Skip to content

You are here:

Protection against the loss of tax revenues caused by cross-border arrangements

Federal Ministry of Finance on the application of Section 4k of the German Income Tax Act

The different tax treatment of a situation in two disparate states can lead to the creation of structures that induce undertaxation. In 2021 already, German lawmakers established additional regulations to prevent such taxation incongruities or hybrid mismatches. The key elements of these rules can be found in Section 4k of the Income Tax Act (Einkommenssteuer­gesetz, EStG). In the summer of 2023 already, the Federal Ministry of Finance (Bundesministerium der Finanzen, BMF) issued draft administrative guidance in this regard. In the following section, we present selected elements of the BMF draft.

General scope of application and situations 

Section 4k EStG applies objectively to cross-border situations

  • in the case of structured arrangements,
  • with related parties,
  • with permanent establishments, or
  • involving concerted practice.

From a timing perspective, the regulation applies to expenses that arose after 31.12.2019. Insofar as the expenses are based on a continuing obligation (rental agreement, etc.) that was previously concluded, Section 4k EStG would moreover only apply

  • insofar as the expenses could have been avoided from the aforementioned date without material disadvantages, or
  • if the continuing obligation was substantially amended after the 31.12.2019.

Section 4k EStG affects three categories of mismatches:

(1) Deduction/non-inclusion mismatch – A tax deduction for an expense in one country without a corresponding amount of income being taxed in the other country.

(2) Double-deduction mismatch – Tax deduction of the same expenses in several countries that is contrary to the system.

(3) Imported mismatch – Deductible domestic (German) expenses exist and the corresponding foreign income is offset by expenditure that, under Section 4k EStG, could not be deducted if the situation were to arise in Germany. 

Protection against deduction/non-inclusion mismatches

No deduction of an expense in the case of a differing classification/attribution of the capital assets

If the income that corresponds to domestic (German) expenses is not taxed abroad, or only at a low rate, because of the differing classification or attribution of the capital assets then the law would deny the deduction of the aforementioned expenses. This situation may arise, for example, in a constellation with profit participation rights, convertible bonds, or other hybrid financial instruments as outlined in the following figure (cf. figure 1).

The BMF draft stresses that the taxation incongruity has to be the reason for applying the anti-hybrid rules. The assumption of undertaxation can be eliminated if, for example, interest income abroad is subject to CFC rules. By contrast, undertaxation should be presumed if the taxation is lower than if the foreign classification/attribution had been carried out in conformity with the German concept.

No deduction of an expense in the case of differing treatment of the taxpayer

If non-taxation occurs as a consequence of the taxpayer being treated differently abroad from the way they would be treated in Germany then Germany would thus deny the deduction of the expense (this would also apply in comparable permanent establishment situations). For instance, such a situation could arise as follows (cf. figure 2).

In this regard, the BMF draft clarifies that the rules may generally affect any sort of expense so that the scope of their application extends far beyond the simple example that has been outlined.

Taxation of income in Germany in the case of differing treatment of the company abroad 

Insofar as an expense is tax deductible abroad and the corresponding income is however not taxed by the shareholder in Germany on account of the differing treatment of a company then, in a break with the basic German tax perspective, the aforementioned income should nevertheless be taxed. Such a case can occur, for example, if a German shareholder Mr C enters into contractual relationships with his foreign company as outlined below (cf. figure 3).

Here, in view of Section 4k EStG, the German shareholder’s interest income would be taxed in Germany.

No deduction of an expense in the case of the non-taxation of income abroad

Finally, in addition to the previous situations, Germany would deny the deduction of an expense if the corresponding income is not subject to tax because of a differing classification/attribution abroad. This can occur, for example, if two states assume that there is a permanent establishment in a third state and regard this as the entity to which profits are attributed, while the latter state does not tax the relevant amounts because, from its point of view, no permanent establishment exists (cf. figure 4).

Protection against double deduction mismatches

Insofar as expenses lower the tax assessment base both abroad and in Germany then the deduction of these expenses would be denied in Germany as, for example in this case (cf. figure 5).

Please note: While the guidelines in the BMF draft on the cases mentioned above under section 2 go into considerable detail and are illustrated with examples, the comments on double deduction mismatches are however merely brief and abstract.

Protection against imported mismatches

These mismatches relate to multi-level structures such as, for example, those shown in the following diagram. In the case that is depicted, Germany now denies the deduction of the interest expense under Section 4k EStG. In its draft, the BMF included detailed explanations in this regard and supported them with examples (cf. figure 6).

Please note: In doing so, the BMF has, among others things, established an important rule according to which the order of the analyses should start with the German taxpayer’s direct creditor and then continue on to the next highest level.

Further details

The legal provision in Section 4k EStG includes various exceptions where no adjustments are made to income. The BMF draft also addresses these escape rules, for example, the elimination of the mismatch in a future taxable period or proof of dual inclusion income.

Please note: Large parts of the BMF draft show a clear attempt by the executive to limit the scope of application of the anti-hybrid rules to a manageable level. The fact that, after several months, the BMF has not yet finalised its administrative guidance would however suggest that, behind the scenes, there is still a considerable need for coordination. Therefore, further developments remain to be seen.

Back to top of page