German application of the Parent Subsidiary Directive on the one hand and transfer pricing adjustments according to sec. 1 German Foreign Tax Act on the other hand.
German taxation has to consider two important cross border issues which were recently decided by the European Court of Justice (ECJ) in favour of the taxpayers.
Withholding Tax on Dividends and Parent-Subsidiary Directive
The first to be mentioned is the German application of the EU-Parent-Subsidiary Directive. The foreign EU-shareholder of a corporation who is tax resident in Germany has the right to a refund of German withholding
tax on dividends or alternatively a tax exemption certificate. The prerequisites to be met are a 10% minimum shareholding by an EU-corporation and the observation of a holding period of at least one year.
Overruling these EU-prerequisites which are transferred to national law of all member states, restrictions are allowed nationally to explicitly avoid such tax benefit in case of artificial structures. Germany introduced two
anti-abuse provisions in sec. 50d para 3 of the German Income Tax Act (ITA); one was effective until 2011 and the revised one since 2012. Content of such anti-abuse provision is a deemed abuse, in particular if the EU parent
operated the function of a holding company. Given this, the taxpayer had to prove by a kind of substance test that the EU-parent is operating an active business instead of administrating shares only by own staff and office space/equipment.
The European Court of Justice had to decide upon the old version and delivered a verdict expressing that the general suspicion of abuse when implementing an EU (holding) is not in line with the Parent Subsidiary Directive
and contradicts the freedom of establishment as well (ECJ of December 20, 2018, C-504/16 and C-613/16, “Deister Holding” and “Juhler Holding”). Whereas the current rule was brought to the ECJ but still pending, the
ECJ decided now on this: The rule is not in line with the directive and the freedom of establishment as in case of the old rule (decision of June 14, 2018; C-449/17, “GS”).
Whereas the decisions concerning the old rule are interpreted by the German tax administration in a circular of April 4, 2018, no such comment is given due to its up-to- dateness concerning the new decision. Although
the interpretation given in the circular is still restrictive as the taxpayer has to prove that there is no artificial structure rather than the tax administry itself, observing the circular should bring the taxpayer into a safe position.
Where this is not possible, an appeal should be filed based on the very clear decisions of the ECJ.
Some rules of the circular:
Despite the wording of the German anti-abuse rules a group view has to be taken to deny an artificial structure.
Outsourcing of activities such as management or administration is not harmful. Operational business is not only active business as e.g. production and distribution but also management of own assets, in particular shares (holding function). Given this, the anti-abuse provisions lose their unassimilated strictness.
Please note that the anti-abuse provision is also applicable in case of withholding tax on dividends based on a tax treaty and of withholding tax on interest and license payments. The German tax administration announced to observe them so far as the ECJ only decided based on the Parent-Subsidiary-Directive and thus the taxpayer unfortunately has to appeal against this as the case may be.
Transfer Pricing Adjustments – Deviation from arm`s length principle due to economic reasons
Sec. 1 German Foreign Tax Act – (FTA) allows the adjustment of transfer prices with regards to transactions between a German domestic corporation and its foreign affiliated companies. In accordance to the law such relation exists in case of a substantial interest of more than 25 % directly or indirectly or the ability of controlling influence on another company. Sec. 1 FTA allows the increase of German taxable profit if the transfer price does not
correspond to arm`s length. No escape-clauses to avoid such adjustment are foreseen in the law.
The European Court of Justice’s ruling was based on the action brought by Hornbach-Baumarkt AG, which operates stores both in Germany and in other EU countries, in the case at hand inter alia in Dutch subsidiaries, which in turn were supported by its parent. In particular this was true by means of letters of comfort to the financing bank; without such financial aid the Dutch subsidiaries would not have been in a position to serve their liabilities
and to obtain bank loans. A compensation was not agreed upon. Whereas such is not challenged in domestic cases, sec.1 FTA provides with a rule to make adjustments in cross border cases. Missing compensation was picked up by the German tax office and an adjustment of the German profit was made pursuant to sec. 1 FTA.
By decision of May 31, 2018 (C-382/16, “Hornbach Baumarkt AG”) the ECJ came to the conclusion that sec. 1 FTA violates the freedom of establishment as far as the taxpayer is not allowed to present economic reasons for the transfer price taken.
Although the freedom of establishment allows national provisions to preserve their tax revenue, evidence to the contrary by presenting economic reasons must be allowed. However, sec. 1 FTA does not actually grant such possibility and so far the provision contradicted EU-law.
It has to be mentioned that the ECJ had already made a decision which clarified a similar question. In this case, the Belgian company SGI granted an interest-free loan to its European subsidiary for economic reasons. Based on Belgian law, the tax authorities made a profit adjustment and used fictitious interest rates. In this decision of January 21, 2010 (C-311-08) the ECJ pointed out that the taxpayer has to be granted the possibility of providing evidence of any economic reasons for the conclusion of the transaction.
A deviation from the arm`s length principle may be justified by economic reasons, such as e.g. the financial aid to maintain the business operations of a foreign subsidiary in the event of economic difficulties. A kind of motive test must be allowed – deviation from arm`s length requires motives which are not made on the basis of tax savings but for economic reasons.
This allows the taxpayer to existing and deferred corresponding structures based on the current German law situation.