date | theme

28. December 2020 | Overview of most important articles of the OECD-MA

11. January 2021 | Double Taxation and Double Taxation Agreement

08. June 2021 | Second home: avoid double residence under the DTA

31. August 2021 | Dividends: Taxation under the double taxation agreement

01. June 2022 | Agreement entitlement of partnerships – application of a DTA (this contribution)

Partnerships are treated differently for international tax purposes. Often, as in Germany, they are considered transparent. However, there are also countries in which partnerships are treated as independent legal entities for tax purposes. This results in considerable problems in the application of a double taxation agreement (DTA). These problems are explained and solved by this contribution. It is central that partnerships may be persons under agreement law (Art. 3 I lit. a) OECD MA) but are not resident in the absence of own income tax or corporate tax liability (Art. 4 I OECD MA). In the latter case, the individual shareholders are rather resident. It may therefore happen that partnerships in the countries assess the validity of agreements differently, which has different effects.

The tax assessment of a partnership depends on its taxability. This is relevant for cross-border situations for the eligibility of agreements, for the assessment of the type of income and the eligibility of foreign tax according to § 34c EStG. The authorization of the agreement means that a legal entity can invoke the DTA and also experience the negative effects of the DTA. The latter must be observed in particular from the point of view that a DTA should also avoid double non-taxation.

Partnerships are treated transparently in Germany. This means that it is not they themselves but their shareholders who are subject to taxation. Consequently, the shareholders earn income from commercial co-entrepreneurship in accordance with § 15 I 1 No. 2 EStG. By contrast, corporations are independent tax entities and are themselves subject to corporate tax. In international transactions, the assessment depends on whether the foreign legal entity, according to its legal structure and economic position, is generally more comparable to a taxable entity or to a majority of persons whose income is taxed pro rata with the members.

Determining the residency of the partnership is uncomplicated if the partnerships are treated uniformly in both contracting states with regard to their tax subject status. The partnership is therefore entitled to agreements if it is an independent tax entity in both contracting states. It is not, however, if it is not taxable. In the latter case, the shareholders are entitled to agreement. Therefore, shareholders may invoke the benefits of the Agreement if they are domiciled in the other Contracting State. If they are resident in a third country, the eligibility of the agreement is governed by the double taxation agreement with that country. If the partnership is entitled to agreement per se, its residence is also decisive for the applicability of a DTA.

The identical treatment of partnerships in the two Contracting States therefore ensures the uniform application of the DTA with uniform legal consequences if they are domiciled in the Contracting States.

If the shareholder is resident in a third country which treats the partnership differently from the contracting states, this causes a problem. For example, the distribution can be made from Austria to Germany, but the shareholder can be based in Dubai. In this case, however, the partnership may also be entitled to agreement with the shareholder. Thus, the source state must apply the more favorable DTA for those entitled to agreements.

The partnership can be recognised as an independent tax subject in the State of residence of the shareholders in contrast to the State of the partnership, i.e. the State of source. Then the source country must grant the benefits of the agreement which the shareholder is entitled to on the basis of the DTA concluded with their country of residence. In the State of residence of the shareholders, the proceeds from the foreign company are then taxed in accordance with the provisions of national law as dividends of an independent company. (In Germany: Parts income procedure, withholding tax or box privilege)

If the partnership is regarded as a tax subject in its country of residence but not in the other contracting state, i.e. in the country of residence of the shareholders, it is resident in the country of residence in accordance with Article 3(1)(a), (b) of the OECD MA. Therefore, the partnership is entitled to agreements. The distributions are then, under agreement law, dividends. Consequently, they are also taxed as such by the shareholders. However, the limiting effects of the agreement which are linked to the partnership's validity are directed in one state against the taxation of the partnership itself and in the other state against the taxation of the shareholders.

Foreign partnerships usually cannot claim relief from domestic withholding taxes due to a DTA. Rather, the partnership partner must request discharge. Decisive for this is the DTA of its State of residence with Germany. In German double taxation agreements, partnerships are sometimes partially granted the right to treaties. This should serve to be able to demand the refund of domestic withholding tax on the part of foreign partnerships.

The use of assets in the sense of fruit production is referred to as asset management, whereas the use of substantial assets by reallocation takes a backseat, see § 14 p. Then the shareholders earn surplus income. The partnership is then not subject to trade tax due to lack of commercial activity. Consequently, the profits of the partnership are not corporate profits within the meaning of Article 7 OECD MA. The income is therefore individually allocated to the special income items. In the case of a zebra company, the activities are to be legally separated under DBA. Then individual shareholders are treated differently. Therefore, you should regularly check the impact of your activity on your agreement eligibility and not assume that you will be treated identically to the other shareholders in each case.