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European Commission attacks German anti-abuse provision on withholding tax relief

27 May 2010

Over the past few years German tax law has increasingly been influenced not only by German legislative and judicial forces / authorities but also by European institutions, such as the European Court of Justice and the European Commission. With its recent request of 18 March 2010 the European Commission moved forward with the second step of the formal infringement procedures against Germany concerning the anti-abuse provisions on withholding tax relief affecting EU holding companies specifically. Taxand Germany reviews these provisions and garners reaction on the impact from Taxanders across Europe.

In principle Double Tax Treaties, the EU Parent-Subsidiary-Directive as well as EU Interest-and-Royalty-Directive provide for the reduction or even exemption from withholding taxes on, for example, dividend payments by German companies to their foreign corporate (intermediate) shareholder. The Directives allow the individual member countries a certain amount of tolerance with regard to the application.

The current national regulations applicable for Germany deny withholding tax benefits to a non-resident (intermediate) company if any of the following conditions (substance requirements) are met:

  • there is no economic or other relevant reason to establish the foreign company
  • the foreign company does not earn more than 10% of its gross income from own its economic activity
  • the foreign company has no adequate business premises for its activities.

The German legislator aims to prevent foreign companies from choosing structures that mean they benefit from favourable treaty provisions only, rather than choosing structures for business considerations. Germany introduced the second condition stated above. From 2007, in addition to adequate premises and a non-tax reason for the interposition of the foreign company, German law requires that more than 10% of the gross income must be earned from the foreign company's own business. Furthermore, to be eligible for withholding tax benefits businesses must not meet any of the conditions stipulated above.

The international tax community has already reacted to the introduction of this legislation. The various substance requirements and economic or business rationale of using holding companies has already impacted the use of intermediary holding companies. For Taxand Malta further tightening of the anti-abuse provision makes it extremely difficult to use holding companies in tax planning structures involving Germany.

Taxand Netherlands considers the current German anti-abuse provision to be understandable from a German point of view however deem there to be substantial overkill in it from their perspective. Currently the withholding tax relief in Germany is questioned by businesses with Dutch holding structures. The request from the EU commission is welcomed by Taxand Netherlands and should also help ease the administrative burden for businesses.

Indeed, international tax planning efforts concerning German investments have increased in recent years.

For Taxand Luxembourg discrimination of foreign companies adds an element of uncertainty for foreign investors who want to invest into Germany. With various German investments held by Luxembourg holding companies not only will Taxand Luxembourg be watching developments in Germany with great interest over the forthcoming months, but international tax practitioners and investors too.

Likewise Taxand Cyprus will find it interesting to see how Germany handles the European Commission's request. Taxand Cyprus expects existing legislation is likely to be revised allowing for an alternative means of establishing genuine economic activity. For them, should this happen, Cypriot holding companies may be in a position to reclaim withholding tax relief and restructuring may be required.

In its request the European Commission now concludes that the requirement for economic activity is disproportionate in its typical application to prove that the contrary is not available to the foreign company. With this condition Germany did eventually exceed what was necessary to meet its objective of preventing tax avoidance. EC law and related European case law require from its member states such as Germany to review each individual case rather than applying general standardised requirements. Taxand UK sees that the trade off appears to be an increased administrative burden against a consistent EU model, when it should be possible to have the latter without the former. From a UK perspective treaty override provisions do not help foreign direct investment.

Germany has been granted a two month period until 18 May 2010 to respond; since this has now passed the Commission has to decide to bring this matter to the European Court of Justice.

Taxand's Take

The German anti-abuse provisions concerning withholding tax benefits on dividends and licence payments were heavily criticised when first introduced as they significantly increased tax planning efforts and even presented an element of uncertainty for foreign investors to invest in Germany.

Taxpayers being denied withholding tax reliefs or withholding tax refunds based on this provision should take the appropriate steps to keep their cases open for the time being to be in a position to reclaim withholding tax relief in case of an amendment of the German anti-abuse regulations.

The European Commission in particular criticises a lack of proof of the contrary in the German anti-abuse provisions. Thus, in principle Germany could remedy the concerns of the European Commission by introducing the possibility for foreign companies not meeting the substance requirements to provide proof of the contrary. However, as of now no official reaction from Germany has been put forward and Germany has allowed for the deadline of 18 May 2010 to expire without providing any comment. It would seem they would rather await the reaction from the European Commission. Watch this space for new developments.

Your Taxand contacts for further queries are:
Ulrich Siegemund
T. +49 6196 592 16364

Sophie Stylianou
T. +357 2269 9222

Peter Kleingarn

Walter Cutajar
T. +356 2730 0045

Wally van Hall

Shiv Mahalingham
T. +44 207 715 5234

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