With an establishment in Spain, a German GmbH & Co. KG can save about 20% in taxes compared to a GmbH. For example, the local taxation of the profits of a permanent establishment in Spain is subject only to a general income tax of 25 %. However, the withdrawal of profits by Deutsche GmbH & Co. KG remains tax-free on the basis of the bilateral double taxation agreement, because from a German as well as from a Spanish point of view the taxation already took place in Spain and the Deutsche GmbH & Co. KG as a partnership in Germany is tax transparent. The withdrawal from a partnership is still not a profit distribution in Germany. So the withdrawal from the German GmbH & Co. KG remains tax-free for their shareholders. However, one must also consider and avoid a potential functional shift in this design. On the other hand, additional taxation can generally be excluded. And in the future, a move abroad will also do without an exit tax.

In international tax law, the permanent establishment plays an important role in the allocation of tax law. In many cases, it is the focus of the relevant regulations in international double taxation agreements. In addition to the place of management, it is therefore an important element to pay attention to when drawing up tax arrangements in international tax law.

In this article we want to present a special design by means of a company in Spain. It allows taxation to be advantageously limited to a total of 25 % of profits. Furthermore, it is accompanied by only limited framework conditions, which must be observed in its application. Although there are certain risks of a general nature, these can be estimated and addressed very well in advance. In this respect, this model represents a moderate design.

Let’s get into our topic right away with the design model. In doing so, we assume that a German entrepreneur either already owns a GmbH & Co. KG in this country or starts a new company. This partnership now establishes a permanent establishment in Spain. There, the entire operational activity of the company actually takes place. It is thus conceived as a fully-fledged, autonomously functioning permanent establishment and therefore by no means resembles a mailbox company, which is often suspect from a tax point of view, as it is sometimes found in infamous tax havens.

Consequently, it is the establishment in Spain that generates the profit of the company. If one now takes a look at the German-Spanish double taxation agreement (DTA) in the course of clarifying the question of which state is entitled to taxation, one finds that the permanent establishment in Spain is the decisive factor. According to Article 7 of the DTA, taxation in this case takes place in the country where the permanent establishment is located. This is in accordance with the so-called establishment principle, which is the basis of most bilateral DTAs worldwide, but at least those that comply with the OECD Model Agreement.

For this, however, one must also pay attention to the definition of the term permanent establishment. Article 5(2) of the DTA provides detailed information on this. As already mentioned, a permanent establishment exists as such if it corresponds in particular to a commercial activity in the broadest sense.

The permanent establishment in Spain is subject to domestic taxation. More specifically, the Spanish income tax is imposed on non-residents. It amounts to 25 % of the profit generated by the establishment in Spain. The remaining 75% will then be owned by Deutsche GmbH & Co. KG.

In doing so, we are leaving the tax framework in force in Spain and changing our perspective by focusing on the German GmbH & Co. KG. GmbH & Co. KG in Germany thus receives the profit generated by the establishment in Spain via a withdrawal. Thus, this profit as withdrawal is not a taxable profit in the sense of German income tax law. Accordingly, this withdrawal in Germany remains without tax consequences.

Consequently, even a withdrawal that the shareholders of GmbH & Co. KG can now make is completely tax-free for them. So the only 25% of the tax levied by Spain on the establishment in Spain remains.

Because on the one hand you have already paid taxes on the profit in Spain, so that in Germany even in the case of taxation an exemption would apply. On the other hand, from the point of view of the Spanish financial authorities, the continued taxation of profit in Germany is of no importance to them. As long as their own taxation law is comprehensively taken into account, that of the German fiscal authorities is of no relevance to them. The fact that the Deutsche GmbH & Co. KG as a partnership with us is a transparent tax entity in which the shareholders alone bear the tax liability plays no role for them. This is especially true because from a tax point of view in Spain only a uniform corporate taxation takes place under the corporate tax. The tax transparency of a German partnership, for example, is completely unknown in Spain.

In addition to observing the definition of a permanent establishment as contained in the DTA, there are some other points in international tax law that must be considered.

The first point concerns the assessment of the potential additional taxation in Germany. It arises in this country if a company in low-tax foreign countries, in which a German corporation is involved, does not take into account certain rules. For our case, however, this is irrelevant, because we have a partnership in Germany. However, in order to be able to obtain the exemption of the profits of the establishment in Spain, one must pay attention to further regulations in this regard in the DTA itself.

So it is important that the permanent establishment in Spain generates so-called active income corresponding to those of the income listed in § 8 AStG. This includes in particular income from business operations and self-employment. We therefore assume that the establishment in Spain actually pursues the goal of generating such active income. In addition, this approach is subject to the condition that the low-tax foreign country levies a total income tax of less than 25 % of profit. Thus, in our design model, we have also fulfilled this condition for avoiding additional taxation in Germany.

Another aspect of our design model by means of a permanent establishment in Spain concerns tax de-entanglement. More specifically, we must ensure that there is no relocation of functions. Because if you relocate certain functions of a company based in Germany abroad, this can trigger tax consequences in this country. Therefore, we now consider the criteria that characterize a relocation of functions.

This includes, for example, the outsourcing of production capacities, research facilities or marketing departments. As long as only an extension of functions already existing in Germany takes place, this remains without tax consequences. On the other hand, a reduction or even complete transfer of such structures from Germany to abroad leads to a de-tricking tax, which is similar to an exit taxation for GmbH shareholders.

Speaking of exit taxation, let’s look at this aspect as part of our design model. We assume that the shareholder of GmbH & Co. KG would like to move to Spain in the future. We can distinguish between two relevant sub-items, namely the place of management and the exit tax.

The place of management of Deutsche GmbH & Co. KG generally remains in Germany. And since the company in Spain is not an independent company that requires its own management, we have the freedom of choice when locating the management. Nevertheless, it is important for the implementation of our design model that the company is completely self-sufficient.

Thus, with regard to residency, there is also free choice for the managing directors. But you have to pay attention to the exit tax. However, the exit taxation only applies to shareholders of a German corporation. Since a GmbH & Co. KG is a partnership, we can manage in this respect without incurred an exit tax.

Nevertheless, it must be borne in mind that in most cases the limited partner in the GmbH & Co. KG is also 100 % owned by the company and thus owned by a corporation. This share would therefore normally be subject to an exit tax. However, such a participation in a general partner GmbH belongs to the special assets of GmbH & Co. KG instead of to the private assets of the shareholder. Therefore, there is no exit tax on this shareholding of the limited partner.