Germany spreads its tax-taking tentacles into Luxembourg

Various German investors as well as American and British ones could be hit by provisions in a tax agreement signed between Berlin and Luxembourg and expected to take effect from next year, according to lawyers Dechert.

Berlin and Luxembourg signed the double tax treaty late last month, to replace the one they had in force since 1958.

The new provisions could negatively affect investments that use the Duchy as a tax-efficient jurisdiction for German inbound investments, the international law firm said.

Investments in German real estate holding companies, held through a Luxembourg holding company, may be subject to German tax under the new treaty, because it provides for a new provision covering capital gains from shares in companies that derive more than 50% of their value directly or indirectly from real estate assets.

The treaty could also affect investments in German target companies – for example by private equity and real estate funds – capitalized through hybrid debt instruments such as profit participating loans, by which a certain portion of German derived profits is repatriated.

Dechert notes: “Under the current Treaty, such financial instruments were – subject to the individual terms – not subject to any German withholding tax. Under the new Treaty, however, Germany is entitled to apply its German withholding tax rate of 26.375% to payments under such financial instruments, if they qualify as so-called ‘profit participating instruments’ – that is, if the respective ‘interest’ payment under such financial instrument is linked to the profit of the German ‘borrower'”.

The lawyers said the new treaty’s provisions are widely expected to be ratified by Luxembourg’s and Germany’s parliaments and apply from 1 January 2013 – “so any restructuring of existing investment structures would need to be implemented during the course of 2012.

“As the changes under the new Treaty may affect US, UK and other non-German fund, private equity and real estate investors holding indirect investments in Germany, this may lead to a heightened interest in exploring alternative structuring solutions,” the international law firm added.

Germany has been trying various ways to increase its tax income from centres beyond its borders.

Another method has been striking a tax agreement with Switzerland, which forces Swiss banks with undeclared accounts held by German taxpayers to collect and remit unpaid tax to Berlin, even if they need not reveal the identity of the account holder in so doing.

London and Washington are pushing for similar agreements.

However, recent data from the Bank of International Settlements suggests such moves have not yet forced money offshore en masse, as the $2.7tn deposited offshore by last year was the same amount as was offshore back in 2007.

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