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German parliament adopts new legislation for transfer pricing documentation 2017 Issue 3 German Tax & Legal Quarterly 3|17 With the publication of its final report on BEPS Action 13 in 2015, the OECD recommends a Master File and Local File concept for transfer pricing documentation. In order to implement these recommendations, the German General Tax Code was amended in December 2016. Now, the respective executive order law (“GAufzV”) has been revised accordingly. The new law is effective immediately with a direct binding impact on the taxpayer and is applicable for financial years starting after 31 December 2016. The amendments to the German documentation requirements primarily correspond to the OECD guidance in Chapter V of the OECD’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017, which outlines the standardized two-tier structure consisting of Master and Local File. Content 02 Legislation 06 German tax authorities 07 German court decisions 12 EU law 14 Spotlight 15 EY publications and events Some interesting points are as follows: Information which is used for the setting of transfer prices needs to be documented in the Local File. In case of benchmarking studies, comprehensive documentation of the search process is required. In case the profit split method is applied, the description of the value chain analysis will become more challenging. If taxpayers quantify the functions performed, risks assumed and key assets used in transactions, each party to the business transaction needs to be able to reliably quantify those allocations. If taxpayers are required to prepare a Master File under German law, items to be documented are in accordance with OECD recommendations. Continued on page 2

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Page 1: German parliament adopts new legislation for … · German parliament adopts new legislation for transfer pricing documentation 2017 Issue 3 German Tax & Legal Quarterly 3|17 With

German parliament adopts new legislation for transfer pricing documentation

2017 Issue 3

German Tax & Legal Quarterly 3|17

With the publication of its final report on BEPS Action 13 in 2015, the OECD recommends a Master File and Local File concept for transfer pricing documentation. In order to implement these recommendations, the German General Tax Code was amended in December 2016. Now, the respective executive order law (“GAufzV”) has been revised accordingly. The new law is effective immediately with a direct binding impact on the taxpayer and is applicable for financial years starting after 31 December 2016.

The amendments to the German documentation requirements primarily correspond to the OECD guidance in Chapter V of the OECD’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017, which outlines the standardized two-tier structure consisting of Master and Local File.

Content

02 Legislation

06 German tax authorities

07 German court decisions

12 EU law

14 Spotlight

15 EY publications and events

Some interesting points are as follows:• Information which is used for the

setting of transfer prices needs to be documented in the Local File.

• In case of benchmarking studies, comprehensive documentation of the search process is required.

• In case the profit split method is applied, the description of the value chain analysis will become more challenging. If taxpayers quantify the functions performed, risks assumed and key assets used in transactions, each party to the business transaction needs to be able to reliably quantify those allocations.

• If taxpayers are required to prepare a Master File under German law, items to be documented are in accordance with OECD recommendations.

• Continued on page 2

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Legislation

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Continued from page 1

• Taxpayers are classified as small enterprises with relief from documentation requirements according to the above principles if in the financial year the sum of the remuneration for the supply of goods or merchandise in business transactions with related entities does not exceed EUR 6 million or where the sum of remuneration for services – other than the supply of goods or merchandise – with related parties does not exceed EUR 600,000.

• Documentation should still be prepared in German language. Upon request by the taxpayer and approval by the tax authorities, the documentation can be submitted in other languages (commonly English).

Beyond the background of the increased documentation requirements, the preparation of contemporaneous documentation is strongly recommended for all cross-border transactions, although contemporaneous documentation requirements still only exist for exceptional business transactions. This is of particular importance as the documentation must be submitted within 60 days upon receipt of the tax authority’s request (30 days for extraordinary business transactions) and penalties can be incurred if the documentation is either essentially unusable, not submitted or not submitted in a timely manner.

Furthermore, due to a stronger focus on the price setting, the taxpayer will to a greater extent have to analyze and document its internal processes. Therefore it is recommended that the taxpayer specifies a clear guideline for its price setting process or that a clear transfer pricing policy in this regard is adopted.

German parliament adopts new legislation for transfer pricing documentation

On 24 September 2017, German citizens will elect a new Federal Parliament. Whatever the outcome, any upcoming coalition’s agenda will be based on the parties’ election programs. From a business perspective, it can be noted that a comprehensive business taxation reform or a reduction of the corporate income tax rate is not on the table. Most tax politicians in Germany consider the tax environment for corporate businesses in Germany to be competitive since the first grand coalition under Chancellor Angela Merkel reduced the CIT rate to 15% in 2008 (to which trade tax needs to be added, resulting in an average tax burden of around 30%).

According to the election programs, three top tax policy priorities can be identified:

• Personal income tax reliefs (including a reduction of the solidarity surcharge) • R&D tax incentives• Continuing the fight against tax evasion and base erosion and profit shifting (BEPS)

Personal income tax reliefsOverall, tax revenues have reached new record levels over the last few years, enabling Germany to in turn significantly reduce its public debt levels. Both major parties and the Liberal Democrats are campaigning on personal income tax reliefs in their manifestos. The proposed amounts vary between EUR 10 and 30 billion per year.

For businesses, two aspects of this discussion are important. Firstly, all partnerships, which are the predominant legal form of business in Germany, are directly affected by any change of the personal income tax rates. Secondly, in the context of a personal tax relief, most parties also recommend a scaling back of the so-called solidarity surcharge, a 5.5% surcharge on the tax bill which was introduced in the 1990s to help finance the German reunification. A reduction or abolishment of the solidarity surcharge would benefit both partnerships and corporations. The exception is the Social Democrats’ approach that would likely benefit only partnerships in the first step but would later also comprise relief for corporations. • • •

How the German federal election may affect business taxation

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Germany was among the 68 participating jurisdictions that signed the OECD’s Multilateral Instrument (MLI) on 7 June 2017. The MLI is a multilateral treaty that will implement the double tax treaty (DTT) related measures of the OECD BEPS action plan in a coordinated way. German officials have now revealed details on the implementation process in Germany.

Unlike other countries, German domestic law requires a two-staged MLI implementation. In a first step, the MLI treaty itself will be ratified like any other treaty. The Federal Ministry of Finance (BMF) has announced that the related legislative process will be started before the end of the year. Consequently, the German MLI ratification can be expected in mid-2018. Accordingly, the MLI will enter into force for Germany roughly three months later (on the first day of the calendar month following the expiration of three months after the ratification).

