German Withholding Tax on Distributions Made to Luxembourg Companies
ADMIN / September 27th
CJEU Deems German Anti-Abuse Rule Set Forth in Paragraph 50d(3) of the EStG an Infringement
One of the most unfortunate German tax legislations was deemed an infringement by the Court of Justice of the European Union (CJEU) on December 20, 2017: Paragraph 50d(3) of the German Income Tax Act (Einkommensteuergesetz, EStG) pertaining to the version applicable up to 2011. In practice, this provision provided and still provides today in its current version that income from capital, such as dividend payments and certain interest payments made by German corporations to their Luxembourg parent companies, is generally subject to a withholding tax in Germany even though the exemption from withholding tax, as defined in the EU Parent-Subsidiary Directive, should apply. The German tax law, within the meaning of Paragraph 50d(3) of the EStG, only grants a tax exemption for foreign holding companies if certain substance requirements, that are almost impossible to fulfil, have been met. The CJEU has now ruled that the framework for the substance requirements governing the provision was disproportionate and in violation of EU law. We believe that the current version of Paragraph 50d(3) of the EStG also infringes EU law as proceedings related thereto are pending before the CJEU. Managing directors of Luxembourg holding companies (“SOPARFI”) with holdings in German corporations should verify whether there are still any pending cases where dividend payments and interest payments were subject to German withholding tax. For ongoing cases, they should file an appeal in order to protect the financial interests of SOPARFI and ultimately of the shareholders. Generally, Luxembourg investment funds do not fall within the scope of the Parent-Subsidiary Directive. However, they may qualify for a refund of withholding tax for past periods due to the difference in treatment of Luxembourg and foreign investment funds (see for example FIM Santander, CJEU from April 10, 2014).
Background: German Withholding Tax on Dividends and Exemption
Dividends and certain other income from capital, such as a certain type of interest paid by companies with a registered office in Germany to companies established abroad, are subject to a limited tax liability in Germany. Luxembourg and other companies, whose place of management or registered office is not in Germany at the time of the capital inflow, have a limited tax liability. In Germany, income earned is subject to a tax deduction of 25%, including 5.5% solidarity surcharge (withholding tax).
However, according to the provisions of the EU Parent-Subsidiary Directive and/or with respect to the relevant double taxation treaties (e.g. Germany/Luxembourg), foreign recipients (creditors) of dividends and certain other income from capital may be fully or partially exempt from capital gains tax. This is done either in a procedure for refund regarding payments already made or in a procedure for exemption regarding future payments. Both procedures are subject to an anti-abuse rule defined in Paragraph 50d(3) of the EStG. If the requirements laid down in this provision have been met, tax exemption can no longer be claimed.
Two cases were referred to the CJEU: The Deister Holding case (C-504/16) and the Juhler Holding A/S case (C-613/16).
In the Deister Holding case, the German company, Deister electronik GmbH, paid a dividend to its Dutch parent company in 2007 on which it withheld the German capital gains tax and the solidarity surcharge. In 2008, the Dutch parent company applied for the German withholding tax to be refunded pursuant to the EU Parent-Subsidiary Directive (90/435/EEC, transposed into German law in Paragraph 43b of the EStG). The tax authority rejected the tax exemption and thus the refund of the tax withheld due to lack of “substance” of the Dutch parent company in accordance with Paragraph 50d(3) of the EStG. The Dutch holding company had a rented office and two employees.
In the Juhler Holding case, a German limited liability company (GmbH) paid a dividend to its Danish parent company on which the German capital gains tax and the solidarity surcharge were withheld. Again, the tax authority rejected the refund of the capital gains tax withheld due to lack of substance of the Danish parent company in accordance with Paragraph 50d(3) of the EStG. At the time of the dividend payment, the Danish Juhler Holding had holdings in more than 25 subsidiaries and supplied intra-group services. It had a phone line and an email address, however, it did not have its own offices. If necessary, it used the premises as well as the other facilities and staff of other companies within the group.
Paragraph 50d(3) of the EStG 2011 – The Showstopper
In general, dividend payments made by a European subsidiary to its parent company established in another Member State are exempt from withholding tax pursuant to Article 5 paragraph 1 of the Parent-Subsidiary Directive. This provision was transposed into the German Income Tax Act (Einkommensteuergesetz) by Paragraph 43b, according to which the withheld German tax on dividend payments made to foreign parent companies will either not be levied or subsequently refunded upon request as long as all requirements have been met.
