German taxation of business relationships with Russia – recent developments and outlook for 2024

As expected, Russia has now officially become a “non-cooperative jurisdiction” for the purposes of the German Tax Haven Defence Act (Steueroasen-Abwehrgesetz; the THDA) following the German Federal Council’s adoption of an updated regulation pursuant to the THDA on 15 December 2023 to reflect the EU’s blacklisting of Russia in early 2023 (as discussed in our previous blog post from March 2023). From 2024 onwards, German taxpayers with business relationships with Russian counterparties are subject to certain defensive measures and special tax compliance obligations pursuant to the THDA – but recent national and international developments lead to additional considerations as discussed below.

Reduction of the low tax threshold

As part of the German Minimum Taxation Directive Implementation Act (Mindestbesteuerungsrichtlinie-Umsetzungsgesetz) passed last December, Germany reduced the low tax threshold for German controlled foreign company (CFC) purposes under the Foreign Tax Act (Außensteuergesetz; the FTA) from 25% to 15% to align the CFC add-back to the global minimum effective tax rate pursuant to OECD’s Pillar Two model rules (for background details, see our blog post here).

As things stand today, this change in law could lead to significantly mitigating tax effects resulting from the application of the extended German CFC rules under the THDA to German majority shareholders in Russian subsidiaries. Whilst the THDA extends the CFC rules to the entire (i.e. not only passive) income of the controlled company, it does not provide for a separate low tax threshold, but merely references the corresponding section of the FTA. In light of the above-mentioned change in law, there should be reasonable grounds to argue that income derived from controlled companies in Russia generally does not constitute low-taxed income within the meaning of the extended CFC rules under the THDA if and to the extent such income is regularly subject to an effective tax rate in Russia of at least 15% (which should generally be the case).

Suspension of the tax treaty between Russia and Germany

Also at the end of last year, Russia ratified the suspension of certain provisions of its tax treaty with Germany (as well as with other “unfriendly” countries) following a related Russian presidential decree adopted earlier in 2023. If treaty protection is no longer available, income derived by German taxpayers – e.g. from dividend, interest or license payments made by Russian resident companies (if and to the extent approved under the Russian counter-sanctions system) – will generally be subject to full (withholding) tax rates in Russia. In addition, from 2026 onwards, dividends and capital gains income derived from Russian subsidiaries will be fully taxable in Germany under the THDA (unless Russia is delisted at EU and national levels in the meantime). This position gives rise to significant double taxation risks.

How will these cases be dealt with in practice? What will be the German tax authorities’ position regarding outbound investments in Russia? Can this topic effectively be addressed in the relevant (intra-group) agreements? Which tax aspects should be considered in exit scenarios or M&A transactions? These are points that require both technical analysis and thoughtful negotiation with tax authorities and Russian counterparties alike.

Outlook

The German Ministry of Finance is currently assessing feedback received from relevant stakeholders on a draft decree to provide guidance on the application of the THDA published in late 2023 (the Draft Decree); a final version is expected to enter into force in the next couple of weeks. The Draft Decree, so far, seems rather high-level and does not touch upon the, in our view, difficult cases and potential effects of recent developments. Thorough case-by-case assessment is likely to be necessary for relevant German companies to obtain certainty on their individual tax exposure.

Against this background, taxation of business relationships with Russia will remain a hot topic going forward. In cases related to Russia, the German tax authorities could take the position that the intended sanctioning effect of the THDA turns out to be too limited. Given the current political climate in Germany, it would not come as a surprise if tax officials or government representatives push for further restrictions via additional legislation and/or administrative rules. 

In addition, discussions regarding the interplay between Germany’s new legislation to implement the global minimum effective tax rate in line with OECD’s Pillar Two model rules and unilateral measures taken under the THDA are only just starting. German corporations with business operations in Russia should continue to closely monitor these developments and consider how best to protect themselves against impending tax risks.

If you would like to discuss the issues raised in this blog post, please get in touch with the authors or your usual Freshfields contact.