On January 12, 2021, amendments to the protocol in the German-UK income tax treaty were signed. The key points of the amendment of the German-UK income tax treaty are

  • the introduction of a new provision in targeting treaty abuse; and
  • the revision of the permanent establishment standard by introducing the anti-fragmentation rule.

Global businesses need to therefore be aware of the following:

Background of new anti-tax avoidance measures

In 2015, the OECD created an action plan covering 15 points. It provided governments with the domestic and international legal instruments to combat base erosion and profit shifting (BEPS). These included new or reinforced international standards to help countries to tackle BEPS. Their aim was to improve the coherence of international tax rules, to reinforce their focus on economic substance, and to ensure a more transparent tax environment.


At the time, when it came to treaty abuse, a minimum standard was agreed on which it was ensured that treaty benefits were (and are) only granted to those who merit them. Moreover, the definition of what constitutes a permanent establishment was modified. One presumes, this was done to better reflect the reality of business.


Some of the anti-tax avoidance measures are directly relevant; such as the guidance on transfer pricing as soon as the new OECD transfer pricing guidelines are applicable in the relevant country. Yet, many of these measures need national lawmakers to actually implement them or to amend income tax treaties.

Implementation of the German-UK income tax treaty

In order to implement the new anti-tax avoidance measures in the area of treaty abuse, the OECD created the multilateral instrument (MLI). The purpose of the MLI is to facilitate the implementation of treaty-related anti-BEPS measures to avoid the lengthy process of re-negotiating and ratifying more than 3,000 treaties. To the surprise of many tax practitioners, many countries, whose commitments affect more than 1,100 income tax treaties, have signed the MLI. However, many countries have opted out of all but the minimum standards and/or have limited the number of covered income tax treaties.


Germany will apply the MLI in only around a dozen out of around 100 income tax treaties. Hence, Germany will not apply the MLI to many important income tax treaties, such as those with the Netherlands, the United Kingdom etc. Instead, Germany intends to amend the income tax treaties with those non-listed countries on a bilateral basis.


This brings us to January 12,  2021 when the amendment protocol to the German-UK income tax treaty was signed. It will come into force on January 1, 2022 if the instruments of ratification are exchanged this year.

Treaty abuse

In order to prevent treaty abuse, the treaty partners have agreed on the following amendments to the German-UK income tax treaty. First, the German-UK income tax treaty will be amended to include the following preamble text:


Intending to eliminate double taxation with respect to taxes on income and on capital without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in this Convention for the indirect benefit of residents of third States);


Moreover, the German-UK income tax treaty will be amended to include a principal purpose test (the “PPT”). The PPT is stipulated in Article 30A of the new treaty. It targets transactions and arrangements based on subjective criteria. It is not a substance test but refers to the purpose of an arrangement or transaction. The PPT reads as follows:


a benefit under this Convention shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention.”


These amendments are an internationally accepted minimum standard to ensure that treaty benefits are only granted to those who deserve them. In return, the “mini-PPTs” will be eliminated, which are included in several articles of the currently applicable German-UK income tax treaty, such as Article 12(5).

Revision of the permanent establishment standard

Germany has decided not to implement most parts of the revised standard for permanent establishments (“PE”) with an exception of the income tax treaty agreed between Australia and Germany. Of all the proposed changes to the PE standard, Germany plans to only make all specific activity exemptions in existing income tax treaties (e.g. maintaining facilities for the display or storage of goods etc.) subject to an overall “preparatory or auxiliary” requirement under its income tax treaties, which will be covered by the MLI. However, this approach has not been adopted for the amended German-UK income tax treaty.


Instead, the more-advanced anti-fragmentation rule will be included in paragraph 4A, a new addition to Article 5 of the German-UK income tax treaty. This corresponds with the UK’s new treaty policy.


Under the new anti-fragmentation rule, the specific activity exemptions from the PE standard are not available to a fixed place of business used or maintained by an enterprise if the same enterprise (or even a closely related enterprise) carries on business activities at either the same place or at another place in the state if:

  • the same or the other place is a PE, or
  • the overall activity from a combination of the activities is not of a preparatory or auxiliary character.

In either case, the activities conducted (by the two enterprises at the same place, or by the same or closely related enterprise at the two places) must also constitute complementary functions that are part of a cohesive business operation.

Implications for global businesses

There should not be many situations in practice where the anti-fragmentation rule will apply. However, the magnitude of the anti-fragmentation rule might mean that some activities of global businesses, which arguably benefit from specific activity exemptions across multiple legal entities, might result in some additional taxable profit in Germany or the United Kingdom. Nevertheless, centralized supply chains and the increasing integration of global businesses should monitored closely. It is quite easy for global enterprises to carry out a business activity which hasn’t been fragmented on purpose, yet could still fall under, and be affected by, the new anti-fragmentation rule. This suggests a potentially high level of compliance burden for global businesses. As a result, it is expected that UK companies will be increasingly scrutinized in German tax audits, to see whether they have PE situated in Germany.