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Germany: Fiscal Court rules substance requirements under Cadbury-Schweppes exception to CFC taxation


Alexander Linn

Thorsten Braun

Germany's controlled foreign corporation (CFC) rules apply to CFCs earning passive income that is taxed at a rate of less than 25%. However, the rules do not apply to subsidiaries located in the EU/EEA if the Germany taxpayer can demonstrate that the subsidiary carries on a genuine economic activity in its state of residence (Cadbury-Schweppes exception, see ECJ, C-196/04). There is scant case law on what constitutes a genuine economic activity for these purposes.

In a recent case before the Lower Fiscal Court of Münster, a Cyprus-resident subsidiary of a German parent company had office space available and one resident employee in Cyprus. The Cyprus entity was engaged in the acquisition of publishing rights for Russian and Ukrainian books; the authors contracted with the Cyprus entity, which then granted an intercompany licence for an arm's-length royalty paid to group subsidiaries in Russia and Ukraine. There was contact between the authors and the publishing group through the local subsidiaries, but the authors contracted only with the Cyprus entity. The royalties were considered passive income and were benefited from low taxation in Cyprus.

The Münster court held that interposing the Cyprus entity to receive the royalties paid by the Russian and Ukrainian subsidiaries instead of the German parent constituted a wholly artificial arrangement because the entity did not conduct a genuine economic activity in Cyprus. The court held that the entity did not use the local resources and the German taxpayer failed to present sufficient business reasons why the licensing activities had to be performed in Cyprus (rather than Germany). Some of the court's conclusions regarding the scope of the EU freedom of establishment and the impact of outsourcing seem questionable. As the decision was appealed, the Federal Tax Court will have the final say on the issue (pending case reference I R 94/15).

Alexander Linn (; and Thorsten Braun (


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