However, German lawmakers have conditioned the exemption from withholding tax by so-called “substance requirements”, previously and currently set forth in Paragraph 50d(3) of the EStG. Hence, German lawmakers aim to prevent the exemption from withholding tax by economically weak shell companies in other European countries, in which, for example, non-European shareholders hold shares in order to receive non-taxable dividends through these European shell companies from Germany (“Treaty Shopping”).
In practice, the substance requirements laid down in Paragraph 50d(3) of the EStG in its earlier and current version can hardly be fulfilled by holding companies. Therefore, dividend and interest payments made by German companies, for example to Luxembourg holding companies, are generally subject to German withholding tax. The provision stipulates, inter alia, that an exemption from withholding tax will not be granted if the shareholders of the foreign holding company would also not be entitled to a tax exemption in the case of a direct investment, and
- if there are no economic or other substantial reasons for the involvement of the foreign company, or
- if the foreign company does not earn more than 10 percent of its entire gross income for the financial year in question from its own economic activity, or
- if the foreign company does not take part in general economic commerce with a business establishment suitably equipped for its business purpose.
In these particular cases, the tax authority rejected the exemption from withholding tax and thus the refund of tax withheld in accordance with Paragraph 50d(3) of the EStG: in the Deister Holding case, for lack of its own economic activity and in the Juhler Holding case, due to the lack of its own staff and premises.
The judgment of the CJEU regarding Paragraph 50d(3) of the EStG
The CJEU considers the provision of Paragraph 50d(3) of the EStG (as amended in 2011) to be in violation of both the Parent-Subsidiary Directive and the freedom of establishment.
The CJEU points out that the Parent-Subsidiary Directive seeks to ensure the neutrality, from the tax point of view, of the distribution of profits within the EU. That is why the Parent-Subsidiary Directive generally precluded the imposition of withholding tax on the profits distributed by a resident subsidiary to its non-resident parent company. Thus, Member States could not unilaterally introduce restrictive measures and subject the exemption from withholding tax to various conditions. Nevertheless, Member States could apply provisions required for the prevention of tax evasion and abuse, which should be proportional and must be subject to strict interpretation. According to the CJEU, this was only the case if the objective of the anti-abuse rule is “to prevent wholly artificial arrangements which do not reflect economic reality, whose only purpose is unduly to obtain a tax advantage”.
That is why, in order to determine whether an operation pursues an objective of fraud and abuse, German tax authorities could not confine themselves to predetermined general criteria, but must carry out an individual examination of the operation at issue. The imposition of a general tax measure, such as Paragraph 50d(3) of the EStG, automatically excluding certain categories of taxable person from the tax advantage, without the tax authorities being required to provide prima facie evidence, was not permitted. Furthermore, the origin of such persons with holdings in parent companies resident in the European Union should not affect in any way the application of the directive and the tax advantages arising thereof.
In addition, the CJEU ruled that the provision constitutes a violation of the freedom of establishment pursuant to Article 49 of the Treaty on European Union as there is a difference in treatment of resident (i.e. German) and non-resident parent companies, since the provision only refers to distributions made to non-resident companies.
Impact on the Current Provision of Paragraph 50d(3) of the EStG
The CJEU ruled on the version of Paragraph 50d(3) of the EStG applicable up to 2011, which was adapted as of 2012. Whereas the earlier version of the provision entirely precluded the exemption from withholding tax if the substance requirements had not been met, the new version allows for a relief on a pro rata basis. However, even in the most recent version, the substance requirements for foreign companies continue to be stringent. Hence, the Finanzgericht Köln (Finance Court Cologne (Germany)) referred to the CJEU further questions regarding the conformity of Paragraph 50d(3) of the EStG to European law. The decision applies to the current version of Paragraph 50d(3) of the EStG applicable as of January 1, 2012. In particular, the Finanzgericht Köln has doubts as to whether this change in legislation adequately reflects the principle of proportionality, since the requirements regarding the exemption from withholding tax for corporations established in the territory of the Community are still disproportionately high. The proceedings are pending before the CJEU under Case No. C-440/17.
The final judgement only refers to the version of Paragraph 50d(3) of the EStG applicable by the end of 2011. However, the current version also raises doubts with respect to the conformity to European law.
If claims can still be asserted for previous years or ongoing cases, they should be made by the managing directors of Luxembourg holding companies with German subsidiaries. In general, the prescription period for lodging an application is four years, beginning at the end of the calendar year in which the income from capital was received, i.e. when it was distributed to the creditor.
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