The New DTA will enter into force on the 30th day following the notification date on which both countries completes their respective ratification procedures, and will become effective on or after 1 January of the following year in which the New DTA enters into force. The New DTA is expected to be effective on or after 1 January 2015 and be applicable to income derived on or after that date.
The New DTA revises the threshold of permanent establishment and decreases the withholding tax rate on dividends from 10% to 5% aligning Germany with other European countries such as France, the United Kingdom, the Netherlands, Denmark and Switzerland. It also incorporates a number of anti-treaty abuse elements, showing the determination of both countries to enhance cooperation in tackling aggressive tax planning for treaty benefits.
This tax newsletter highlights the key changes in the New DTA as follow:
Permanent Establishment (“PE”)
- The time threshold for a building site, construction, assembly or installation project, typically called “construction PE”, is extended from six months to twelve months;
- The time threshold for constituting a service PE is changed from six months to 183 days within any 12-month period. This is a welcoming change as it is always not clear as to what constitute a month and often part of a month in China, for example, would constitute a month;
- The application of the independent agent exemption is further refined to be in line with the United Nations Model Double Taxation Convention. Under this new definition, an agent who is devoting its activities wholly or almost wholly on behalf of an enterprise would be considered to be a dependent agent of that enterprise if the arm’s length relationship between the two parties is not established. In other words, an enterprise cannot claim that its agent is independent and benefit from not creating a PE in the other country, unless the principal and agent are truly dealing under arm’s length terms.
Reduction of Withholding income Tax (“WHT”) rates
Following the general trend of other tax treaties recently renegotiated by China, the New DTA reduces the WHT on dividends from the current 10% to 5% if a corporate beneficial owner directly holds at least 25% of the equity of the company paying the dividend. It should be noted that from China’s perspective, under its Circular Guoshuihan (2009) 81, a foreign company, i.e. the German company in this case, can enjoy the reduced WHT rate under an applicable treaty, only if the required participation, i.e. 25% or more, was held at all times during the past 12 consecutive months before the receipt of the dividends.
In addition, the New DTA also includes a new 15% WHT rate applicable to income or gain directly or indirectly derived from immovable property by an investment vehicle under certain circumstances. An investment vehicle is a vehicle which annually derives and distributes most of the income or gain derived from immovable properties is exempted from tax. This new provision will not affect Chinese residents who receive dividends from China as under China’s domestic laws, the WHT rate on dividends is 10%.
The WHT rate on interest remains at 10%. However, interests paid to certain Chinese state-owned commercial banks will no longer be exempted from German WHT under the New DTA.
The WHT on royalties paid for the use of, or the right to use, any industrial, commercial or scientific equipment is reduced from 7% to 6%. In all other cases, the WHT rate remains at 10%.
Revamping of the capital gains provision
The New DTA also follows the trend of recent treaties renegotiated by China for capital gains. Under the existing DTA capital gains are taxed in the source country. For example, gains derived from share transfers from China to Germany would be taxed in the source country, China. The New DTA provides a tax relief on capital gains in the source country for the following three types of share dispositions:
- If 50% or less of the value of the shares represents directly or indirectly immovable property, i.e. non-property-rich company;
- If the transferor holds directly or indirectly less than 25% of the shares of the disposed company for the 12-month period preceding the share transfer;
- If shares are substantially and regularly traded on a recognized stock exchange and the total of the shares disposed by the transferor during the fiscal year in which the disposal takes place does not exceed 3% of the quoted shares.
Additional anti-treaty abuse provisions
An article (Article 29) provides anti-abuse rules and allows both contracting states to apply domestic laws concerning the prevention of tax evasion and avoidance. In order to combat tax-treaty abuse, the anti-abuse article would deny treaty benefits on arrangements or transactions entered into mainly for the purpose of obtaining the treaty benefits.
This new article is in line with the suggestions made by the OECD in its preliminary discussion on Base Erosion and Profits Shifting (BEPS) Action 6 to prevent treaty abuse. Please refer our tax commentary on BEPS issued in March 2013.
Nevertheless, the newly added article also allows taxpayers to apply for Mutual Agreement Procedure (MAP), if they consider they have not been taxed in accordance with the treaty as a result of the anti-avoidance provision application.
The New DTA would revise some tax allocation principles, such as PE, WHT and capital gains provision, that will directly affect enterprises having cross border investments and transactions in Germany and China.
For example, the reduction of WHT rate on dividends may mean that enterprises may consider delaying dividends payment until after 1 January of the next calendar year after the New DTA enters into force.
As the new anti-treaty abuse provisions clearly reflect the determination of both countries to enhance cooperation in tackling aggressive tax planning for treaty benefits, multi-national corporations should assess their current structures and arrangements to ensure the eligibility requirements are met to enjoy the treaty benefits.