Germany: German anti-treaty shopping rules under scrutiny

Alexander Linn

The Tax Court of Cologne has referred three separate cases regarding the application of Germany's anti-treaty shopping rules to the Court of Justice of the European Union (CJEU). The court questions whether the rules are compatible with the freedom of establishment principle in the Treaty on the Functioning of the European Union (TFEU) and/or the EU Parent-Subsidiary Directive.

Two of the cases involve the anti-treaty shopping rules that applied during the period 2007-11, and were referred to the CJEU in 2016 (pending as C-504/16, Deister Holding) and August 31 2016 (pending as C-613/16, Juhler Holding). These rules were amended from 2012 in response to an infringement proceeding initiated by the European Commission. In a decision dated May 17 2017, the Tax Court of Cologne referred the current version of the anti-treaty shopping rules (section 50d (3) EStG) to the CJEU.

In all three cases, a foreign entity had requested a refund of German withholding tax on dividends, which was denied based on the anti-treaty shopping rules. Under these rules, foreign entities receiving payments subject to German withholding tax will be entitled to a reduction of withholding tax only to the extent they meet either a shareholder test (similar to a derivative benefits test) or business income test (i.e. earn income from active trading activities), unless the entity meets both a business purpose and a substance test.

While the reason for the denial of benefits was slightly different in each case, the main elements of the cases and the EU law aspects are similar: a German entity in a similar situation would benefit from a tax exemption without having to meet any further requirements, but a non-resident entity seeking relief from German withholding tax must meet very strict substance and/or business purpose requirements. The Tax Court of Cologne considers this disparity in treatment to be a restriction of the freedom of establishment. Because the rules are so stringent, the court also stated that the restriction cannot be justified by the need to prevent tax avoidance since it goes beyond what is necessary to achieve that objective (proportionality principle). The court also stated that even the revised rules violate the proportionality principle and cannot be justified.

Since the German anti-treaty shopping rules are so strict and often apply in situations that are not driven by a tax avoidance motive, the outcome of the cases will be important for German inbound investors. Foreign taxpayers that suffered withholding tax on German dividends due to the application of the anti-treaty shopping provisions should monitor developments and keep relevant assessments open.

Alexander Linn (allinn@deloitte.de)

Deloitte

Tel: +49 89 29036 8558

Website: www.deloitte.de