On October 28, 2016, the new tax agreement between Japan and Germany ("Agreement between Japan and the Federal Republic of Germany for the Elimination of Double Taxation with Respect to Taxes on Income and to Certain Other Taxes, and the Prevention of Tax Evasion and Avoidance"; hereinafter referred to as the "New Agreement") came into force following the completion of all necessary procedures. The New Agreement applies to taxes for any taxable year beginning on or after January 1, 2017 (in the case of taxes levied on the basis of a taxable year) and to taxes levied on or after the same date (in the case of taxes not levied on the basis of a taxable year).
The New Agreement wholly amends the previous tax agreement between Japan and Germany (hereinafter, the "Former Agreement"). While the December 2015/January 2016 issue of this Update briefly mentions the New Agreement, this article shall provide more detail.
New Provision Regarding Taxation of Business Profits. With respect to the taxation of business profits attributable to a permanent establishment ("PE") such as a branch of a foreign corporation, under the New Agreement, the "arm's-length principle" must be applied in a stricter manner for the calculation of profits attributable to the PE. Among other areas, internal dealings between the head office and its branch should be recognized in calculating attributable profits in principle (Article 7).
Expansion of the Exemptions from and Mitigation of Source-Country Taxation. The New Agreement expands the exemptions from and mitigation of source-country taxation on investment income (i.e., dividends, interest and royalties).
Specifically, (i) as for dividends, while under the Former Agreement the applicable tax rate in a source-country was 10 percent of the gross amount of dividends payable between certain affiliates and 15 percent for other dividends, the New Agreement relaxes source-country taxation rules to allow for three scenarios: either (a) the dividends are tax exempt if the beneficial owner of the dividends directly owns 25 percent or more of the voting shares of the paying company for at least 18 months, (b) the applicable tax rate is 5 percent of the gross amount of the dividends if the beneficial owner of the dividends owns 10 percent or more of the voting shares of the paying company for at least six months, or (c) the applicable tax rate is 15 percent in all other cases (Article 10).
In addition, (ii) as for interest and royalties, while both of them were generally subject to a tax of 10 percent in a source country under the Former Agreement, the New Agreement makes both payments tax exempt (Articles 11 and 12).
It should be noted that the benefits set forth in (i) and (ii) above are subject to satisfaction of the requirements under the limitation on benefits clause as described below and the completion of certain procedures as provided in Article 27.
Introduction of the Limitation on Benefits Clause. A resident of a contracting state is entitled to a benefit under the New Agreement only if such resident is considered a "qualified person" or otherwise objectively satisfies alternative requirements. Notwithstanding the above, a benefit under the New Agreement will be denied if it is reasonably concluded that, with regard to all relevant facts and circumstances, obtaining the benefit was one of the principal purposes of the relevant transaction (Article 21).
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As seen above, the New Agreement substantially changes the existing tax treatment under the Former Agreement and thus is worthy of attention when Japanese companies with a parent, subsidiary, or branch in Germany, or those companies having a counterparty in Germany, carry out transactions going forward.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.