In its decision of 10 April 2019 (I R 15/16) the German Federal Court of Finance (Bundesfinanzhof – BFH) has confirmed that a tax-neutral repayment of contributed equity as well by non-EU-corporations is possible and rejected the position of the tax authorities.
- Non-EU corporations as well can repay contributed equity tax-neutral.
- The Federal Court of Finance (BFH) has rejected the tax authorities’ dismissive stance towards a tax-neutral repayment of contributed equity by non-EU-corporations.
- The amount of repaid contributed equity is based on foreign commercial and corporate law and is determined pursuant German rules on the specific appropriation sequence (Verwendungsreihenfolge).
- A separate determination procedure is not required.
The tax authorities have so far taken the view that corporations tax resident outside the EU cannot make tax-neutral repayments of equity previously provided to them.
The tax authorities argued that the German Corporation Tax Act does not provide an express possibility for non-EU-corporations to repay contributed equity in a tax-neutral manner.
As a consequence, all repayments of stated equity and other equity contributions were classified as taxable dividends in the hands of the German shareholders. In recent years, tax audits have increasingly shifted their focus to such situations.
Key statements of the BFH decision
On 10 April 2019 the Federal Court of Finance confirmed its previous decisions and clarified once again that as well non-EU-corporations can repay contributed equity tax-neutral under the legal framework applicable since 2006, to the effect that not every equity repayment is generally to be treated as a taxable dividend.
The decision of the Federal Court of Finance was taken in respect of a German corporation, which received payments from a corporation resident in the USA. The tax office treated the payments as dividends rather than as a tax-neutral repayment of contributed equity.
The Federal Court of Finance argued that in light of the free movement of equity the principles on repayment of contributed equity also apply to payments made by non-EU-corporations. Hence, not every repayment made by a non-EU-corporation constitutes a taxable dividend.
The amount of the distributable profits is determined based on the respective foreign commercial and corporate law. Whether there is a tax-neutral repayment of contributed equity shall then to be determined in accordance with the general German order of use in relation to repayment of equity (so-called Verwendungsreihenfolge pursuant to Sec. 27 para 1 sentences 3 and 5 Corporation Tax Act).
Accordingly, there shall be a tax-neutral repayment of contributed equity to the extent that the payments exceeded the distributable profit as of the previous record date.
The Federal Court of Finance stresses that (in contrast to corporations tax resident in the EU) no separate determination procedure with a preclusion period needs to be observed, since the statutory procedural rules are not applicable to non-EU-corporations. Instead, the determination of payments as tax neutral repayment of contributed equity shall be made in the respective shareholder’s tax assessment. This is an advantage with regard to the strict preclusion period.
Observations and Outlook
By its decision, the Federal Court of Finance once again emphasises that as well non-EU-corporations can make a tax-neutral repayment of contributed equity. A burdensome formal determination procedure is not necessary.
It remains to be seen, which specific evidence will have to be provided in order to prove a tax-neutral repayment of contributed equity.
The Federal Court of Finance’s decision has not yet been published in the Federal Tax Gazette and is therefore not binding on the tax authorities. It therefore remains to be seen how the tax authorities will position themselves and how the legislator will react. In particular, the legislator could extend the formal procedure including the preclusive period also to non-EU-corporations.