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Amendments to the German Anti-Treaty-Shopping Rules
Foreign entities holding shares in German corporations like an AG or a GmbH are completely or partially relieved from any withholding tax on dividends received on the basis of the applicable double tax treaties or the parent-subsidiary-directive. However, under the current anti-abuse provision of the German Income Tax Act (ITA), such foreign entities can only benefit from these exemptions if certain requirements are met.
1) existence of economic or other relevant reasons to interpose the foreign company as shareholder of the German entity in relation to the payments received
2) the foreign company has with respect to its own business purpose, adequate business substance to engage in general commerce
3) more than 10% of the foreign company's gross income is derived from own business activities.
Taxand Germany discusses these requirements and analyses the implications of this tax relief.
If these requirements are not met by the foreign company, the German tax authorities will examine the company's shareholding structure. A bottom-up review will be carried out and if a shareholder (at a level further up the corporate chain) meets all the conditions, then relief will be granted in relation to the portion of that shareholder's holding, but if the shareholder is a resident of a non-treaty country, no relief from German withholding tax will be granted.
With respect to the 10%requirement, pure holding companies will not qualify for the relief, as the mere administration of assets is not considered to be active business. The exemption will apply only if the holding company engages in the active management of more than one subsidiary.
A foreign parent company is fully excluded from a potential relief, if the 10% threshold criteria is not met. For example, if a company derives 9% of the gross income from own active business activities, still such company would be disqualified. The anti-abuse provision does not allow any scope for submission of any proof to demonstrate that the structure in question is not abusive.
In light of the existence of the above provision, The European Commission initiated an infringement proceeding against Germany on 18 March 2010 on the basis that the 10% threshold was disproportionate. As a response to this infringement proceeding, sec. 50d para 3 ITA was amended by the "Law on the Implementation of the EU Mutual Assistance Directive and Other Changes in Tax Law" which was passed by the German Bundestag on 27 October 2011 to make the provision compliant with EU laws.
The amendment proposes to abolish the 10% income criteria. However, a foreign entity may only benefit from the double tax treaties or the parent-subsidiary-directive in relation to income generated from own business activities ,provided that there are economic or other substantial reasons for the establishment of the entity and the entity participates in the general market with appropriately equipped business premises. The revised provision still requires income from own business activities in order to be eligible for a refund, but now allows a partial relief if the total amount of income from own business activities is less than 10%.
In addition to this, the benefit under provision of double tax treaties or parent-subsidiary directive can also be availed if the foreign company's shareholders qualify for the same. According to the proposed law, the foreign entity has the burden of proof to demonstrate the existence of economic or other relevant reasons and the adequate business substance.
The amendments to the anti-treaty-shopping rules shall come into effect on 1 January 2012.
It is likely that foreign entities will benefit only to a limited extent from this amendment, namely foreign companies with a portion of not more than 10% income from own business activities which currently are fully excluded from the possibility to receive a refund of withholding tax on the basis of sec. 50d para 3 ITA. Based on the amendment, a partial refund will be possible for such companies in the future (provided the additional requirements of economic substance and the existence of economic reasons for the structure are given).
For the amendment to become effective, the consent of the German Bundesrat is required and this is scheduled to be considered towards the end of November 2011. The amendment is expected to come into force on 1 January 2012 without further changes.
The question is whether the above described amendment will be sufficient in the eyes of the European Commission. This amendment is not helpful for pure holding companies unless they decide to engage in the active management of their subsidiaries.
Non-German companies holding German companies should analyse whether the amendment to sec. 50d para 3 ITA can result in an extended refund.
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