convention, Art. 9(1) of the double taxation agreement between Germany and Luxembourg) are applicable, and therefore a counter-correction under a double taxation agreement is generally possible for the recipient of the interest. This means that the risk of double taxation is much lower in contrast to the originally planned introduction of Section 4l of the German Income Tax Act, which would not have permitted a counter-correction due to the lack of applicability of Article 9 of the double taxation agreement between Germany and Luxembourg.

The regulation is to apply from the 2024 assessment period.

Please find below a list of the decisions that we consider to be the most important:

Among other things, the Bundestag passed the following resolutions:

• Income from photovoltaic systems of up to 20% will remain unaffected in the context of the extended property reduction in trade tax and when an investment fund qualifies as a specialized investment fund;
• Introduction of a statutory regulation on the mandatory use of electronic invoices;
• Introduction of declining balance depreciation for movable assets purchased after 31 March 2024 (previously planned for 30 September 2023) and before 1 January 2025. Depreciation is to be up to 20% (previous target: 25%), up to a maximum of 2.5 times the straight-line depreciation;
• Introduction of a declining balance depreciation on residential buildings of 5% (previous target: 6%).

Some of the measures removed include the following:

• Extension of the loss carryback according to Section 10d of the German Income Tax Act;
• Obligation to report domestic tax arrangements.

It should also be mentioned that as part of the Future Financing Act, the VAT exemption under Section 4(8)(h) of the German Value Added Tax (VAT) Act (Umsatzsteuergesetz – UStG) for the management of certain investment funds was extended to all alternative investment funds. Previously, the exemption only applied to undertakings for collective investment in securities and alternative investment funds comparable to these. For this reason, the management of closed-end specialized AIFs, among other things, was previously not VAT-exempt. With the regulation now applicable from 1 January 2024, VAT-exempt management includes all investment funds as defined in the German Capital Investment Code (Kapitalanlagegesetzbuch). There will be no expansion of the activities that fall under the definition of management.

¹ Draft Law on the Growth Opportunities Act and Minimum Taxation Directive Implementation Act – Aiqunited