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German Trade Tax Participation Exemption breaches Freedom of Capital Movement

04May

According to the Advocate General, the German trade tax exemption clause for third-country participations infringes on EU law by constituting a restriction of the fundamental freedom of capital movement.

Background

German trade tax law generally exempts income derived from dividends for investments meeting a minimum participation level of 15 %. However, the exemption of third-country (non-EU) dividends is contingent on further conditions being met. One condition is that the subsidiary must derive their income almost exclusively from “active operations”, as defined by the German Foreign Tax Act. The Advocate General has now issued his opinion on the case which is currently pending at the European Court of Justice (C-685/16).

In the case at hand a German company was the sole shareholder of an Australian Limited. The German tax authorities were of the opinion that the conditions for the exemption of the Australian dividend were not met due to the Australian subsidiary being classified as a holding company that does not derive “active income” as defined by the German Foreign Tax Act. The foreign dividend was thus exempt from Corporate Income Tax (95 per cent), but not exempt for trade tax purposes. The German company challenged the decision and argued that the relevant provision constitutes a restriction of the free movement of capital, which according to European law is applicable both between member states of the EU, as well as between EU member states and third countries.

The Advocate General’s opinion

In his opinion, the Advocate General affirms a restriction of the free movement of capital. The restriction results from the diverging conditions for the exemption of domestic and third-country dividends. The Advocate General does not see any justifications for the restriction of the free movement of capital and concludes that the provision is therefore incompatible with EU law.

Outlook

It now remains to be seen whether the European Court of Justice will concur with the Advocate General’s opinion. If the European Court of Justice was indeed to regard the provision as a restriction of the free movement of capital, the German legislator would have to react by amending the relevant part of the provision. Both harmonization of the exemptions for third-country and domestic dividends and a complete overhaul of the relevant provision would then be conceivable.