With regard to the taxation of income from co-entrepreneurships, the question must be raised in the international context in particular as to which state has the right to tax the individual assets in comparison to the purely domestic situation. In this context, the Federal Fiscal Court (“Bundesfinanzhof” – BFH) recently had to decide (BFH of 29 November 2017 – I R 58/15) whether it is advisable to submit a German declaratory statement for a domestic partnership which manages assets but is commercially oriented within the meaning of § 15 (3) no. 2 EStG and in which exclusively foreign co-entrepreneurs participate if the domestic partnership receives profit distributions from its participation in a domestic corporation. Before this question can be answered, it must be examined beforehand according to which criteria the participation in the domestic corporation can actually be assigned to the domestic partnership.
The facts in brief
In the domestic GmbH & Co. KG (I-KG), two Chilean corporations (CL-KapGes.) held shares of 70% and 15% respectively. CL-KapGes. each operated its own company in Chile and thus maintained corresponding operating facilities there. I-KG was only commercially oriented. Originally, it generated income from letting and leasing as well as dividends from a 50% stake in a domestic corporation (I-GmbH). I-KG had no personnel of its own and no Offices of its own. Only the general partner was entitled to manage the company. In the years in dispute, I-KG received profit distributions from I-GmbH, which I-KG took into account in its respective declaratory statements. The tax office did not follow this and taxed the profit distributions with compensatory effect, on the grounds that I-KG did not maintain a permanent establishment in Germany. There is no double taxation agreement (DTA) between Chile and Germany.
Dividends distributed by domestic corporations are generally subject to withholding tax of 25% plus the solidarity surcharge of 5.5% (a total of 26.375%). It follows that the withholding of capital gains tax by the distributing corporation has a compensatory effect if the beneficiary is only subject to limited tax liability with this income and the income is not generated in a domestic business. However, if this income can be allocated to domestic Business assets (i.e. a domestic permanent establishment), this income must be declared as part of the assessment procedure. From an economic perspective, applying the exemption provisions of § 8b (6) in conjunction with (2) KStG and § 9 no. 2a GewStG to a shareholding of at least 15% means that the distribution of profits is only subject to a final tax burden of 1.5% and that the audit of § 50d (3) EStG is not required.
Approach of the Federal Fiscal Court
National law must be examined as a matter of priority with regard to the tax consequences of the above-mentioned distribution of profits. The Federal Fiscal Court found that the foreign co-entrepreneurs of a commercial partnership generate commercial income on the basis of the fiction of commerciality. The tenor of this statement is thus also that a commercial partnership can in principle arrange a domestic permanent establishment for its foreign co entrepreneurs. If this occurs, the application of the final withholding tax is excluded. Whether a domestic permanent establishment exists must also be checked again on the basis of the criteria catalogue of national law, i.e. according to § 12 AO. In the discussion case, a domestic permanent establishment in the sense of a management permanent establishment could be affirmed in accordance with § 12 sentence 1 no. 1 AO, since the day-to-day business of I-KG was carried out exclusively in Germany by Managing Director A of Komplementär-GmbH.
As a result, the actual core question had to be clarified as to whether the profit distributions had actually been made in the domestic permanent establishment of the partnership. However, in deviation from the purely domestic case, it is not sufficient that the participation in the I-GmbH is the total assets of the I-KG under civil law or is allocated to the assets of the partnership under commercial law. Rather, an obligatory examination of the cause must be carried out, since the two CL-KapGes. also exercised their own entrepreneurial activities in their country of residence. Thus, a weighting must be carried out to determine to which permanent establishment the economic connection of the participation “I-GmbH” is closer on the basis of the actually developed business activities. In general terms, this means that the lower the entrepreneurial share of the foreign co-entrepreneurs, the more likely they are to be allocated to the domestic permanent establishment of the partnership. In the case of a pure financial holding company which does not carry out its own business activities abroad and holds an interest in a commercial partnership in Germany, the examination of the cause should lead to a clear result according to which the interest is to be allocated to the domestic partnership permanent establishment.
Ultimately, one can also refer to the principles of the Federal Fiscal Court judgment of 17 November 1999 (I R 7/99, BStBl. II 2000 p. 605) for the answer to the allocation question. Afterwards the question whether an asset belongs to the business assets is answered according to its economic affiliation. I.e. the personal and material means are attributed to the respective permanent establishment which are in an economic cause-and-effect relationship with the permanent establishment.
Application to the DTA case
In order for a partnership to act as an agent for its co-entrepreneur domiciled in a DTA foreign country, it must on the one hand generate corporate profits in accordance with Art. 7 OECD-MA and on the other hand fulfil the requirements of Art. 5 OECD-MA. The commercial character within the meaning of § 15 para. 3 no. 2 EStG does not affect the agreement law, i.e. the fiction is not sufficient to achieve corporate profits within the meaning of Art. 7 OECD-MA (cf. inter alia BFH of 28 April 2010 – I R 81/09, DB 2010 p. 1322).
For the existence of the reservations of permanent establishments under the provisions of the agreement, an actual functional affiliation of the shares to the domestic permanent establishment is required. However, the question as to which criteria are to be used for the actual allocation has still not been clarified unequivocally. In the opinion of the tax authorities, assets “actually” belong to a permanent establishment if they are to be allocated to the permanent establishment in accordance with § 1 (5) AStG (cf. Federal Ministry of Finance of 26 April 2014, BStBl. I 2014 p. 1258). In accordance with § 7 para. 1 BsGaV, the allocation of participations is decisively influenced by their use as an authoritative personnel function within the meaning of § 1 para. 5 sentence 3 no. 1 AStG, i.e. the characteristic of the use is determined by the functional connection to the business activity of the permanent establishment.
However, it should be noted that the DTA provisions cannot affect the national legal understanding (cf. BFH of 20 July 2016 – I R 50/15, DB 2016 p. 2452). I.e. if one comes to the conclusion that the profit distributions are to be included in the assessment due to the allocation of the participation to the domestic permanent establishment of the partnership and the tax exemption according to § 8b para. 6 in conjunction with para. 2 KStG is therefore applied, no DTA application is required anymore. This also applies against the background that a DTA does not avoid the 5% nesting penalty (cf. BFH of 22 September 2016 – I R 29/15).
The central point of the discussion case is therefore that the purely national understanding that assets of the total assets belong to the business assets of the partnership for tax purposes cannot be applied to cross-border situations. Rather, an allocation decision must be made on the basis of the individual characteristics of the foreign co-entrepreneurs or the partnership. Even if there is still no established case law with regard to the procedure of the allocation decision, it is nevertheless obvious to examine the respective commercial activities of the companies and to clarify the fundamental question of where the decisions on the acquisition, holding and strategic orientation of the associated company (in this case I-GmbH), including its integration into the group structure, are made.
The Federal Fiscal Court has referred the matter back to the Fiscal Court of Bremen (“Finanzgericht” – FG ), since the FG as previous instance (judgment of 25 June 2015 – 1 K 68/12) (blanket) assumed that even in a cross-border case the mere disclosure in the total assets of the I-KG is binding for the allocation of the investment. Since the decision is of high practical relevance, it is to be hoped that the FG will further concretise the principles established by the Federal Fiscal Court and provide the taxpayer with a corresponding guideline regarding the legally secure allocation of participations in cross-border situations – especially in the absence of a DTA.
This article was first published in: Handelsblatt online, Tax Board, 4 July 2019
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