German anti-treaty shopping rules not consistent with EU law

Background

The foreign shareholder of a domestic corporation has the right to be refunded or exempted from withholding taxes on a profit distribution when the requirements of a double taxation agreement or the EU parent-subsidiary directive are met. In Sec. 50d (3) ITA (version of the Annual Tax Act of 2007) the refund or exemption domestically depends on further restrictive requirements which are deemed to constitute abuse if not fulfilled. Thus a foreign company cannot claim for total or partial relief if its shareholders would not have been entitled to the relief had they earned the income directly, and: (1) if no economically significant or other reasons exist to involve the foreign company or (2) if the foreign company earns less than 10 % of its gross income by virtue of its own economic activities or (3) if the foreign company does not participate in the economy with a properly established business and suitable premises for their business purposes.

Upon request of the fiscal court in Cologne, the European Court of Justice delivered an early judgement on 20 December 2017 regarding two linked court proceedings on the conformity of this regulation with European law.

Actual situations

In the “Deister Holding” case a holding company with its residence in the Netherlands held shares of 26.5 % in a GmbH located in Germany. The sole shareholder of the Dutch holding company was an individual with residence in Germany. The holding company ran an office with two staff members in the Netherlands. The holding company granted loans to its subsidiaries.

In the “Juhler Holding” case a holding company located in Denmark held shares in more than 25 subsidiaries, including shares in companies based and active in Denmark. One of the subsidiaries with a 100 % participation rate was a GmbH located in Germany. The holding company held real estate assets and controlled the financial assets within the group of companies in order to optimize interest expenses. A telephone connection and email address was available, but not any staff of its own or offices. If needed it used equipment and staff from other group companies. Sole shareholder of the holding company was a Cypriot company which did not carry out any economic activities of its own and whose sole shareholder was a natural person with residence in Singapore.

In both cases, based on Sec. 50d (3) ITA (2007), the Federal Central Tax Office (Bundeszentralamt für Steuern) refused to refund the withholding taxes paid on the profit distributions of the GmbHs.

Decision

The European Court of Justice judged that the general suspicion of abuse in Sec. 50d (3) ITA (2007) is neither consistent with the parent-subsidiary directive nor with the freedom of establishment. In the eyes of the Court the provision constitutes an irrefutable suspicion of abuse or evasion, as in case of the fulfilment of one of the requirements the foreign parent company does not have the possibility to prove the existence of economic reasons. Furthermore, considered individually or collectively, the legal requirements constitute neither an abuse nor an evasion.

Consequence

Although this judgement concerns the previous version of Sec. 50d (3) ITA, a great number of considerations of the European Court of Justice are applicable to the current version. For this reason a lot points to the current provision also not being in line with European law. Consequently, the fiscal court of Cologne has already referred the question of whether Sec. 50d (3) ITA in its current form is consistent with EU law to the European Court of Justice. Companies should challenge refused claims for refund / exemption with reference to the ECJ judgment and the pending referral of the fiscal court of Cologne.