1. What is the most significant change to your region/jurisdiction’s tax legislation or regulations in the past 12 months?
For larger businesses within Germany and most of Europe, the focus in the past 12 months was, and still is, on the implementation of the pillar two requirements – getting audit ready and getting compliance ready requires considerable efforts and ties up a lot of resources. Different implementation timelines in the various EU member states – for example, with implementation in Spain being (expected) very late in the year – adds complexity to coordination.
2. What has been the most significant impact of that change?
The introduction of pillar two has emphasised the importance of data as the pressure to automate parts of the compliance process has increased. This extends to the importance of country-by-country reporting [CbCR] data, which previously was not that high on the priority list but has become a number one priority in order to benefit from the CbCR safe harbour.
From a potential controversy perspective, many impacts are some years down the road. However, we may expect to see the following features of controversy in a pillar two world based on conversations over the last months:
In discussions with tax judges, the question of who will get to decide on the correct accounting treatment (very often: International Financial Reporting Standards treatment) is often debated. This will be a very interesting development to watch.
The divergence between the development of the OECD model rules with repeated administrative guidance and the need for local implementation legislation is expected to create a number of questions that will have to be answered by courts. At least, those parts of guidance which would be a cost for a taxpayer very likely cannot be implemented with retroactive effect in Germany and I expect similar constitutional challenges in various member states, adding to the complexity of different implementation timelines.
The various procedural interdependencies between tax provisioning, the regular tax assessments, changes to these tax assessments, and the pillar two tax assessment process will require increased attention to procedural rules, even outside controversy scenarios. But winning a year-long litigation procedure on corporate income tax or coming out of a mutual agreement procedure only to trigger a top-up tax would be a ‘hollow victory’.
3. How do you anticipate that change impacting your work and the market moving forwards?
Currently, in Germany, there is a very limited tolerance for ambiguity when it comes to tax compliance. Somewhat simplified, in the tax return process, taxpayers should present all relevant facts to the tax authorities where the interpretation of rules is unclear in order to be protected against allegations of criminal tax evasion. In that regard, there is no materiality threshold, and any potentially wilful misconduct can result in prosecution.
Now, with pillar two, materiality will become an issue for taxation, as accounting values will directly be relevant to taxation. It remains to be seen how that will impact the way tax compliance and controversy will be handled by the tax administration.
4. How has this changed the way you offer tax advice?
We are used to rules with a certain degree of complexity in the international tax field. Some parts have historically relied on intense documentation requirements, such as transfer pricing rules. Other rules do not have comparable requirements but are also complex and ambiguous, an example being anti-hybrid rules, especially when it comes to imported mismatches. We have dealt with the ambiguity by different methods but often recommended taxpayers to proactively disclose additional facts in the tax return filing; for example, on the tax treatment of intragroup payments at the recipient level when the application of the anti-hybrid rules cannot be ruled out.
Given the relative novelty and the complexity of the pillar two rules, combined with the materiality approach in accounting, dealing with ambiguity will require different approaches. Also, due to the calculation methodology and the various interactions within the pillar two rules, providing tax advice is either only indicative in nature – such as that a certain transaction is expected to reduce the effective tax rate in a given jurisdiction – or requires detailed modelling.
Then, the decision on how to approach controversy scenarios in all fields of taxation, including the decision on whether or not interim relief is sought, will always have to consider pillar two effects of win/lose scenarios. This makes controversy more complex than in the past.
5. What potential other legislative/regulatory changes are on the horizon that you think will have a big impact on your region/jurisdiction?
I am mainly talking about Germany here, as there have been two working groups of tax experts in Germany that have been set up by the German Ministry of Finance with the task to present ideas for the simplification of the German tax system, both for individuals as well as for businesses. The working groups delivered their final reports to the Ministry of Finance in late summer [2024] and both reports have been widely discussed in academia and within the tax community. Also, both reports have been viewed as non-partisan, which increases the likelihood that some aspects of these reports will be implemented by the new government after the snap elections in Germany in early 2025. Some aspects of these suggestions are coherent with developments at EU level of ‘decluttering’.
6. What are the potential outcomes that might occur if those changes are implemented?
The recommendations of the group of specialists include a variety of suggested changes to the German tax system.
For businesses, some of the more relevant changes would include a check-the-box election to be taxed as a corporation or a pass-through entity, more-generous loss relief rules (e.g., extended carry-back of losses), closer alignment between German local GAAP [generally accepted accounting principles] and tax GAAP, and a reform of partnership taxation rules to bring these in line with international principles. For corporate reorganisations with the carry-over of book values, the proposals would reduce the complexities of determining a branch of activity and shorten certain lock-in periods. For international taxation, the proposals urgently recommend a reduction of overlapping anti-avoidance rules and a revision of the EU ATAD [the Anti-Tax Avoidance Directive], in line with the EU efforts on decluttering.
