date | theme

31. December 2018 | Additional taxation: Recognition / Avoidance / Designing with example

03. March 2022 | DTA and additional taxation under Union law

24. June 2022 | Double taxation in the case of additional taxation: Avoidance by the ATAD Directive

01. July 2022 | Reduction amount in the case of additional taxation (§ 11 AStG n.F.): Profit distributions by foreign companies

If passive and low-taxed income of a foreign company is available according to § 8 (1) AStG, this company is an intermediary company. The income is then added to a substantially participating domestic company (attribution taxation). This can be prevented by a counter-evidence according to § 8 paragraph 2 AStG. We explain how you conduct it and to whom you need to present what information.

The legal consequences of additional taxation are generally triggered when an unrestricted taxpayer controls a foreign corporation and that corporation generates low-tax income from passive activity. Income from passive activity is income that does not come from the active activities listed in § 8 (1) AStG. Therefore, income from active activity does not trigger additional taxation.

In § 8 paragraph 2 to 4 AStG, the legislature has inserted an exculpation clause. This allows the domestic shareholder of a foreign company to prove that it carries out a significant economic activity. The legal consequence of successful proof to the contrary is that the company is not qualified as an intermediary company and therefore does not fall under the provisions of German additional taxation. As a result, the income actually classified as passive is no longer subject to additional taxation.

This requires a substantial economic activity in the foreign company. This must be carried out independently and independently using the material and human resources necessary for the performance of the activity and requires adequately qualified staff. In addition, the business relationships must comply with the arm's length principle (§ 1 AStG). In addition, the counter-evidence is spatially limited.

According to § 8 (2) Statz 2 and 3 AStG, it should be a prerequisite for the exercise of a substantial economic activity that the necessary equipment and sufficiently qualified personnel with independent and self-responsible activity are available. Therefore, no significant economic activity can interfere if the company has its activity carried out predominantly by third parties. The explanatory statement refers to the tangible presence in the form of business premises, staff and equipment. In addition, the company should be designed in a factual and personnel perspective in such a way that it can make its own business decisions. The simple licensing as an asset management activity does not require a special business appart. According to the case-law of the ECJ, it is therefore sufficient for the real economic activity in the State of establishment to be directed towards a stable and continuous participation in trade.

According to § 8 paragraph 3 AStG, the counter-evidence is limited exclusively to EU and EEA companies. It is therefore not eligible for participation in third country companies. Regarding the old legal situation, the Federal Finance Court (BFH) and the European Court of Justice (ECJ) have ruled that the counter-proof should also be possible in third-country cases under recourse to the free movement of capital. The reason for this was that § 7(1) and § 7(3) AStG of the old version conceivable constellations in which there was no control under company law. In these cases, therefore, there was no certain influence on society which would result in the intervention of the freedom of establishment. That is why only the free movement of capital came into consideration, so that the whole regulation would have to be examined on the basis of the free movement of capital.

Whether this is also to be assumed under the new version of § 7 (1) and § 7 (2) AStG is assessed differently and has not yet been decided. The problem is that in Article 7(2) of the ATAD Directive, Member States are given the opportunity to prove against EU and EEA companies. Accordingly, the Member States may deny the possibility of proof against third-country society. Then the question arises as to whether secondary law can or cannot infringe primary European Union law.

The business relationship which establishes the passive income and via which the counter-evidence is to be employed must comply with the arm's length principle of § 1 AStG (third-party settlement clause). In this way, the legislator intends to counteract group-related design models in which a group parent company carries out comparatively insignificant service functions with a minimum of material equipment in a European low-tax country, but also carries out an intra-group financing activity with the participation of domestic group companies to a considerable extent, whereby significant financing income is achieved. The latter would otherwise escape additional taxation.

The reference to § 1 AStG practically extends the transfer price documentation obligations of domestic taxpayers. However, this is not comprehensible, since, firstly, because of the priority of § 1 AStG and the provisions of § 10(3) AStG for the hidden distribution of profits and contribution, only adequate income is recognised for the additional taxation.

Substance testing and activity testing of the counter-evidence must always refer specifically to the respective passive income. If the low-taxed company receives income from different activities, the proof of substance is therefore necessary for each of these activities.

The foreign company may receive hidden profit distributions from a subsidiary. These hidden profit distributions can lead to passive and low-taxed income of the foreign company according to § 8 (1) no. 7 (a) sentence 1 AStG. Then they are subject to German additional taxation at a domestic shareholder. In this case, you should also consider whether you prevent the taxation of passive shareholding income by the counter-evidence in § 8 (2) AStG. There are some problems.

First of all, the requirement to comply with the arm's length principle could justify that the possibility of counter-evidence for hidden profit distributions is never in question. The BFH case law clarifies the ranking between the income correction, the arm's length principle and the additional taxation. Accordingly, a corresponding correction of non-common business relationships by way of hidden distributions of profits and hidden deposits already has to be made when determining the income underlying the additional amount. It is therefore not possible, in terms of logic, to subject non-compliant income to additional taxation.

As a result, the possibility of counter-evidence of passive income from hidden distributions of profits does not therefore fail because of the third-party settlement clause laid down in § 8(2), fourth sentence, of the AStG. This also seems reasonable, since the income that accrues to the foreign company in the form of the concealed profit distribution received ultimately arises precisely because of the observance of the arm's length principle.

Then the question arises as to what specific requirements are to be made of the counter-evidence in the case of additional income from hidden profit distributions. It is problematic that the income underlying the hidden profit distributions often does not exist under foreign law.

There is no activity in the actual sense. Rather, the distribution of profits constitutes a one-off situation. The counter-evidence, on the other hand, requires a consideration of the respective passive income and not of the activity of society as a whole. It is therefore questionable as to which activity the counter-evidence is to be carried out.

The economic activity for receiving profit distributions must be proven. However, the substance for the provision of services and supplies which may be the basis for the distribution of profits must not be disclosed. On the one hand, deliveries and services must be evaluated according to completely different criteria. On the other hand, constellations in which the foreign company receiving the hidden distribution of profits is not a service provider but a service recipient could not be sufficiently examined. Therefore, it is not appropriate to examine whether the foreign company has sufficient substance for carrying out the transaction underlying the distribution of profits.

The requirements for the counter-evidence for hidden profit distributions could be derived from § 50d paragraph 3 EStG. Both § 50d(3) EStG and § 8(2) AStG are based on the idea of preventing the abuse of foreign companies without sufficient substance.

Since the participation of the providing subsidiary is the source of income for the profit distribution received, the substance requirements of the material economic activity could be measured by the quality of the investment management of the foreign company. However, it must not be necessary to meet the high requirements of active participation management. According to the case law of the ECJ on § 50d(3) EStG, the mere passive management of participations is sufficient to exclude a purely artificial arrangement. Passive shareholding management requires that the company actually exercises its rights as a shareholder, such as convening the shareholders’ meeting, making distribution decisions or, for example, approving the annual accounts. On the other hand, only minor demands must be placed on the material and human resources of society.

The counter-evidence to avoid additional taxation requires proof that the foreign company carries out a substantial economic activity. This requires adequate documentation. Problems arise in particular when passive income concerns hidden profit distributions. We are happy to advise you on this.