However, due to a German MLI reservation (article 35 sec. 7 MLI), the application of the MLI provisions on specific tax agreements remains blocked until a second implementation step has been conducted. Therefore, Germany will consult with all (currently 32) MLI signatories that also wish to change their tax treaties with Germany via the MLI.

In these consultations, Germany and all other states will confirm the specific changes that the MLI will cause with respect to each covered tax agreement. Subsequently, Germany will implement these consultations into the domestic legal code. This will require several additional legislative processes to activate the MLI for each covered tax treaty. Finally, the calculation of the application date of the MLI changes will be based on the date on which Germany and the other contracting state have notified that their internal procedures have been completed. This will lead to a staggered application of the MLI to the German treaty network, depending on the progress of the consultations.

According to BMF officials, the MLI will be applicable on a first group of covered tax treaties not before 1 January 2019. The upside of this lengthy implementation process is that taxpayers can expect additional clarity on the MLI consequences. The consultation documents will officially outline how each covered tax treaty will be affected by the MLI.

Multilateral Instrument will affect German double tax treaties not before 2019

R&D tax incentivesThe majority of OECD and European Union Member States currently have some form of R&D tax incentives in place (e.g. tax credits, super-deductions or patent boxes). Germany, though a global R&D player and very generous on non-tax government R&D funding, does not. This will likely change under the next government, as almost all parties are now campaigning for the introduction of some form of R&D tax incentive. The most probable outcome will be a tax credit targeted at small and medium-sized enterprises.

Fight against tax evasion and BEPSA broad consensus exists among all parties to continue Germany’s international cooperation on the fight against BEPS and tax evasion. The next German government will therefore implement the EU’s Anti-Tax Avoidance Directives (ATAD 1 and 2) and the OECD’s Multilateral Instrument (MLI).

ConclusionGiven the stable economic development with record-low unemployment and record-high tax revenue, Germans can look forward to tax reliefs in 2018. But as the parties’ election programs clearly show, this will mainly focus on personal income taxes. Nevertheless, partnerships with individual partners will directly benefit from a reduced PIT rate and all businesses could benefit from the likely reduction of the solidarity surcharge. Furthermore, the introduction of R&D incentives could be an additional incentive for investment in Germany.

Legislation

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Legislation

On 26 June 2017, the new German Anti-Money Laundering Act (Geldwäschegesetz) entered into force. It implements the 4th EU Anti-Money Laundering Directive and is intended to prevent money laundering and terrorist financing.

Besides new provisions on meeting increased risk control demands and higher financial penalties, the Act introduces a new central electronic transparency register which stores information about the beneficial owners of all legal entities governed by private law as well as registered partnerships. These organizations have an obligation to notify the transparency register of the following details of their beneficial owner(s) and any subsequent changes:• First name and last name• Date of birth• Place of residence• Type and extent of economic interest

A beneficial owner is the natural person who owns or controls the entity. In case of companies or partnerships, a beneficial owner is a natural person who directly or indirectly holds 25% or more of the voting rights and/or of the shares in the capital in the legal entity or partnership or who exercises control in a comparable manner.

Regarding foundations/trusts with legal capacity and similar structures, the beneficial owner is• any individual who acts as trustee or trust administrator or protector;• any individual who is a member of the management board of the foundation;• any individual who is named as a beneficiary;• any group of individuals for whose benefit the assets shall be administered or distributed;• any individual who directly or indirectly exercises controlling influence on the asset or revenue

management or distribution of assets.

It is not necessary to provide the information to the transparency register if such information is available in documents and entries in public registers which can be accessed electronically.

The information to be communicated to the transparency register must be submitted by 1 October 2017. Failure to meet this obligation may result in fines of up to EUR 100,000 for simple infringements and of up to EUR 1 million in case of serious, repeated or systematic infringements. Accordingly, companies, trusts, and foundations should carefully assess their beneficial owner(s) and provide the information to the transparency register in time. Determining the beneficial owner(s) can be quite difficult, in particular in situations with indirect shareholdings or where the criterion of control is relevant, which might be triggered if vote pooling or consortium agreements are in place between the shareholders.

Introduction of new transparency register in Germany

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Foreign investors not located in the European Union who are interested in acquiring a company located in Germany or at least a 25% interest therein should be aware that the acquisition may be subject to review and prohibition by the German Federal Ministry of Economics and Energy (“the Ministry”). The provisions of the Foreign Trade Act allow such review and prohibition if the transaction endangers the public order or security of the Federal Republic of Germany, regardless of the size of the company and the sector in which the company is active. As of 18 July 2017 the respective provisions in the German Foreign Trade Ordinance have been materially tightened.

In particular, procedural rules were amended so that the Ministry now has more effective ways to review and possibly prohibit a transaction. In case the transaction is prohibited by the Ministry, relevant contracts between the parties are null and void.

Obligatory informationUnder the new law, it is not only necessary to report to the Ministry transactions possibly affecting specific industries such as manufacturing of war weapons or other military equipment or products with IT-security functions (sector-specific review). In addition, a reporting obligation for transactions in any other industry (cross-sectoral review) was introduced in case the transaction may endanger the public order or security of the Federal Republic of Germany. This is in particular relevant when so-called critical infrastructure is involved (i.e. enterprises that provide services of general interest such as water, electricity, telecommunication etc., that are highly relevant because their breakdown would pose a serious threat to public security). This duty to inform the Ministry also for cross-sectoral reviews is a significant change compared to the previous situation where the parties might have tried to “play for time” because they were not obliged to report the transaction to the Ministry and the Ministry was only allowed to assess the necessity to review the transaction within three months after the conclusion of the contract. Now, the period only starts when the Ministry has become aware of the conclusion of the transaction.

Extended inspection periodsMoreover, most of the inspection periods were materially extended. Instead of the one-month assessment period for the sector-specific review, the Ministry now has three months to decide whether or not a review is required. For granting a certificate of compliance in the course of the cross-sector review, the assessment period was doubled to now two months. If the Ministry starts the review process, the foreign investor has to provide the Ministry with the transaction documentation. Following receipt of the transaction information, there is now a subsequent four-month period (instead of only two months) in which the Ministry can determine whether the acquisition endangers the public order or security of the Federal Republic of Germany, and as a result, can prohibit the transaction with the consent of the German federal government. Additionally, during negotiations between the Ministry and the parties, the respective periods are suspended.