In addition to these changes, the group of specialists also recommends specific improvements to the procedural aspects of taxation, including a better focus on high-risk cases in tax audits and decriminalisation of later amendments to tax returns; e.g., where a tax audit identifies an omission or inaccuracy in a filing without any indications for wilful misconduct. In terms of reporting requirements, the group of specialists emphasises the ‘once only’ principle.
7. Do you think that change will have a positive effect on both your practice and the wider regional/jurisdictional market?
Europe as a whole (and Germany, in particular) would benefit from a reduction in complexity and a reduction of the compliance burden for businesses and individuals. Most of the suggestions of the group of specialists go in a good direction in this regard, without putting additional pressure on public budgets. Also, from a controversy standpoint, it makes sense to reduce complexity, which I think would allow controversy to focus on the important and fundamental aspects without being distracted by other things.
8. Are there any regulatory/legislative changes you believe should be implemented in your region/jurisdiction?
I sense a feeling of exhaustion with most people in the international tax field in terms of legislative changes. But what should really be implemented is a reduction of complexity and an alignment of various data and reporting requirements across different fields.
It probably is not realistic for certain compliance burdens to simply be abolished, but much could be achieved by harmonising data requirements, concepts, terminology, and the like. In addition to that, with the implementation of pillar two, many anti-avoidance provisions should be revisited. This includes CFC [controlled foreign corporation] rules and anti-hybrid rules. Some elements of this can be achieved at the domestic level and we have recently seen some movement in that direction from the German legislator, where the Ministry of Finance has suggested an abolishment of a special rule restricting the deduction of royalty payments made to licensors benefiting from a non-nexus-compliant preferential regime. Also, the suggestions of the group of specialists emphasise this aspect. Other elements will require European coordination, such as relaxation of CFC rules under ATAD.
This is why I look forward to some real ‘decluttering’ efforts at EU level.
9. How do you believe those changes would help improve the tax landscape in your market?
For many businesses within Germany (and Europe), compliance costs have increased over time, and the complexity of tax rules is infamous. For example, monitoring DAC6 reporting requirements can be a costly exercise even if no, or only very few, arrangements need to be notified. The benefit of the reporting requirement for the legislators remains unclear. Still, there was a discussion on extending mandatory disclosure rules to domestic arrangements in Germany, which would have further increased compliance costs.
I expect a lot of pressure on public budgets across the EU over the next years, which will make rate reductions and other tax relief measures a difficult policy choice. However, helping companies manage their compliance burdens more efficiently by relieving them of redundant reporting requirements and by abolishing certain anti-avoidance rules that are no longer needed can also be a pro-growth tax policy that does not decrease tax revenues.
10. How are issues surrounding the taxation of the digital economy affecting your work?
In line with the change in terminology at the OECD, I would say it is not only the taxation of the digital economy but the taxation of the digitised economy that has changed the work. Maybe more changes have resulted from the digitisation of the overall taxation process.
Of course, there are certain rules applicable only to the digital economy, such as DSTs [digital services taxes] in some countries. However, the more fundamental change I see is the data-driven compliance and tax audit process. This is not a ‘big bang’ change but has gradually evolved over time. In addition to that, new questions like the importance of data in a value chain need to be answered. Often, when a new question comes up, it is for taxpayers to provide the initial responses, with tax auditors and eventually tax judges reviewing the answer, sometimes with hindsight.
11. How would you describe the tax authorities’ approach in your region/jurisdiction?
The regular assessment process in Germany postpones scrutiny of tax returns to a later tax audit. Within the audit, there are usually extensive requests for information and documentation, most notably in the area of transfer pricing.
One aspect that makes the audit environment sometimes challenging is the criminalisation of mere errors or omissions. This is often driven by pressure on tax auditors to refer certain cases to criminal tax investigators, as they sometimes fear being challenged themselves under allegations of a failure to enforce tax laws appropriately.
Absent these cases, the approach of tax auditors in Germany is typically constructive and professional. As a general rule, disagreement on the technical interpretation of a rule does not negatively impact the relationship with the tax authorities if an open discussion results in an agreement to disagree. We recommend considering potential litigation as a valid option in any tax audit strategy. Not all disagreements in a tax audit are suitable for litigation, but having a clear view of those disagreements where litigation is an option is helpful even if an overall settlement is being discussed. Also, in many cases, certain preparatory steps can be undertaken in the audit process on cases that may go into litigation in order to make the actual litigation process more efficient. Finally, where a disagreement in a transfer pricing issue cannot be resolved in the tax audit and is transferred to a mutual agreement or arbitration procedure, tax authorities tend to be constructive in the process.
Agreeing on a route to litigation or arbitration with the tax authorities can help to resolve disputes quickly, as focus can be on the material aspects of a dispute rather than procedural complexities, which can involve choosing the right year for litigation or the right administrative act to appeal, and agreement on certain facts prior to the litigation phase.
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