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Do German CFC rules constrain the EU free movement of capital, which may also cover investments into third countries? This question has been hanging in the air for quite some time. In fact, currently the taxpayer cannot fend off German CFC taxation by applying to Sec. 8(2) of the German Foreign Tax Act (AStG), i.e. the Cadbury Schweppes test, by providing economic reasons for the establishment of a CFC located in a country outside the EU or EEA.
The CJEU has now set its course for German extended CFC taxation on foreign passive investment income (FPII) under Sec. 7(6) AStG in the eagerly awaited X GmbH-case (C-135/17). Regrettably, however, the court did not clarify the application of the standstill clause (Art. 64(1) TFEU), thus leaving the question open whether Sec. 8(2) AStG needs to be expanded to also cover CFCs located in third countries.
The case
X GmbH, which is resident in Germany, held a 30% share in Y AG, resident in Switzerland. Y AG entered into debt purchase and transfer agreements with Z GmbH. Y AG generated profits from this which were classified by the tax authorities as FPII, i.e. profits to be subjected to CFC rules at the level of X GmbH under Sec. 7(6) AStG. This provision extends CFC taxation to shareholdings of at least 1% provided the foreign company generated FPII. Following an unsuccessful administrative appeal and legal proceedings before the tax court, the Federal Tax Court of Germany referred case to the CJEU for examination as it doubted whether the rules in question were compatible with EU law (decision of October 12, 2016 I R 80/14). As a result, the CJEU had the opportunity to measure the (extended) CFC rules against the free movement of capital.
This article was written by:
Carsten Quilitzsch
Flick Gocke Schaumburg, Taxand Germany
Christian Engelen
Flick Gocke Schaumburg, Taxand Germany
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The application of the German CFC rules on FPII can constrain the EU free movement of capital. At first glance, the CJEU seems to want to impose more stringent requirements for the taxpayer in relation to third countries in terms of reviewing proportionality. At a closer look, however, Sec. 8(2) sentence 2 AStG also requires countries to exchange information on the basis of the EU Mutual Assistance Directive. Depending on the individual case, things may therefore not be much different from Sec. 8(2) AStG.