EU Law-Compliant Application of the Anti-Directive/Treaty Shopping Rule

Background

The foreign shareholder of a domestic corporation has the right to be refunded or exempted from withholding taxes on profit distributions when the requirements of a double taxation agreement or the EU parent-subsidiary directive are met. The so-called “abuse prevention norm” of Sec. 50d (3) ITA makes the refund or exemption domestically dependent on further – restrictive – requirements. The European Court of Justice (ECJ) recently delivered a verdict and ruled that the general suspicion of abuse in Sec. 50d (3) ITA (version of the Annual Tax Act of 2007) is not in line with either the EU parent-subsidiary directive and the freedom of establishment (see dhpg article dated 14/3/2018). Even though the ECJ’s ruling refers to a previous version of the anti-treaty shopping provision, many of the Court’s considerations can be applied to the current version of Sec. 50d (3) ITA. The financial court of Cologne has already submitted the current version of Sec. 50d (3) ITA to the ECJ for review. With a circular dated 4/4/2018, the German Federal Ministry of Finance has now highlighted the implications of the ECJ’s ruling.

The Circular

The circular contains instructions regarding both the previous and current version of the abuse provision in cases where the relief from withholding tax is asserted by the creditor based on the parent-subsidiary-directive (PSD), which is implemented into German law in Sec. 43b ITA. The older version of Sec. 50d (3) ITA is no longer to be applied. The current version of the provision generally remains in force, provided that sent. 2 shall no longer be applied. Sec. 50d (3) sent. 2 ITA states that the analysis of the conditions of Sec. 50d (3) ITA shall be based solely on the substance and activity of the foreign company that receives the payment. The substance and activity factors of other group companies are not to be taken into account. Nonetheless, the circular intends Sec. 50d (3) ITA to be applicable in cases where a complete review of the facts of the case give rise to the suspicion that there are no economic or other substantial justifications for the involvement of the foreign company, besides the attainment of tax advantages.

Furthermore, the Federal Ministry of Finance revises the statements of its circular dated 24/1/2012 regarding the criterion of own business activity with regard to asset management (figure 5.2). Most notably asset-managing activities now qualify as business activities as long as the company generates its gross income from the management of assets. This applies to passive asset management only insofar as the company actually exercises its shareholder rights. With regard to the criterion for the proper organisation of business operations (figure 7), it is regulated that a proper organisation of business operations for asset management does not necessarily requires that the company employ permanent, managerial or any other personnel for its activities in its country of domicile. The aforementioned regulations are to be applied in all pending cases.

Note

It should be noted that the scope of Sec. 50d (3) ITA is not limited to refund and exemption rights asserted pursuant to the PSD (Sec. 43 ITA). Instead, it extends to refund and exemption rights based on double taxation treaties, as well as the interest and royalties directive (IRD, Sec. 50g ITA). Since the circular, however, explicitly only addresses cases concerning the PSD, refund and exemption rights based on double tax treaties or the IRD are not covered. However, the relevant literature already suggests there to be a violation of the freedom of free capital movement in third-country cases, making it probable that Sec. 50d (3) ITA in its current version will have to be revised even further in the future.