No workaroundsIn order to prevent workarounds, the Ministry is expressly allowed to review transactions by parties resident in the European Union when there is an indication that the parties use an abusive construction to avoid the review, e.g. creating an EU company only to acquire a company possibly subject to review.

Increased relevance of the German Foreign Trade Act for M&A transactions

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Under German case law, the waiver or forgiveness of a shareholder loan towards a corporation is deemed to be a (non-taxable) shareholder equity contribution – limited however to the valuable part of the loan receivable, i.e. the amount which a third party acquirer would pay for the loan. To the extent that the loan receivable is worth below its face value, the waiver would generally lead to a taxable gain for the subsidiary.

It had been debated for some time whether the opening of liquidation proceedings for a German subsidiary corporation which is financed with a shareholder loan can be construed to be a deemed waiver of the shareholder loan, with the above-mentioned potential negative tax consequences. The Frankfurt Higher Fiscal Authority (Oberfinanzdirektion) has now issued a circular (dated 30 June 2017), which has been agreed with the BMF and the State Finance Ministries, clarifying that the mere opening of and consent to liquidation proceedings alone does not constitute a deemed debt waiver. Only where it can be objectively assumed that the creditor will never claim back its receivable, can a waiver be assumed. This applies in a case where the subsidiary is in insolvency proceedings, too. Also the subordination of the shareholder loan should not lead to a deemed debt waiver, as long as the repayment of the loan from free property (and not just future profits) is stipulated.

Taxable debt forgiveness gain through liquidation of subsidiary?

German tax authorities

On 17 July 2017, the Federal Ministry of Finance (BMF) published a letter regarding the German tax treatment of “cum/cum transactions”, i.e. the trading of German shares around the date of dividend declaration. The German tax authorities explain the tax consequences of domestic dividend income for a non-German recipient (before enactment of sec. 36a of the Income Tax Act as of 1 January 2016) and evaluate cum/cum transactions in the light of the General Anti Abuse Rule.

The letter distinguishes between cum/cum transactions, which reduce tax leakage as a result of a definite dividend withholding tax, and structured securities lending, in which a tax deduction under the old German dividend tax exemption regime for German corporates was intended. For the latter, the BMF letter of 11 November 2016 remains valid. The tax authorities confirm that for cum/cum transactions in general a transfer of civil law and economic ownership to the borrower/purchaser takes place upon the posting of equities in the custody account of the borrower/purchaser before dividend date. This makes an individual examination of the requirements for a transfer of economic ownership except for structured securities lending obsolete. All types of cum/cum transactions which have a dividend date after 28 February 2013 and which have not yet been subject to statutes of limitation are likely to be considered as abusive if they resulted in a reduction of a withholding tax leakage.

The letter ruling in general will be applied to all open tax years. Cum/cum transactions before 1 March 2013 will – based on our understanding – not be challenged by the German tax authorities as long as the lender/seller was tax resident in the EU. For lenders/sellers from outside the EU, cum/cum transactions before that date might be challenged if such tax years are still open.

Cum/cum transactions on the basis of spot transactions shall be considered abusive without specifying limitations. Though the letter indicates that spot transactions need to be linked to a hedge transaction (forward/swap) with the same counterpart, this is not finally clear based on the wording of the letter ruling.

Furthermore, cum/cum transactions of domestic investment funds will be challenged under the same criteria. As domestic investment funds in general benefit from a relief at source regarding the withholding tax, they will now be charged with the respective withholding tax in the case of a cum/cum transaction. There shall be a secondary liability for the custody bank of the German investment fund – as the custody bank is deemed to be in a position that it could (and should) have identified the underlying transaction as a cum/cum transaction.

The legal consequences from a particular cum/cum transaction qualifying as abusive are as follows: 3/5 of the entire withholding tax of 25% (i.e. 15%) for the borrower/purchaser is neither credited nor refunded, i.e. only 10% may still be creditable/refundable. The non-creditable portion of 15% is allowed to be treated as a tax deductible expense.

Update of the German tax treatment of “cum/cum transactions”

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German court decisions

In general, capital gains derived by corporations from sales of shares in corporations are exempt from corporate income tax and trade tax. Correspondingly, capital losses derived by corporations from sales of shares are generally not deductible. In the decision 13 K 2946/14 K dated 27 April 2017, the tax court of Münster dealt with the issue of applicability of these general principles to an employee stock option scheme.

P AG, a listed German stock corporation, set up a stock option scheme for its board members, the executive management of the subordinated affiliated entities and selected executive employees. The strike price was derived from the market price of P AG’s stock prior to the grant date and amounted to EUR 9.4 per share. The options were exercised two years after the grant date, when the stock market price rose to approximately EUR 17 per share. The shares were delivered to the option holders by S GmbH, a subsidiary in a tax group with P AG. Prior to the delivery, S GmbH purchased the shares at a current stock market price of EUR 17.4 per share. S GmbH was reimbursed by other group entities for the expenses it incurred for the shares delivered to the option holders employed by these group entities. With regard to the options exercised by the own executives of S GmbH, it recognized personnel expenses amounting to EUR 8 for each delivered share. In total, 83,350 shares were delivered to the employees of S GmbH.

Whether a tax exempt capital gain or a nondeductible capital loss should be assumed in a situation where a corporation purchases and delivers its own shares to the qualifying employees was not at issue since S GmbH purchased the shares of its parent. The court noted that the tax authorities and the majority of tax professionals considered the purchase of own shares as a capital decrease, and the subsequent delivery of these own shares as a capital increase. This interpretation would leave no room to assume a capital gain or loss. Then the court went on to address the controversial issue of calculating the capital loss.

The tax authorities took the position that all non-reimbursed expenses incurred by S GmbH, which amounted to EUR 666,800 (83,350 shares x EUR 8), were to be added back at the level of P AG as the tax group parent. They argued that these expenses were in fact nondeductible capital losses from share sales. The court in principle followed this argumentation. However, it sided with the taxpayer on the argument that the incentive nature of the stock option scheme was to be taken into account. The increase of delivered shares in value between the date of exercise (EUR 17 per share) and the grant date (EUR 9.4 per share) should, according to the court, be considered additional remuneration for the work performed. Capital losses from sales of shares were only realized in the amount of EUR 33,340 (83,350 shares x EUR 0.4), because S GmbH purchased them above the exercise price.

