BFH rules on application of German CFC rules to companies that outsource business activities to related management company

The Federal Tax Court (BFH) recently published a decision relating to the application of the German CFC rules to an Irish resident insurance company that outsourced all of its business activities to a related Irish resident management company (case reference I R 61/09). For income from insurance activities to qualify as “active income,” the CFC engaging in the insurance activities must have business operations that are set up in a businesslike manner.

In the case, a German resident insurance company set up an Irish subsidiary (“Dublin Docks company”) that was subject to an Irish reduced income tax rate of 10% on its income from reinsurance and investment activities. The Irish resident insurance company and two of its Irish resident sister companies had concluded management and services agreements with a related management company that was also resident in Ireland. The management company had its own office and employees and carried out the business of the insurance company based on the management and services agreement. All contracts with third party customers had been concluded by the management company on behalf of the insurance company. The insurance company was legally bound by the contracts and assumed the relevant risks and opportunities. In addition, only the insurance company - and not the management company - had the necessary regulatory permission to carry out activities in the insurance business. The Irish resident managing director of the management company was simultaneously the managing director of the insurance company and two of its Irish resident sister companies.

The BFH held that the Irish subsidiary qualified for the exception for insurance companies as it had to be considered to have business operations that are set up in a businesslike manner despite the fact that most of these activities were outsourced to a related management company. Although the BFH considered EU-law arguments not to be decisive, it continued to argue that the denial for the exception for insurance companies in the current case would also be in contradiction to the principles of the Cadbury-Schweppes decision of the European Court of Justice (ECJ).

The BFH did not apply the specific exception according to which the CFC rules are not applied if genuine commercial activities are carried out and if the mutual assistance directive or an exchange of information provision applied which was enacted following the ECJ decision in Cadbury-Schweppes. The BFH decision can nevertheless be expected to have implications for taxpayers outside of the insurance business as it offers a better idea of what the BFH may view as necessary substance to fall within the scope of the general EU/EEA exception by demonstrating that the CFCs engage in genuine economic activities in their country of residence. In line with the objective of the freedom of establishment, which is to promote the participation in the economic life of another Member State on a stable and continuing basis, the BFH does not consider outsourcing to violate substance requirements.

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