German Add-on taxation in the case of third countries

Published: 14 Oct 2020

Under sec. 7 (1) Foreign Tax Act (AStG), income from so-called intermediate companies (companies generating income within the meaning of sec. 8 AStG with registered office or business operations outside Germany, in which German unlimited taxable persons hold an interest of more than 50%) is taxable in Germany in the amount corresponding to the (domestic) participation in this intermediate company. The intermediate company is negated for this part of the income (supplementary taxation). In addition, sec. 7 (6) AStG regulates the special additional taxation of so-called interim income of an investment nature (sec. 7 (6a) AStG); in this case, a 1% shareholding is sufficient to trigger additional taxation in accordance with sec. 7 (1) AStG.

In its ruling on December 18, 2019 (Ref. I R 59/17), the Federal Court of Finance (BFH) commented on the application of sec. 7 (6) AStG in relation to subsection 1. Accordingly, the provision contained in sec. 7 (6) AStG regulating the addition of interim income of an investment nature is no longer of independent significance if the conditions for (general) add-back taxation in accordance with sec. 7 (1) AStG are already fulfilled. In addition, the BFH clarified that activities that are economically related are to be uniformly subsumed under sec. 8 (1) AStG in the sense of the functional approach; exceptions to this are only possible for individual activities with a considerable economic weight. That means, that activities which are generally of active nature might be treated uniformly with passive income if functionally related and might be entirely subject to German add-back taxation.

The case concerned the participation of two domestic GmbHs in a Hungarian holding company (Kft), with GmbH1 holding only 0.0037% and GmbH2 holding 99.9963%. At the end of 2004, the Hungarian holding company had holdings in a total of 13 markets operating in Hungary, each of which was also organised in the legal form of a Kft. The holding company provided central services to its subsidiaries (e.g. assistance in opening and expanding the Hungarian company, purchasing and sales consultancy, accounting, marketing). In the years 2000 to 2003, the Hungarian holding company mainly generated income from the granting of loans to the Hungarian subsidiaries. The loans were refinanced from equity and from loans provided by the GmbH2.

Corporate income was taxed at 18% in Hungary until 2003; from 2004 the tax rate was reduced to 16% (low taxation as defined in the AStG). Hungary joined the EU on May 1, 2004.

In the opinion of the tax office, the interest income of the Hungarian Holding-Kft was so-called passive income within the meaning of sec. 8 (1) no. 7 AStG, which was subject to add-back taxation. On the other hand, the services provided to the subsidiaries were to be subsumed as active activities under sec. 8 (1) no. 5 AStG.

Accordingly, it determined corresponding additional amounts for the years 2000 to 2003 (assessment years 2001 to 2004), which in turn were allocated as add back income to the domestic parent companies in accordance with their shareholding quotas.

The lower instance (Finanzgericht, FG) followed the view of the tax authorities and dismissed the action.

The appeal lodged against this was largely successful; the BFH considered the appeal to be unfounded only for the marketing year 2000 (assessment year 2001). According to the BFH, the transactions were subject to general additional taxation under sec. 7 (1) AStG and thus sec. 7 (6) AStG was of no independent significance. The granting of credit and the provision of services were not considered by the BFH under the facts of sec. 8 (1) no. 5 AStG (active activity from a functional point of view) since there was no functional economic connection between the service activities performed by the holding company and the granting of credit. The domestic limited liability companies were not entitled to provide counter-evidence in the context of a so-called “motive test”, as this was only introduced in 2008 and moreover is not applicable to third countries (Hungary joined the EU in 2004). An exemption under the Double Taxation Agreement with Hungary was also out of the question. The BFH concluded that, although the application of the additional tax leads to a restriction of the free movement of capital with a third country, the fundamental freedom of movement of capital was not applicable because of the so-called standstill clause.

For the remaining marketing years 2001 to 2003 (assessment years 2002 to 2004), the BFH considered that the inclusion of additional amounts infringes the freedom of movement of capital under European Union Law because of the restriction on the movement of capital with a third country. The BFH considered that the restriction could not be justified on overriding reasons in the general interest and, in particular, on the basis of the prevention of tax evasion and tax avoidance. In its judgment of May 22, 2019 (Ref. I R 11/19), the BFH decided, following the judgment of the European Court of Justice (ECJ) “X” on February 26, 2019 (Ref. C-135/17), that the addition of interim income of an investment nature from a company established in Switzerland leads to a restriction on the free movement of capital contrary to European Union Law. In the present case, therefore, the same applies since Hungary joined the EU later in 2004. The standstill clause is not applicable because of the changes in law which took effect on January 1, 2001. Furthermore, the BFH assumed, based on a binding finding of the FG (lower instance) that the shareholdings of domestic limited liability companies in the Hungarian holding company were not based on an artificial arrangement. Confirmation by the Hungarian authorities was not required in this case.

Due to the growing international interdependence of corporate and group structures, the provisions of the AStG are becoming increasingly important. Additionally, particularly due to the tightening of the regulations of foreign tax law, tax payers should pay attention to the formation of different income, that partly may be classified as passive income, as a functional unit from a functional perspective within the meaning of sec. 8 (1) no. 1 to 10 AStG.

We are happy to support you in the verification of foreign (interim) income and in the corresponding appeal procedures.

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Arell Buchta

Firm: Eureos Gmbh - tax, legal, audit, advisory
Country: Germany

Practice Area: Tax Advisory

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