As the Federal Tax Court (BFH) has not yet ruled on the calculation of capital losses in employee stock option schemes, the tax court of Münster allowed appeal. The final decision is now pending before the BFH (I R 43/17).

While this case dealt with a purely domestic situation, it should have broader relevance and impact the taxation of similarly structured stock option schemes involving non-German parented groups.

Two German sister corporations belonging to a foreign (EU) group were acting as holding companies of two separate business divisions. Both corporations were fully controlled by the same non-resident ultimate corporate shareholder. Each of these holding companies was a parent in a fiscal unity with its German subsidiaries. With the intent to diversify commercial risks of two cyclic business divisions, both sister companies entered into an agreement, according to which they committed themselves to consolidate the profits or losses recognized in their statutory accounts and to reallocate the aggregate amount to the parties of the agreement at a ratio of 1:1. The agreement was concluded for an indefinite period of time. It was not ordinarily terminable during the first 4 years, registered in the commercial register and properly executed. Payments made were expensed and payments received were recognized as revenues. The tax authorities reclassified the payments made and received pursuant to the agreement into deemed dividends and informal capital contributions. • • •

Calculation of nondeductible capital losses in employee stock option schemes

Can a profit sharing agreement be deemed to constitute a partnership engaged in a trade or business?

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German court decisions

The tax court of first instance followed the tax authorities’ view. The taxpayer appealed to the Federal Tax Court (BFH), arguing that the payments made were to be treated as expenses on the basis of the freedoms guaranteed by the European Union law. The BFH (I R 35/14) now dismissed the taxpayer’s argument. According to the BFH, the German lawmakers were not obliged to recognize a tax group among a group of same-tier companies under common control. The ultimate corporate shareholder could not successfully claim the infringement of its freedom of establishment, because in a purely domestic case, a parent company would not be able to achieve a tax-effective consolidation of profits and losses among its sister companies, either.

Notwithstanding the above, the appeal was partially successful. The contested decision was annulled and the case was remitted to the first instance for a further hearing and a new decision. According to the BFH, the first instance should have clarified whether the parties of the profit sharing agreement had established a partnership engaged in a trade or business. It noted that neither a public disclosure of the arrangement nor the existence of legal title to property were to be considered necessary prerequisites of such a partnership. With reference to a decision rendered in the 1930s, where the Reich Tax Court denied a trading partnership among the parties of a profit sharing agreement, the BFH pointed out that the case law had significantly changed since then. The BFH acknowledged that the allocation of profits and losses in the case at hand might be influenced by the common ultimate shareholder. Payments which violated the arm’s length principle were to be reclassified into deemed dividends and informal capital contributions.

The BFH’s decision currently impacts only a limited number of taxpayers. Profit sharing agreements have rarely been implemented so far. However, the further process of this case may nonetheless result in important findings regarding the definition of what constitutes a partnership, and what the consequences of such profit pools can be in a group context.

In two decisions rendered on 16 March 2017 (IV R 31/14) and on 30 March 2017 (IV R 11/15), the German Federal Tax Court (BFH) further clarified its view on the rules applying to the reorganization of a partnership.

In the case IV R 11/15, the BFH extended its new line of case law applying to withdrawals of partners from a partnership for which the exiting partner receives a portion of the assets of the partnership, while the remaining partners continue to run the partnership (“Sachwertabfindung”). While in the past such transfers were treated under the standard rules for transfers of assets between a partner and the partnership (sec. 6 para 5 German ITA), the BFH reversed in 2015 settled case law by stating that where a branch of activity is transferred to the exiting partner, the rules covering partnership divisions (“Realteilung”) shall cover such a reorganization (BFH, 17 September 2015, III R 49/13). Both provisions provide for a tax neutral transfer of assets, however, prerequisites for tax neutrality (e.g. with respect to liabilities transferred to partners as part of the transaction, minimum holding periods) are less strict under the partnership reorganization rule. Further, in case of transfers to corporate partners, the rules on partnership reorganizations provide for more flexibility where a branch of activity or a partnership interest is transferred. By way of a circular, the German Ministry of Finance (BMF) confirmed that view (see circular dated 21 December 2016) and extended the applicability of that provision to transfers of partnership interests in lower-tier partnerships, but explicitly stated that single-asset transfers shall not benefit from the revised treatment of partnership exits against the partnership’s assets. The BFH now held in its decision dated 30 March 2017 – contrary to the BMF circular – that the partnership reorganization principles apply to single asset transfers as well. The question whether in specific situations the transferred assets qualify as a branch of activity or not should now be less relevant, as in each case the rule on partnership reorganizations should apply. Nevertheless, as the partnership reorganization rule itself distinguishes between transfers of branches of activities and partnership interests on the one hand and single assets on the other hand (e.g. with respect to applicable minimum holding requirements), the qualification of the transferred assets still matters.

Furthermore, in its decision IV R 31/14, the BFH held that in case a partnership is dissolved, all its assets are transferred to its partners and at least one of the partners continues to operate a business with the assets received, such dissolution shall be treated as a partnership reorganization as well. In the court proceedings, the tax authorities had taken the view that one partner sold his interest to the other partner, thus triggering capital gains taxation at level of that partner. In the BFH’s view, in such a case a capital gain could be triggered only at the level of the partnership and only to the extent the prerequisites for tax neutrality under the partnership reorganization principles are not met.

Both decisions now provide additional legal certainty with regard to the rules applicable to partnership reorganizations, both for cases where the partnership continues to exist and where the partnership as such is dissolved as a result of the exit of the partner(s) and provide for more flexibility with respect to the consideration granted to the exiting partner.

German Federal Tax Court facilitates reorganizations of partnerships

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German court decisions

Under the German loss-trafficking rule, tax loss carryforwards are forfeited proportionally if, within a five-year period, more than 25% of the shares of a loss-making entity are directly or indirectly transferred to a single new shareholder or a group of shareholders. If, within a five-year period, more than 50% of the shares are transferred, the entire loss carryforward is forfeited. To prevent abuse of the rule, the rule includes a measure under which investors with common interests and acting together are deemed to be one acquirer for purposes of the rule.

