In brief

The German Federal Ministry of Finance on July 14 published a comprehensive draft decree on its interpretation of the German anti-hybrid rules, which apply generally to all expenses incurred after December 31, 2019. While the draft decree clarifies certain items, several questions remain unresolved. Comments can be made by August 10, 2023.  

Observation: The draft decree is subject to comments and potential changes. Multinational companies with German subsidiaries should monitor the legislative process and analyze the impact of the draft decree on the deductibility of expenses in Germany. Businesses also should comply with the documentation requirements of the treatment of transactions under foreign law, as required by the draft decree. 

New draft guidance 

The newly issued draft is the first guidance from the German tax authorities on the anti-hybrid rules. Below are some key initial observations on the draft decree: 

• Imported hybrid mismatch rule: This rule applies even if there is no (economic) connection between the expenses of the German taxpayer and the ‘hybrid’ expenses. Hence, application of the imported hybrid mismatch rule is not limited to mere ‘back-to-back’ scenarios, and it would be required, under the current interpretation, to analyze a variety of payments between non-German entities.  

Example (based on an example in the decree): A German corporation pays interest to its affiliated foreign B Co. B Co makes royalty payments to another related foreign entity, resulting in a deduction without inclusion outcome. The interest income and royalty payment of B Co are not economically connected but are netted when determining the income of B Co. The interest payment of the German corporation would be nondeductible according to the draft decree under the imported hybrid mismatch rule.  

• Dual inclusion income for disregarded payments: The draft decree does not address whether a payment that is disregarded for US tax purposes (and therefore not taxed in the United States) may constitute dual inclusion income. 
• Non-taxation under Controlled Foreign Corporation (CFC) rules: The German anti-hybrid rules also apply if there is a non-taxation under a foreign CFC taxation, provided such non-taxation is triggered by a hybrid mismatch and the income is not taxed in any other jurisdiction. Based on this, a payment to an entity that is not taxed in its jurisdiction (e.g., because it is tax resident in a zero-tax jurisdiction) may be covered by the German anti-hybrid rules if the payment is disregarded for US tax purposes and, therefore, not subject to US Subpart F income inclusion in the hands of the US direct or indirect shareholder. The draft does not include any reference to the treatment of US global intangible low-taxed income (GILTI) for purposes of the German anti-hybrid rules. Hence, there is uncertainty whether a non-taxation for US GILTI purposes also would be deemed to give rise to a deduction without inclusion outcome. 
• Double deduction due to deduction under foreign CFC rules: A double deduction also shall arise if expenses are tax deductible for German tax purposes and for purposes of a foreign CFC tax. In such cases, the application of the dual inclusion income exception would be required. However, the explanatory notes of the law include a statement based on which a foreign CFC tax does not result in a double deduction, provided certain requirements are met. The draft decree does not refer to this statement from the explanatory notes. The draft decree also does not include any reference to the treatment of US GILTI for purposes of the German anti-hybrid rules. Hence, there is uncertainty whether a deduction for US GILTI purposes would be deemed to give rise to a double deduction. 
• Documentation requirements: The draft decree states that taxpayers must comply with the extended rules for cooperation under German law to document the treatment under foreign tax law. These rules require that documents are provided to the German tax authorities which allow the determination of the respective transaction under foreign law (such as foreign accounting documents or statements of the treatment of the transactions by foreign tax authorities). If taxpayers do not comply with these documentation requirements, the tax authorities may assume that the German anti-hybrid rules apply and expenses are not deductible.