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Germany: CFC rules regarding third countries referred to CJEU

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Germany's Federal Tax Court (BFH) has doubts that the German controlled foreign company (CFC) regime applicable to passive income with an investment character is in line with EU law and, therefore, the BFH referred a case (C-135/17) to the Court of Justice of the European Union (CJEU).


Alexander Linn

According to the BFH, the fact that a German shareholder is not permitted to demonstrate that subsidiaries located outside the EU/European Economic Area (EEA) carry out genuine commercial activities could violate the free movement of capital in Article 63 of the Treaty on the Functioning of the European Union (TFEU).

Under the rules, certain profits that are considered passive income of a CFC that is resident in a low tax jurisdiction and controlled by German resident shareholders may be attributed proportionally to those shareholders and included in their taxable income. Based on legislation implementing CJEU case law, where the foreign company is located in another EU/EEA member state, the German shareholder has the right to demonstrate that the CFC carries out genuine commercial activities (motive test), and if the shareholder meets this burden, no CFC income will be attributed to the German taxpayer. However, the motive test is not applicable to CFCs that are resident outside the EU/EEA, which potentially results in a restriction on the movement of capital between member states and third countries.

The case referred to the CJEU involves a German corporation that held 30% of the shares in a Swiss resident company. The Swiss company received passive income of an investment nature from factoring activities, which was considered by the German tax authorities to be passive income from financial transactions and which was taxed at a low rate in Switzerland. The profits were attributed proportionally to the German shareholder and included in its taxable German income. According to the German tax authorities, the German shareholder was not entitled to invoke the motive test with respect to its Swiss CFC because Switzerland is not part of the EU or the EEA.

The BFH argues that Article 63 of the TFEU and not the freedom of establishment applies because the German CFC-rules are applicable to a holding of 1% (or even less) if the foreign company is engaged in the business of certain financial transactions. Even for regular passive income, it is sufficient if any number of German resident shareholders owns the majority of the CFC. In a purely domestic situation, there would be no attribution of passive income with an investment nature.

Therefore, the BFH has requested a preliminary ruling from the CJEU on the following issues:

  • Whether the restriction on the free movement of capital is permissible under the "standstill" clause in Article 64 of the TFEU, even though the scope of Germany's CFC rules have been subsequently expanded and technically amended after 1993; and

  • If the German rule is not safeguarded by the standstill clause, whether the CFC rules violate the free movement of capital provisions because a German shareholder with subsidiaries in a third country does not have the right to demonstrate that the subsidiary carries out genuine commercial activities.

Taxpayers that previously have been assessed on CFC income attributed from third-country CFCs should review and potentially challenge their assessments in the event that the CJEU issues a taxpayer-favourable decision.

Alexander Linn (


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