In the case at hand (I R 30/15), the German Federal Tax Court (BFH) had to decide when a group of investors are acting together in common interest. A German limited liability company (X-GmbH) was held by another limited liability company, A-GmbH, who had a share of 53%, and four other shareholders, each holding 10.4%. A-GmbH sold its shares to three of the other shareholders, so that each of them acquired indirectly at the same time 17.7% of the shares in X-GmbH. The tax office argued that the three acquirers are a group of investors with similar interests within the meaning of the German loss-trafficking rule, with the result that the X-GmbH losses are no longer deductible.

The BFH ruled that the three acquirers do not constitute a group of investors with similar interests, since there were no common interests of the three acquirers. Contrary to the view of the tax office, it is not sufficient if several investors merely pursue any common purpose. Moreover, the mere possibility of joint control on the basis of aggregated share ratios is not a sufficient indication of common interests. The group of investors would need to co-operate in order to achieve a dominant, uniform influence on the target. There were no binding governance agreements which would be binding on a uniform formation of the will of the group of acquirers, such as voting agreements, consortium agreements or other binding agreements. Such an agreement must be compulsory at the time of acquisition. The BFH concluded that the obligation to furnish proof of the existence of such agreements is incumbent upon the tax office.

In two decisions (10 K 106/13 F and 10 K 3435/13 F) rendered on 28 April 2017, the tax court of Münster ruled on the preconditions for the income derived through a London-based private equity (PE) fund to become subject to domestic taxation. The plaintiffs were German residents with the legal status of limited partners. The fund acquired distressed companies with an intention to turn them around and resell at profit. In total, it made ten investments which were gradually disposed of. Generally, majority interests were acquired. Representatives of the PE fund were appointed to the management or supervisory boards of the portfolio companies. To a large extent, the acquisitions were financed with debt and high-yield bonds. Current earnings were allocated entirely to the investment management company. Limited partners were able to make their profits only from disposing of portfolio investments. The PE fund was dissolved in 2011. Her Majesty’s Revenue and Customs (HMRC) responded to the information request of the German Federal Tax Office (BZSt) that no tax documents of the PE fund had been found and concluded that the fund had not filed any tax returns. At issue were the years 1997 and 1998 in the one case and the years 1999 through 2001 in the other case.

The plaintiffs asserted that they carried on a trade or business through a permanent establishment in London. Business profits of this permanent establishment were to be exempted from taxation in Germany under the Germany-UK Double Tax Treaty (DTT) 1964. According to the tax authorities, these profits should be subject to tax in Germany, because they were derived through an asset managing, i.e. not trading, partnership. The tax authorities further contended that the earnings were to be taxed in Germany even if they qualified as “business profits” pursuant to sec. 50d para. 9 sentence 1 no. 1 EStG (German Income Tax Act), stipulating that a foreign-sourced item of income may not be exempted in the hands of a German resident if the other Contracting State exempts it from taxation due to a mismatch in the application of treaty provisions. • • •

Federal Tax Court decides on forfeiture of losses in case of ownership change by a controlled group

A mismatch of treaty provisions shall not be assumed if the domestic law of the other Contracting State provides for non-taxation

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German court decisions

The court first held that the PE fund conducted a trade or business. In reaching this conclusion, the court analyzed the structure of financing, the assignment of earnings from the alienation of the investments as well as the influence that the investment management company exerted on the portfolio companies. Taxing rights on the business profits derived through the permanent establishment in London were to be allocated to the UK. The court further denied the applicability of the treaty-overriding clause of sec. 50d para. 9 sentence 1 no. 1 EStG to the case at issue. If the activities of the PE fund had been qualified as asset management, the plaintiffs’ earnings would have not been subject to taxation in the UK. Under this assumption, the court noted that UK domestic law did not provide for taxation of the capital gains derived by non-residents from alienation of assets which were not forming the business property of a domestic permanent establishment. If the HMRC had qualified the earnings in question as business profits, they would have been subject to taxation in the UK. Under this assumption the court surmised that no tax was imposed by the British tax authorities due to the lack of knowledge of the circumstances of the case. None of these assumptions indicated a mismatch in the application of the DTT provisions. Such a mismatch would have existed only if HMRC had exempted these earnings from taxation based on the assumption that Germany should have the taxation right on them.

The court allowed no appeal to the Federal Tax Court (BFH), probably because a similar fact pattern had already been decided upon by the BFH in 2011. It should be noted that under newer German tax treaties and due to changes in domestic law, the tax result of a similar fact pattern would likely be different, as Germany usually exempts foreign income only if this was effectively taxed abroad.

According to German case law, hidden employee monitoring measures are typically permissible only if they are based on the specific serious suspicion that an employee has committed a severe breach of contractual duty or a crime and are subject to a balancing of interests. For example, video surveillance of a company’s premises must take into account the privacy rights of the employee. Therefore, full surveillance of individuals is not permitted. In addition, covert monitoring measures are generally prohibited as a matter of principle. This also applies to the monitoring of a company’s IT infrastructure. Employers should be aware of the basic principles of the applicable data protection law and apply diligence when conducting monitoring measures – to ensure compliance with the law, but also to avoid negative media coverage as several cases involving employee monitoring received nationwide media attention in Germany.

German case law holds that monitoring by means of video surveillance is generally allowed as long as the principle of proportionality is respected. This requires the employer to assess, prior to implementation, which areas should be monitored; whether the monitoring is appropriate both in terms of how it is carried out and its duration; and how this might affect the privacy rights of employees. It is also important to take into account whether monitoring is necessary as a result of specific past incidents or whether it is implemented as a generic policy.

Openly communicated monitoring measures can be permitted if required to protect legitimate interests of the employer, depending on the scope and circumstances as well as on available alternatives (e.g., for fleet management purposes). Beyond the strict requirements from a data protection perspective, introducing employee monitoring measures also triggers works council co-determination rights in Germany.

The German Federal Labor Court (Bundesarbeitsgericht, BAG) decided on 27 July 2017 that the hidden use of key logger software for the purpose of employee monitoring violates data protection law, and that findings obtained by such monitoring are barred as evidence in court proceedings (BAG 2 AZR 681/16). According to the BAG, hidden use of key logger software in an employment relationship requires a specific justifying suspicion that the specific employee has committed a crime or another serious breach of duty.

