German regulation on international partnership investments
By Klaus Küspert, Munkert & Partner GbR
Despite the forthcoming BEPS discussion and its implications, including some international in nature, I would like to take this opportunity to introduce you to a typical German approach to treaty overriding. Unfortunately, the Federal Constitutional Court of Germany recently accepted such overriding in cases of “white” income derived by German residents from foreign countries. It is very likely that this approach will also cover inbound transactions, as described below.
After the German Federal Finance Court decided that income from corporate investments held by foreign taxpayers is only taxable under treaty law in the investor’s home country, even if those investments are part of a German partnership which is passive but deemed to be active, the German authorities formed a special provision via the legislative body to cover the exodus of taxes derived from the aforementioned schemes.
This provision refers to section 50 (i) (2) of the Fiscal Code of Germany. In our experience, such paragraphs do not normally bode well. In this case, it contains a valid example of treaty override and tax clauses working in combination. In effect, the new law stipulates that all partnerships qualifying under the above law as of June 29 2013 are fully taxed if investments are sold or the partnership is restructured by a merger, change of ownership or being part of a donation or a transfer upon decease. Consequently, restructuring processes would be taxed even in cases not deemed as taxable under German law, even if the transaction involved would not end up in a loss of German jurisdiction to impose taxes on this subject. However, inbound cases are still the target of a change in this law. Besides, the authorities have doubts as to the conformity with EEC law if non-resident-related outside and resident-related inside transactions are taxed differently.
As the income tax code was not changed during 2014 or 2015, the authorities took over and issued various regulations on this matter. Most recently, they presented an updated version on 21 December 2015. Regulations completed around Christmas time are intended to bear fruit before the start of a new tax year. However, in most cases they have nothing to do with glory and greatness.
In the case in question, the regulation uses a lot of words to outline exceptions from exceptions. Exceptions are made for transactions within partnerships covered by section 50 (i) if Germany fully recovers its taxation rights after the transaction. Unfortunately, this does not apply if a non-resident (limited) partner exchanges his interest in the partnership against a corporate investment. It is highly disputed whether such a rule may violate EEC law as in this transaction hidden reserves are doubled within the corporate vehicle and the shares issued in exchange for partnership interest.
It is assumed that the German legislation will take over and change section 50 (i) of the Fiscal Code in the near future. Foreign investors using German partnerships as a vehicle should be careful. Rulings are difficult to achieve, especially if the final version of the code is still pending. In practice, a German partnership model for inbound investments with corporate background is vague and not advisable for the time being.
This conclusion may not be amusing but its background can be explained. The story goes that God created the Earth in seven days. Well, on the eighth day, he called in a consultant who told him that some evil was necessary so as to make all humans aware of what they have. For this reason, on the eighth day, God created German tax legislation. We deal with its consequences every day.
Published: March 2016 l Photo: Colourbox.de - Sergey Novikov