By Davide Anghileri, University of Lausanne
A German law introducing less favourable business tax treatment for dividends received from subsidiaries located in non-EU countries is in breach of EU laws requiring free movement of capital, the European Court of Justice (ECJ) ruled in 20 September decision (Case C-685/16, EV v Finanzamt Lippstadt). As such, the German law must be rewritten, the court concluded.
Under the relevant German tax legislation, dividends from domestic shareholdings are exempt from German business tax, subject to a 15% minimum holding requirement.
By contrast, for foreign shareholdings, the exemption is subject to stricter rules. In addition to the minimum holding requirement, the distribution must satisfy certain additional conditions, including an active business test at the level of the distributing subsidiary.
Therefore, the German referring court asked the ECJ whether the German rules applicable to dividends from non-EU subsidiaries violate the free movement of capital (article 63 et seq. of the Treaty on the Functioning of the European Union).
Freedom of establishment
The ECJ first observed that the German legislation should be assessed in the light of EU law on free movement of capital and not under the freedom of establishment (article 49) as holding at least 15% of the share capital of a subsidiary does not necessarily imply that the company holding those shares exercises a definite influence over the decisions of the company distributing the dividends.
Hence, the legislation at stake does not apply solely to situations in which the parent company has a shareholding that is likely to allow it to exercise a definite influence over the decisions of its subsidiary and to determine its activities, the court said.
Free movement of capital
The ECJ then concluded that the German legislation constitutes a restriction on the movement of capital between Member States and non-member States, prohibited, in principle, by article 63 TFEU.
Under the German law, income from capital originating in non-member States receives less favourable tax treatment than dividends distributed by resident companies. Thus, the shares of companies established in non-member States are less attractive to resident investors than those of resident companies, the court said.
Standstill clause
Moreover, the ECJ rejected the German government’s argument that the legislation is justified under the standstill clause provided by article 64 of TFEU.
This provision states that restrictions on the free movement of capital to or from third countries are not in breach of the TFEU if the legislation existed on 31 December 1993 under national or EU law adopted in respect of the movement of capital and in case such restrictions involve direct investments.
On this point, the ECJ pointed out that the legislation at stake was substantially changed after the 31 December 1993 and therefore the standstill clause could not apply.
Finally, the ECJ affirmed that the legislation at stake could not be justified by the need to prevent abuse and tax evasion.
German companies receiving dividends from domestic shareholdings and German companies receiving dividends from foreign shareholdings are comparable, the court said. Moreover, because the legislation at stake introduces a non-rebuttable presumption of fraud and abuse the law is not targeted exclusively to wholly artificial arrangements which do not reflect economic reality, the court said.
Davide Anghileri
Davide Anghileri is a PhD candidate at the University of Lausanne, where he is writing his thesis on the attribution of profits to PEs. He researches transfer pricing issues and lectures for the Master of Advanced Studies in International Taxation and Executive Program on Transfer Pricing.
Anghileri, a Contributing Editor at MNE Tax, previously worked as a policy advisor to the Swiss government on BEPS issues.
Davide can be reached at [email protected].
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