Key logger software captures any keyboard input on the computer on which the software is installed. If used by employers, key logger software allows the comprehensive monitoring of an employee’s activities on a business computer, including any use for private purposes. The key logger software used in the case at hand also frequently created screenshots of the computer screen at regular intervals. In the case at hand, the key logger recordings revealed that the employee had spent substantial working time using the computer for private purposes. Based on this, the employer dismissed the employee for cause without notice. The BAG ruled that key logger recordings created without a specific suspicion against the employee concerned cannot be used as valid evidence in court proceedings.

The BAG’s position on key logger software is in line with the recent opinion of the Article 29 Working Party on data processing at work (WP 249, adopted on 8 June 2017). In this opinion, the Working Party stated that logging employees’ keystrokes, mouse movements or capturing screenshots in remote working scenarios is highly unlikely to be justified based on a legitimate interest of the employer. According to the Article 29 Working Party, using such monitoring technologies is typically disproportionate in order to address the risk of unauthorized access, loss or destruction of information.

Legal boundaries of employee monitoring in Germany

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German court decisions

The German Federal Tax Court (BFH) has asked the European Court of Justice (ECJ) to rule in two cases on the invoice requirements which allow the deduction of input VAT.

In order to deduct input VAT, a business must hold an invoice that complies with certain legal minimum information requirements. The invoice must show, among other things, the full name and address of the supplying business as well as of the recipient. In this regard, the BFH has referred two cases to the ECJ and is asking whether a proper invoice needs to state the address where the taxable person carries out its economic activity, or whether it is sufficient that the latter can simply be contacted there (e.g. post box address). The second issue raised is whether and under what procedures a taxable person may argue that he was in good faith with regard to the formal correctness of the invoices if the authority finds out that the issuer of those invoices is involved in a fraud or abuse case, in order to deduct input VAT. These cases are currently pending before the ECJ as joined cases C 374/16 Geissel and C 375/16 Butin. The German tax authorities denied the input VAT deduction of the recipient on the grounds that the invoices were formally not correct as they did not show a proper address of the supplier.

On 5 July 2017, the advocate general of the ECJ, Nils Wahl, expressed his opinion on these joint cases. In summary, the advocate general suggests that the formalistic approach of the tax authorities should be rejected. In his opinion, any type of address, including post box addresses, is sufficient provided that the person can indeed be contacted under that address. Therefore, it should not be necessary to show the place of the economic activity as the address on the invoice in order to identify the issuer of the invoice.

It remains to be seen whether and in how far the ECJ will follow the advocate general.

Following a referral from the German Federal Tax Court (BFH), the European Court of Justice (ECJ) is currently dealing in the case C-462/16 Boehringer Ingelheim with the VAT treatment of statutory rebates granted by a drug manufacturer to health insurance funds. In Germany such discounts must compulsorily be granted by the pharmaceutical manufacturers to the benefit of the health insurances pursuant to a framework agreement concluded with the National Association of Public Health Insurance Funds. For VAT purposes, the German tax authorities allow a VAT reduction corresponding to the amounts granted to public health insurances, whereas they have denied such VAT reduction for the amounts payable to private health insurance funds. In particular, the ECJ must outline now whether the principles already elaborated in case C-317/94 Elida Gibbs apply also in the case of private insurance rebates. This would mean that the rebates reduce the VAT liability of the drug manufacturer even though they are not paid directly to the customer but to customers further down in the supply chain. Furthermore, the ECJ must also assess whether a different treatment of rebates granted to public health insurance funds vs. rebates granted to private health insurance funds contradicts the principle of equal treatment.

On 11 July 2017, the ECJ published the opinion of the advocate general with regard to this case. In summary, the advocate general suggests that the private health insurance rebates allow a reduction of the VAT included in the amounts paid – i.e. a positive result for the claimant. The opinion reads as follows: A pharmaceutical company which supplies medicinal products is entitled to a reduction of the taxable amount under Article 90 of the EU-VAT-Directive 2006/112/EC where• it supplies those medicinal products to pharmacies via wholesalers,• the pharmacies supply those products, subject to tax, to persons with private health insurance,• the insurer of the medical expense insurance (the private health insurance company) reimburses the

persons insured by it for the costs of purchasing the medicinal products, and• the pharmaceutical company is required to pay a ‘discount’ to the private health insurance company

pursuant to a statutory provision.

Statistically, in the majority of cases the ECJ follows the opinion of the advocate general. Pharmaceutical companies will closely observe the further development of the case (the decision of the ECJ is expected in 2017) and can hope for a successful result.

Address of the supplier as formal invoice requirement for input VAT deduction

VAT refunds on statutory rebates of pharmaceutical manufacturers

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EU law

On 30 May 2017, the German Federal Tax Court (BFH) requested a preliminary ruling from the European Court of Justice (ECJ) because of remaining doubts regarding the compliance of the intragroup restructuring exemption for real estate transfer tax (RETT) purposes introduced as of the year 2010 with Article 107 (1) of the Treaty of the Functioning of the EU (TFEU). This case is one of four cases pending at the BFH where the court raises the question of whether the provision falls within the scope of state aid rules.

According to Article 107 (1) TFEU, any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favoring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the internal market, i.e., it qualifies as unlawful state aid. It is settled case law that the notion of aid can encompass not only positive benefits such as subsidies or loans, but also interventions which mitigate charges in various forms, such as tax advantages. The law only prohibits aid favoring certain undertakings or the production of certain goods, i.e. selective aid. In order to determine whether a tax measure is selective, it must be examined whether in the context of a particular legal tax system that measure constitutes an advantage for certain undertakings in comparison with others which are in a comparable legal and factual situation. State measures which differentiate between undertakings and are therefore prima facie selective may only be justified where that differentiation results from the nature or the general scheme of the tax system of which they form part.

In the case referred to the ECJ, the German tax authorities denied the application of the intragroup restructuring exemption for a merger of a subsidiary holding real estate into its ultimate parent company with reference to the wording of the provision. The exemption from RETT requires that the parent company must hold the shares of a company owning real estate after a transaction subject to RETT for a period of at least five years. In the case at hand this requirement could not be fulfilled because of the merger which resulted in the dissolution of the merged company.

