On 24 January 2012, the German Ministry of Finance (BMF) issued guidance on the interpretation of the amended anti-treaty shopping rule that came into effect on 1 January 2012. The guidance aims to clarify relevant terms and some of the practical questions associated with the amended rule. In their guidance, the tax authorities also state that they will apply the amended rule (and the guidance) to all pre-2012 cases if they are not yet final and if the application of the rule is to the taxpayer’s benefit.
The tax authorities’ interpretation of the anti-treaty shopping rule may actually make the requirements for withholding tax relief even more difficult to meet in practice. This will be the case, in particular, for companies that do not qualify as a management holding company. It is likely that the new approach for the determination of withholding tax relief will lead to significant additional documentation obligations for all foreign holding companies, except for those with an ultimate parent company that is listed on a stock exchange or a qualifying investment vehicle.
For foreign holding companies with an ultimate parent company that is listed on a stock exchange (or that is a qualifying investment vehicle), the withholding tax situation should remain unchanged in many cases. Provided all interposed entities are resident in a tax treaty/EU directive country with the same level of withholding tax relief, the new apportionment mechanisms described in the guidance should not be relevant.
For all other taxpayers, it will be important to analyze the gross receipts of the foreign holding company to determine whether “harmful” activities exist when applying for a German withholding tax exemption certificate. In many cases, structuring possibilities should be available to reduce the impact of these activities on the German withholding tax position. However, ongoing monitoring of activities and income streams will be required to ensure that taxpayers will be able to comply with their notification obligations under the guidance.
Although the wording of the amendment to the anti-treaty shopping rule was agreed with the European Commission, it is doubtful that the interpretation of the rule is in line with EU law. Specifically, there is a high likelihood that the new interpretation violates EU law in cases where the German entity is actively managed and German withholding tax relief is denied merely because the foreign holding company – in addition to the German dividend income – earns other income from “harmful” activities that are unrelated to Germany.
Under domestic law, Germany levies a 26.375% withholding tax (including the solidarity surcharge) on dividends (and certain types of profit participating interest) and a 15.825% withholding tax (including the solidarity surcharge) on royalties paid by a German corporation to foreign shareholders/recipients. Withholding tax relief under the EU Parent-Subsidiary Directive, the Interest and Royalties Directive and applicable tax treaties usually can be obtained either by applying for a withholding tax exemption certificate before the payment is made (and complying with certain requirements) or by requesting a refund after the payment is made. Both forms of withholding tax relief are subject to the German anti-treaty shopping rule.
In response to an infringement procedure initiated by the European Commission in 2010, the German government amended the anti-treaty shopping rule (effective from 1 January 2012). According to the revised wording of the rule, a foreign company that receives a payment subject to German withholding tax will be entitled to withholding tax relief to the extent:
If the foreign company fails both tests, the company will be entitled to withholding tax relief only if it meets both of the following two additional tests:
The shareholder test, therefore, will determine the personal entitlement for withholding tax relief/reduction. The business income, business purpose and substance tests will determine the factual entitlement to withholding tax relief.
The new guidance clarifies that the look-through approach still applies when determining personal entitlement to relief:
The following cases illustrate how the formal/personal entitlement of the shareholder should be determined, see examples.
As in the past, a foreign holding company which is a listed entity or a qualifying investment vehicle enjoys certain benefits for determining whether it is entitled to withholding tax relief. Such taxpayers will not be required to meet the new business income, business purpose and substance tests provided they are personally entitled to withholding tax relief (i.e. protected by a tax treaty or an EU directive).
If a foreign holding company is held directly or indirectly by a listed company, the personal entitlement of each interposed company would need to be reviewed (see above). If each interposed entity is personally entitled to the same (or a higher) withholding tax relief as the ultimate parent, the additional tests regarding business income, business purpose and substance would not need to be tested at each level (see Example 1 below).
However, if one of the interposed entities is only entitled to lower withholding tax relief than the ultimate listed parent, the factual entitlement at the level of the lower tier entities should be reviewed (i.e. perform the business income, business purpose and substance tests) to determine whether one of them is factually entitled to a higher withholding tax relief (see Examples 2 and 3 below).
Examples
According to the guidance, the tax authorities will test the factual entitlement to withholding tax relief based on the new business income, business purpose and substance tests (for details on the tests, see below). The tax authorities now interpret these tests as an “apportionment rule.”
On the basis of the business income, business purpose and substance tests, a company’s gross receipts will be separated into “good” income/receipts and “bad” income/receipts, which will determine whether a company will be entitled to full or partial withholding tax relief.
New approach
As noted above, withholding tax relief should be granted to the extent the foreign company can be deemed to engage in own business activities. The guidance clarifies the tax authorities’ view on how to interpret the concepts of “genuine own business” and “gross receipts from genuine own business activities:”
The explanations in the guidance on the business purpose and substance tests for the most part remain unchanged from the old guidance.
Business purpose test: According to the tax authorities, a business purpose is absent, in particular, if the foreign company serves mainly to safeguard domestic assets in times of crisis, or if the foreign company is to be used for future succession arrangements or for securing the retirement assets of the shareholders. The same applies for business reasons resulting from the circumstances of the group, such as coordination, organization, establishing customer relations, costs, local preferences and overall corporate set ups that do not qualify as economic or other relevant reasons according to the tax authorities. The guidance states that legal, political or religious reasons are relevant reasons for these purposes.
The guidance does not indicate the date on which the business reasons must have existed. This may be relevant in group structures where activities have changed over time and where previously there may have been business reasons for the structure, but these reasons no longer exist because the business activities (and/or the political, social and economic environment) have changed. Moreover it also should provide taxpayers with additional arguments in acquisition scenarios: Where a taxpayer acquires a foreign holding company that holds a German company, it could be argued that if the seller was only willing to sell the foreign holding company (rather than the German subsidiary), this should qualify as a business reason because the foreign holding company was not interposed at the option of the acquirer.
Substance test: What is new in the guidance is that the tax authorities provide three examples of what could be considered an indication for sufficient business substance:
The guidance also clarifies that substance that exists at the level of other group companies cannot be taken into account when determining substance at the level of the direct shareholder, even in the case of a tax group or other form of tax consolidation.
It also appears that, because the business purpose and substance tests must be interpreted as applying on a pro rata basis, the percentage of gross receipts for which substance and business reasons can be demonstrated and that should therefore be viewed as constituting “good income” will have to be determined.
Timing aspects: According to the tax authorities, the factual entitlement must be analyzed with respect to an application for a refund of withholding tax for the year in which the dividends/royalties were received by the foreign shareholder. Where an exemption is requested, the factual entitlement must be determined for the year in which the application is filed. If the foreign company’s financial statements are not available at the time the application is made, the financial statements of the preceding year will be used.
Examples: The following examples represent our understanding of how the factual entitlement to a withholding tax reduction/relief is calculated. It should be noted that the interpretation is in many cases unclear, so the actual practice of the tax authorities will have to be monitored carefully.
The guidance includes a fairly detailed and complex example in which the tax authorities explain in what order the above tests have to be performed.
This sequence of steps can be illustrated in the following flow-chart.
Taxpayers generally will have to notify the tax authorities of changes in the gross receipts or shareholders that are relevant for the withholding tax relief. According to the guidance, notification will not be required if:
The de minimis rule will not apply where a shareholding percentage falls short of a minimum percentage provided by a tax treaty or an EU directive.
Affected taxpayers should consider the following:
If you have any questions or are interested in an unofficial English translation of the guidance, please contact the authors of this article at gtln@deloitte.de or your regular Deloitte contact.
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