Governmental proposal for redraft of German “Anti-Treaty Shopping Provision”

Background 

On January 20, 2021, the German government published a draft law for the Gesetz zur Modernisierung der Entlastung von Abzugsteuern undder Bescheinigung der Kapitalertragsteuer (Act for modernization of the relief of withholding taxes and the certification of capital gains tax, AbzStEntModG). Among other things, this draft contains a new wording proposal of the so-called “Anti-Treaty Shopping” provision in Sec. 50d (3) German Income Tax Act (ITA), in order to comply with European law requirements.  

Sec. 50d (3) ITA serves to prevent the misuse of benefits from double taxation agreements (DTA) through the interposition of foreign companies with the sole aim of obtaining unwarranted benefits under the DTA (so-called treaty shopping). If the conditions set out in Sec. 50d (3) ITA are met, foreign companies are not entitled (in whole or in part) to a refund of or exemption from German withholding tax.

New draft of Sec. 50d (3) ITA

Under the planned new provision in Sec. 50d (3) ITA-Draft, there is a presumption that the purpose of using a tax treaty is for tax avoidance, subject to the ability to demonstrate proof of the contrary.  There is an exception for listed companies which are excluded from the scope of the provision. The proposed new rules represent a tightening of the conditions to qualify for tax relief.

A corporation, association of persons, or estate, shall not be entitled to relief from capital gains tax and tax withholding pursuant to Sec. 50a ITA insofar as

1. persons have an interest in or are beneficiaries under the articles of association of, the foundation business or the other constitution, where these persons would not be entitled to relief if they received the income directly (personal entitlement to relief; persönliche Entlastungsberechtigung), and
2. the source of income has no substantial connection with economic activity of this corporation, association of persons or estate.  The earning of the income, its transfer to participating or beneficiary persons as well as an activity insofar as it is carried out with a business operation that is not appropriately set up for the business purpose, shall not be deemed to be an economic activity (factual entitlement to relief, sachliche Entlastungsberechtigung).

This means that a hypothetical claim for relief by the shareholder or other beneficiary must be capable on the same claim basis as the claim by corporation itself. This has the effect that the requirements will not to be met if the hypothetical claim of the shareholder or other beneficiary arises, for example, from a DTA, but the relief claim of the corporation is based on the EU-Parent-Subsidiary-Directive.  Further, a substantial connection between the source of income and an economic activity of the corporation shall not be demonstrated if for example, the economic activity consists solely of providing supporting services to one or more subsidiaries (e.g. in the area of accounting or legal advice). In case of such so-called passive investment management, in which the corporation does not engage in any significant activity beyond the receipt of dividends and, if applicable, their onward transfer (e.g. as a loan to its shareholders), no economic activity shall be assumed.

To the extent, the economic activity of the corporation needs to be carried out with a business operation appropriately set up for the business purpose, Sec. 50d (3) ITA-Draft takes account of the fact that the activities of affiliated companies can be outsourced to third parties and that this outsourcing should be included in the overall assessment of economic substance.  This is a helpful relaxation of the current rules which only look at the activity undertaken directly by the corporation itself when assessing substance. 

Producing evidence to demonstrate no abusive purpose

To be able to access treaty benefits companies will need to demonstrate that their interposition in the dividend chain does not have a main purpose of obtaining a tax advantage.  In this context, all non-tax reasons are to be taken into account. If only partial proof can be provided, the relief should accordingly only be granted in part.

Exemption: Stock exchange clause

Irrespective of the mentioned proof, a corporation shall be entitled to relief – as under current law – if substantial and regular trading takes place in the main class of its shares on a recognized stock exchange (so-called stock exchange clause).

According to the reasoning of the draft act, however, this exception shall in future only apply if the corporation itself is a listed company, but not if listed companies only (directly or indirectly) hold an interest in the corporation claiming the relief. This means that there is no  “look through approach” and subsidiary entities of listed companies would not automatically be able to access treaty benefits without first passing the principle purpose evidence test.

Finally, the draft law provides a further tightening by deleting the automatic exemption for investment funds as contained currently in Sec. 50d (3) 5 ITA.

Temporal application

The new act has not yet passed the German parliament. Once the act has been enacted it shall apply in all open cases unless Sec. 50d (3) ITA in the version applicable at the time of the inflow of income does not preclude the entitlement to relief.

Impact on existing tax exemption certificates

It is currently unclear whether the proposed legislation would lead to a notification obligation with respect to a pre-existing valid exemption certificate, for the recipient of the investment income or remuneration within the meaning of Sec. 50a ITA, or whether there is protection of legitimate expectations with regard to tax exemptions already granted.

If you are affected by the matters discussed above, please do not hesitate to contact us.