The BFH intended not to follow the interpretation of the tax administration but referred the matter to the ECJ because of remaining concerns regarding the qualification of the intragroup restructuring exemption as state aid. However, the court pointed out that in its opinion the provision is not selective because it can in principle be applied by all undertakings. In addition, according to the BFH, the exemption is justified in cases of intragroup restructurings where the real estate remains in the ownership of the group.

For taxpayers which took advantage of the intragroup restructuring exemption in the past the qualification as state aid could raise a significant financial risk. A Member State granting state aid without having obtained the approval of the EU Commission as in the case at hand violates EU law and can be obliged to recover the state aid granted to the taxpayer with retroactive effect of up to ten years. Even if there are significant doubts that the intergroup restructuring exempting can be qualified as state aid, taxpayers must take the legal uncertainty until the decision of the ECJ into consideration in case of restructurings which are only RETT exempt under the application of the intragroup restructuring privilege. It is expected that the decision of the ECJ will also give more guidance regarding the question under which requirements a tax provision can be qualified as a selective advantage in the meaning of state aid rules.

Exemption from real estate transfer tax for certain intragroup restructurings referred to the European Court of Justice because of a potential violation of EU State Aid rules

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EU law

By order dated 17 May 2017, the local tax court of Cologne referred the German anti-treaty shopping rule (sec. 50d para 3 German Income Tax Act, EStG) to the European Court of Justice (ECJ) to determine whether the rule complies with the conditions Union Law sets forth for national anti-abuse rules both under the freedom of establishment (Art. 49 TFEU) and under the Parent-Subsidiaries Directive (Directive 2011/96/EU of 30 November 2011). The case is pending before the ECJ with the case reference C-440/17. The referral is the third referral to the ECJ dealing with the German anti-treaty shopping rule. While the former referrals (C-504/16, Deister Holding and C-616/16, Juhler Holding) dealt with the anti-treaty shopping rule in its version as applicable until 31 December 2011, the recent referral deals with the new version of the rule applicable as of 1 January 2012. The new rule states that the benefits of a double tax treaty (DTT) or the Parent Subsidiaries Directive are not granted with respect to dividend withholding tax insofar as (i) the shareholders of the receiving entity are not entitled to the benefits the direct recipient is entitled to under the DTT or the Parent-Subsidiaries Directive had they received the income directly, (ii) the gross receipts of the foreign entity in the relevant year do not derive from the entity’s genuine own business activities and (iii) there are no economic or other relevant reasons for the interposition of the foreign entity (which needs to be established at the level of the receiving entity and not from a group’s perspective) or the foreign company has sufficient substance to engage in its trade or business and it participates in general commerce.

In the case at hand, a German company held its lower-tier German subsidiary via a Dutch holding entity. Beyond its holding activity, the intermediate Dutch entity provided intercompany financing and carried out procurement activities for other group entities. The Dutch holding had an office and employed sufficient personnel to operate its business. The distributing German subsidiary of the Dutch holding withheld statutory German dividend withholding tax and its Dutch parent applied for a refund. The German Federal Tax Office denied that application due to the fact (i) that the German ultimate shareholder would not have been entitled to obtain a refund had that entity held the German distributing company directly (rather, the withholding tax would have been credited at level of the shareholder), (ii) that only the (small) income from its procumbent activity qualifies as income from genuine own business activity and (iii) there is no valid economic or other reason for interposing the Dutch holding. In such a case, the existing substance at the level of the Dutch holding does not result in the non-applicability of sec. 50d para 3 EStG. The court now seeks guidance whether the application of the anti-treaty shopping rule in such a case goes beyond the limits which Union Law sets for national anti-abuse rules. In this regard, the referring court expressed doubts in particular with respect to the fact that the interposition of the foreign holding company did not result in tax savings for the group and the fact that the possibility to prove substance in the form of premises and personnel at the level of the holding was not sufficient to render the anti-treaty-shopping rule inapplicable. In the court’s view it could further be doubtful from a Union Law perspective whether, by ignoring reasons for interposing the foreign holding from a group’s perspective, the rule is still proportionate with respect to its aim to target abusive schemes and whether other income which is not derived through genuine own business activity leads to a reduction of the portion of the withholding tax refund.

Foreign shareholders of German entities suffering from German withholding tax should carefully analyze their situation. In particular in cases where sufficient substance exists at the level of the shareholder, it should be considered to apply for an exemption certificate which entitles the distributing entity to apply a reduced (or zero) withholding tax rate for future dividend distributions.

Revised German anti-treaty shopping rule under scrutiny of the ECJ

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Spotlight

Companies are legally obliged to file correct tax returns in due time. However, mistakes in the filed tax returns and notifications might occur, despite reasonable diligence in the tax department of the company. Companies face the challenge to organize and document the tax relevant circumstances properly in order to be considered tax compliant.

In May 2016, the German Federal Ministry of Finance (BMF) issued an administrative directive in which a Tax Control Framework was honored first time as an element of tax compliance potentially preventing German taxpayers from being pursued for tax fraud. The BMF stated: „If internal Tax Control Frameworks are in place, this may be regarded as evidence that the taxpayer acted neither intentionally nor with (gross) negligence”. The directive responded to discussions whether a mere notification and correction of incorrect tax returns are sufficient to avoid potential tax criminal risks or whether the correction must comply with the formal requirements of a voluntary disclosure after respective regulations were severely tightened in 2011 and 2015.

In June 2017, the Institute of Public Auditors in Germany (Institut der Wirtschaftsprüfer – IDW) concluded on a practice statement with respect to the requirements of a Tax Control Framework addressing the purpose, design and audit of such a framework based on the existing IDW Auditing Standard 980 (IDW PS 980). Following the practice statement, a Tax Control Framework would usually comprise a group tax policy, specific tax guidelines, a risk and control matrix as well as a process documentation. As the implementation of a Tax Control Framework based on IDW PS 980 has become a means to effectively protect individuals from tax criminal risks, many German taxpayers are currently in the process of aligning their internal control frameworks and tax functions to the recent developments by drafting or updating the above elements of their frameworks.

Taxpayers who are able to prove that an adequate Tax Control Framework has been implemented will be able to substantially mitigate legal risks resulting from tax audits. Furthermore, the risk of tax criminal measures and administrative penalties after filing corrected tax returns will be significantly reduced.

