Federal Ministry of Finance restricts application of Anti-Treaty/-Directive Shopping Rule
The Federal Ministry of Finance has restricted the scope of the anti-treaty/directive shopping-rule under section 50d para. 3 of the Income Tax Act (ITA). Previously, the ECJ had ruled on December 20, 2017 (Joined cases Deister Holding AG (C 504/16) and Juhler Holding A / S (C 613/16)), that section 50d para. 3 ITA 2007 violates both the freedom of establishment and the Parent-Subsidiary-Directive (see Noerr News of 22.12.2017 – German language). With circular letter dated April 4, 2018, the tax authorities reacted on this ruling. As a consequence, the former provision of section 50d para. 3 ITA 2007 shall not apply to all open cases, in which the recipient of a profit distribution is entitled to a refund under the Parent-Subsidiary-Directive (i.e., section 43b ITA). Also the scope of the current regulation of section 50d para. 3 ITA 2012, which has been in force since 2012, shall be restricted according to the circular letter.
ECJ: Section 50d para. 3 ITA 2007 violates EU law
Profit distributions of German corporations made to parent companies with their seat or place of management in another EU member state are in principle exempt from withholding tax under the Parent-Subsidiary-Directive (implemented in Germany in section 43b ITA). The exemption from withholding tax can, however, be denied due to the anti-treaty/directive-shopping rule under section 50d para. 3 ITA.
In particular, an exemption from withholding tax is excluded to the extent that persons indirectly participate in the distributing company who would not be entitled to a refund or exemption if they received the profit distribution directly. The mandatory requirement for an exemption is always that there are economic or other bona fide reasons for involving the foreign company. In addition, the foreign company has to participate on the general market and has to have sufficient substance to carry out its business purposes. When assessing whether these requirements are met, only the attributes and features of the foreign company can be taken into account. By way of contrast, organizational, economic or other relevant characteristics of related parties have to be disregarded.
In a preliminary ruling from the Fiscal Court of Cologne, the ECJ decided on December 20, 2017 (Joined cases Deister Holding AG (C 504/16) and Juhler Holding A / S (C 613/16)) that section 50d para. 3 ITA 2007 violates both the freedom of establishment and the Parent-Subsidiary Directive. According to the Court, the member states are allowed to adopt rules to prevent purely artificial structures that merely serve to obtain a tax advantage. However, the scope of such provision must be closely aligned to the objective of preventing abuses. According to the ECJ, it is not compliant with EU law to assume abuses on the basis of general criteria. By way of contrast, assuming an abuse requires a comprehensive review and consideration of all circumstances pertaining to each individual case.
Restricted scope of application to old cases
The Federal Ministry of Finance reacted to the ruling of the ECJ with its circular letter dated April 4, 2018. Pursuant to this circular letter, section 50d para. 3 ITA 2007 shall no longer apply to all open cases in which the a foreign taxpayer claims a refund under section 43b ITA. Consequently, all pending refund application have to be approved by the Federal Central Tax Office (BZSt). However, refund claims that are based on provisions other than section 43b ITA (e.g., refund claims in relation to withholding taxes on interest or royalties under the Interest- and Royalties-Directive) are not covered by the now published circular letter of the tax authorities. On basis of the ECJ case law, such refund claims should, in our view, exist under EU law.
Also restrictions of scope of current cases
Furthermore, the circular letter of the Federal Ministry of Finance also restricts the scope of application of currently applicable section 50d para. 3 ITA 2012.
In cases where the recipient of profit distributions applies for a refund under section 43b ITA, the restriction of section 50d para. 3 sent. 2 ITA 2012 shall not apply pursuant to the circular letter. Consequently, the interposition of a foreign parent company is no longer to be regarded abusive under the anti-treaty/directive shopping rule, even if the interposed company cannot meet the anti-abuse-requirements by itself but the anti-abuse-requirements are only fulfilled, by a related person. However, pursuant to the circular letter an abuse shall still be assumed if economic or other considerable bona fide reasons are missing and if the interposition of the foreign company is only intended to achieve tax advantages.
In addition, the circular letter also amends the published view of the tax authorities in their previous circular letter dated January 24, 2012. In particular, in cases where the recipient of a profit distributions claims a refund under section 43b ITA, an interaction in regular course of business shall also be given, if the company realizes its gross income from mere asset administration; this applies also in cases of passive investment management if the company actually exercises its shareholder rights in relation to the portfolio companies. Finally, in an asset management context sufficient substance shall not necessarily require that the company permanently employs managerial and other personnel staff in the country of its residence.
Compliance of section 50d para. 3 ITA with EU law still questionable
The restriction of the scope of section 50d para. 3 ITA 2012 by the Federal Ministry of Finance can only be regarded as a first step towards an anti-treaty/directive-shopping rule that is fully in compliant with EU laws. First of all, it is already questionable whether an infringement of EU laws can be simply cured by an administrative guideline; in our view, an amendment by the legislator would be required.
In addition, there are still significant doubts as to whether the anti-treaty/directive-shopping rule complies with EU law from a substantive perspective. In fact, despite the recent restrictions made by the Federal Ministry of Finance, the denial of a refund continues to be based on a general assumption of an abuse without taking into account the specific circumstances of each individual case. This should, in our view, still contradict the case law of the ECJ, which will soon have to decide again in another preliminary ruling from the Fiscal Court of Cologne (GS, pending under C-440/17).
Moreover, in our view the limited application of ECJ case law only to cases under the Parent-Subsidiary-Directive should not be sufficient to make 50d para. 3 ITA 2012 compliant with EU law. Consequently, we generally advise foreign taxpayers whose withholding tax refund applications have been turned down by the tax authorities based on section 50d para. 3 ITA 2012, to keep such case open by appealing them until further clarification is provided by the ECJ.
Any Questions? Please contact: Dr. Martin Haisch, Dr. Matthias Geurts
Practice Group: Tax & Private Clients