Earlier this month, the German Corporate Tax Reform 2008 secured the approval of all Germany’s legislative bodies and will become effective on 1 January next year. The Corporate Tax Reform 2008 does not provide for any ‘grandfather clauses’ for current transactions but for structures involving German entities with deviating fiscal years, the changes might already have an impact on fiscal years starting in 2007. The reform can be divided into two key elements: firstly, the intended reduction of an overall tax rate for corporations (corporate and trade tax) from 38.6% to slightly below 30%; and secondly a new general interest deduction limitation rule – the new rule – which will have a significant impact on leveraged transactions in Germany.
The new rule abolishes the current German thin cap rules under which interest paid to related parties is deductible as long as the debt to equity ratio of 60% to 40% is complied with. With respect to third-party bank debt, the current thin cap rules specifically require that there be no harmful back-to-back financing in place, which can be ensured through a proper structuring of the security package. If a back-to-back financing is excluded, third-party bank debt is deductible without further restrictions. Under the new rule, interest expenses on shareholder loans and third-party bank debt are only deductible in an amount equal to the interest income of the German entity and, above that, up to 30% of the earnings before interest, taxes, depreciation and amortisation (EBITDA). The interest expense and interest income definitions are broad and include payments on all instruments where the holder is entitled to either any return of capital or a return on capital. Income or expenses from discounted instruments are treated as interest in this context.
