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Former German Thin Capitalisation Rules not Compliant with Treaty Discrimination Article


The history of the German thin capitalisation regulations is one of the constant changes caused by the conflict between the government to secure national revenue and the judicative preventing discrimination amongst taxpayers. Taxand Germany highlights the particular rules that have been challenged.

It was already established in the past that thin capitalisation rules did not comply with the freedom of establishment provision of the EC treaty and thus not to shareholders resident within the European Community (EC). The reason being that cross border shareholder loans were treated more strictly than intercompany between German entities loans.

Now, the Supreme Tax Court has clarified in the latest decision that the rules also infringe the non-discrimination clause for companies resident in non-EC countries such as set forth in the double taxation treaty between Germany and Switzerland.

The thin capitalisation rules applicable until 2003 stated that interest paid to non-residents would be re-characterised as a deemed dividend distribution if the allowed total debt-to-equity ratio (safe haven) was exceeded and no exemption was available.

In the case now decided by the Supreme Tax Court interest payments at arm's length conditions were made by a German company to its Swiss resident shareholder. A tax audit later applied the German thin capitalisation rules and thus re-classified the interest payments to deemed dividends. Although the Supreme Tax Court confirmed the application of the national tax rules in principle, their application became ultimately prevented by the non-discrimination clause of the double tax treaty between Germany and Switzerland. The non-discrimination clause set forth in Section 25.3 of the treaty states that a German company with a Swiss shareholder must not be treated differently from a company with a German shareholder. The wording of the non-discrimination clause corresponds with Section 24.5 of the OECD model treaty.

As a result the interest paid by the German company was deductible for German tax purposes.

Taxand's Take

The decision by the Supreme Tax Court affects cases in which inter-company interest payments to non-EC shareholders were challenged based on the thin capitalisation regulations applicable until 2003. As the specific non-discrimination clause corresponds with the OECD model treaty the decision will be relevant for a significant number of corporate shareholders resident in non-EC states.

To the extent the relevant years are still open and deduction of interest expenses should be applied when referring to the decision above.

Your Taxand contact for further queries is:
Arianne Jerey-Hener
T. +49 6196 5922 4810

Taxand's Take Author