The Cologne Fiscal Court (“FG Köln”) has decided (judgement of 23 January 2019 – 2 K 1315/13, not yet officially published; revision pending, file number I R 27/19) that section 50d para. 3 EStG in the version of the Annual Tax Act 2007 of 13 December 2006 is applicable, but in the light of EU community law and the rulings of the European Court of Justice (ECJ) of 20 December 2017 (C-504/16, C-613/16) and 14 June 2018 (C-440/17) must be restricted in such a way as to preserve its validity – i.e, the case law principles of the ECJ must also be applied to interest. In the context of the presumption of abuse, however, a counterevidence must be permitted, whereby a substance allocation of related companies is permissible.
Facts (reduced)
The plaintiff is a Cypriot corporation which has subscribed to convertible bonds in an AG domiciled in Germany. The convertible bond bears interest at 5.5% per annum. The plaintiff held a total stake of 15% in the AG. The plaintiff’s business model is to acquire and hold interests in companies in the shipping industry as a strategic and financial investor. During the disputed period, the plaintiff only held the participation in the AG based in Germany. The plaintiff’s management services were provided by a sister company closely associated with the plaintiff, a Ltd. based in Cyprus, which had personnel and office space equipped with the necessary work equipment and communication devices. The plaintiff itself did not have any physical presence of its own in Cyprus and used the offices of the Ltd. For the years in dispute 2010 and 2011, the plaintiff applied for a 15% refund of the capital gains tax pursuant to section 50d para. 1 sentence 2 EStG in conjunction with article 11 DTA-Cyprus on the interest income generated by it. The refund was rejected by the tax authorities on the basis of section 50d para. 3 EStG (2007).
Decision of the Cologne Fiscal Court
In its ruling of 23 January 2019 (2 K 1315/13), the FG Köln first dealt with the question of the limited income tax liability of interest from convertible bonds prior to the conversion process pursuant to section 49 para. 1 No. 5a EStG. In the result it decided conclusively for a limited tax liability and justifies this with the wording of the standard, the law systematics as well as the law history.
The FG Köln correctly rejects the exclusion of reimbursement pursuant to section 50 para. 3 EStG (2007). In the light of the ECJ case law, the FG does not apply section 50d para. 3 EStG as amended by the Annual Tax Act 2007 of 13 December 2006 without any restrictions, but instead carries out a reduction that preserves the validity. The provision of section 50d para. 3 EStG does not serve exclusively to prevent purely artificial constructions which are not capable of any economic reality and which are set up solely for the purpose of using unjustified tax advantages. Rather, section 50d para. 3 EStG gives rise to an irrefutable presumption of abuse or evasion, as it does not allow the non-resident company the possibility of proving the existence of economic reasons in the case in which one of the conditions provided for in it is fulfilled (cf. ECJ of 20 December 2017 – Case C-504/16, C 613/16, Deister Holding/Juhler Holding). When applying the abuse provision of section 50d para. 3 EStG, the taxpayer must therefore, against the background of the case law of the European Court of Justice, be able to prove that there is no abuse in individual cases. The irrefutable presumption of abuse on the basis of given general criteria is disproportionate.
On the basis of these principles, the FG Köln states that a refund of capital gains tax cannot be refused solely because the plaintiff does not have an appropriately established business. The FG Köln then carries out a motive test in the course of the counterevidence. Here it attaches importance to the fact that the group of companies to which the plaintiff belongs has a group company in the state of residence in the form of a Ltd., which provides the management services for the plaintiff and is itself free from doubts about abuse. This Ltd. has an appropriately established business operation and carries out an active economic activity. Using the case law on the predecessor regulation of section 50d para. 3 EStG (2007) (cf. Federal Fiscal Court of 31 May 2005 – I R 74/04, DB 2006 p. 370), the FG Köln emphasises that an abusive structure cannot be assumed in the case of asset-managing intermediate companies if it cannot be assumed, due to the durability and function of the company and in the case of an active group company domiciled in the same state, that the receipt of income from a German company, particularly in the case of this intermediate company, is only made for tax reasons. Since the plaintiff and the Ltd., which provides the management services for the plaintiff, are active and long-term, the FG Köln denies an abuse of rights.
The prohibition of the transfer of features within the meaning of section 50 para. 3 sentence 2 EStG is also interpreted in such a way as to maintain its validity on the basis of the principles of jurisdiction and in the light of the free movement of capital, and is therefore restricted in the present case. Consequently, the circumstances of the plaintiff’s substantive sister company can also be taken into account. As a result, the FG Köln therefore affirms that the plaintiff has a claim for reimbursement of 15% from section 50d para. 1 sentence 2 in conjunction with article 11 of DTA-Cyprus.
Conclusion
The central problem of the present case is the application of the ECJ case law on section 50d para. 3 EStG as amended by the Annual Tax Act 2007 of 13 December 2006 to interest income. In its decision of 14 June 2018 (Case C-440/17), the European Court of Justice also found that section 50d para. 3 EStG 2012 was contrary to European law. The decisive reason for this was – as with the predecessor regulation – the irrefutable, flat-rate allegation of abuse of the regulation without prior examination of the individual case. Here, the opinion of the FG Köln is very welcome, which, without addressing this issue, assumes that the jurisdictional principles of the European Court of Justice issued on dividends also apply to interest income. Although this is not expressly addressed by the Cologne Fiscal Court, this seems logical in the light of the ECJ case law, since the principles developed for this purpose cannot only apply to the Parent-Subsidiary Directive (dividends), but consequently also to other income (e.g. interest). The substance of a foreign company must be examined separately from the qualification of its income.
Overall, it remains to be hoped that this ruling will serve as an occasion to extend the case law issued by the European Court of Justice to all types of income in the future. In general, a reduction of section 50d para. 3 EStG in the version of the Annual Tax Act 2007 and in the version of 2012 is necessary in order to maintain the validity of the ruling against the background of the case law of the European Court of Justice. In this respect, the possibility of proof to the contrary, which must apply to the entire group structure, must also remain open. For the FG Köln, Office space, personnel, work facilities and the necessary communication equipment were sufficient for the assumption of sufficient substance. The exact facts of the case would have been of interest here, such as the number of employees and an explanation of what the FG understands by the necessary work facilities and the necessary communication equipment. In general, however, there will be no high demands on the substance of purely asset-managing holding companies.
The FG Köln has permitted the revision, since the case is of fundamental importance in the light of the ECJ case law, in particular with regard to the limited tax liability of income from convertible bonds (cf. the pending revision procedure I R 6/18) and the application of section 50d para. 3 EStG. In the meantime, an appeal has been lodged, file number of the Federal Finance Court I R 27/19. In view of the high practical relevance, it remains to be seen whether the Federal Fiscal Court shares the view of the FG Köln on all decisive points and whether it upholds the decision. Incidentally, it remains to be seen whether the legislator does not feel compelled to react and revises the provision of section 50d para. 3 EStG or whether it continues to leave the interpretation of a provision contrary to European law to the courts.
This article was first published in: Handelsblatt online, Steuerboard, 11 September 2019