The potential effects of Brexit remain uncertain and the actual extent of the changes resulting from the UK leaving the EU depends largely on the negotiations between the EU and the UK, which are yet to be conducted.

However, it is certain that Brexit will lead to material changes for companies in cross-border structures. For example, due to the European freedom of establishment, UK limited liability companies (Ltd.) or limited liability partnerships (LLP) which have their seat of administration in Germany (these are still about 9,000 companies) are currently permissible in Germany although they do not fall under the German company laws.

In case of a “hard” Brexit, British companies should no longer benefit from this freedom of establishment. As a consequence, since exclusively German company law will apply to all companies from non-EU countries but with their seat of administration in Germany, a UK Ltd. may be qualified as a German private company (Gesellschaft bürgerlichen Rechts) and instead of the limited liability for shareholders and managing directors UK company law provides for, German company law states unlimited liability in such cases.

Accordingly, it might be recommendable to avoid this uncertainty and possible negative legal consequences by taking corporate law measures already at this time. For example, a UK Ltd. can be merged into a German corporation by way of a cross-border merger. Alternatively, it is also possible to carry out a cross-border change of legal form on the basis of the VALE decision of the European Court of Justice. Another solution might be to transfer the business of the UK Ltd. to a German entity by way of an asset deal; however, the tax implications should be investigated carefully before carrying out such transactions.

Besides cost aspects, it has to be noted that all of the measures mentioned above may take some time. For example, completing a cross-border merger might take up to six months due to the statutory periods to be observed and the potential involvement of works councils. Accordingly, if any such measure is considered, companies should not wait too long, in particular since certain corporate measures will no longer be available after Brexit (e.g. the cross-border merger according to the German Transformation Act can only be used by companies of the EU member states).

Tax Control Framework – Institute of Public Auditors in Germany concludes on practice statement

Quo vadis Limited?

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Worldwide Personal Tax and Immigration Guide2016–17

EY German Tax & Legal Quarterly 3.17 | 15

EY publications and events

Please find pdf-versions of the EY publications listed below by clicking on the related picture. The free EY Global Tax Guides app provides access to our series of global tax guides. www.ey.com/GL/en/Services/Tax/Global-tax-guide-app

Upcoming EY events

Worldwide corporate tax guide (2017 edition) The worldwide corporate tax guide summarizes the corporate tax systems in 166 jurisdictions.

Worldwide personal tax and immigration guide (2016-17 edition)The worldwide personal tax guide summarizes personal tax systems and immigration rules in more than 160 jurisdictions.

Worldwide VAT, GST and sales tax guide (2017 edition) This guide summarizes the value-added tax, goods and services tax and sales tax systems in 122 jurisdictions.

Munich International Tax Seminar (MITS)

EY Real Estate Funds Breakfast

Year-end tax conferences

• Plenaries and workshop presentations by international EY partners on current international tax and TP topics of interest to tax directors/international tax managers

• Optional visit of the Oktoberfest for the 2017 opening ceremony, as well as lunch/afternoon entertainment

Language: EnglishEvent contact: Aleksandra Blachowska, [email protected] and location: 15—16 September 2017 in Munich

• Update on current tax, governance, procedural and transaction-related topics regarding real estate funds and their AIFMs• Focus on

• Tax structuring of real estate investments in Switzerland, Austria and Italy• Sale of the German real estate portfolio of an open special AIF from a tax perspective• Update on German investment tax law (InvStG) and real estate transfer tax law (GrErwStG)

Language: GermanEvent contact: Gabriela Grözinger, [email protected] and location:

12 September 2017 Munich 20 September 2017 Eschborn/Frankfurt 25 September 2017 Hamburg

• Review and outlook on developments in German tax law: New legislation, important tax court decisions and views of the German tax authorities

Language: German Event contact: Steven Hughes, [email protected] Date and location:

21 November 2017 Berlin 02 November 2017 Bremen 27 November 2017 Cologne 23 November 2017 Dortmund 21 November 2017 Düsseldorf 05 December 2017 Eschborn/Frankfurt 21 November 2017 Freiburg 29 November 2017 Hamburg 29 November 2017 Hanover

01 December 2017 Jena 27 November 2017 Leipzig 06 December 2017 Mannheim 28 November 2017 Munich 14 November 2017 Nuremberg 27 November 2017 Ravensburg 28 November 2017 Saarbrücken 05 December 2017 Stuttgart 23 November 2017 Villingen-Schwenningen

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EY German contactsCities in alphabetical order

Hamburg

Bremen

Hannover

DortmundEssenDüsseldorf

Cologne

Eschborn/Frankfurt am Main

Mannheim

Heilbronn

Stuttgart

Saarbrücken

Freiburg Villingen-Schwenningen

Ravensburg

Munich

Nuremberg

Berlin

Leipzig

Dresden Erfurt

Friedrichstraße 14010117 BerlinPhone +49 30 25471 0Telefax +49 30 25471 550

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Mergenthalerallee 3–565760 Eschborn/Frankfurt/M.Phone +49 6196 996 0Telefax +49 6196 996 550

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Titotstraße 874072 HeilbronnPhone +49 7131 9391 0Telefax +49 7131 9391 550

Börsenplatz 150667 ColognePhone +49 221 2779 0Telefax +49 221 2779 550

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Arnulfstraße 5980636 MunichPhone +49 89 14331 0Telefax +49 89 14331 17225

Am Tullnaupark 890402 NurembergPhone +49 911 3958 0Telefax +49 911 3958 550

Gartenstraße 8688212 RavensburgPhone +49 751 3551 0Telefax +49 751 3551 550

Heinrich-Böcking-Straße 6–866121 SaarbrückenPhone +49 681 2104 0Telefax +49 681 2104 42650

Flughafenstraße 61 70629 Stuttgart Phone +49 711 9881 0Telefax +49 711 9881 550

Max-Planck-Straße 1178052 Villingen-SchwenningenPhone +49 7721 801 0Telefax +49 7721 801 550

EY German Tax Desks

LondonPhone +44 20 7951 4034

New YorkPhone +1 212 773 8265

ShanghaiPhone +86 21 2228 6824

TokyoPhone +81 3 3506 2238

EY German Tax & Legal Quarterly 3.17 | 16

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EY | Assurance | Tax | Transactions | Advisory

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