In its decision of 13 June 2018 (I R 94/15), the Federal Financial Court (‘Bundesfinanzhof’) decided on the application of the German Controlled Foreign Corporation (“CFC”) rules to a company in Cyprus.
The German parent company held an indirect 100% shareholding in a Cypriot resident company (“C Ltd.”) through a Dutch resident company (“NL BV”). C Ltd. was engaged in obtaining copyright licences and sub-licensing to group companies in Russia and Ukraine. In order to carry out those activities, C Ltd. had office space available and one resident employee in Cyprus. The royalties paid by the Russian and Ukrainian subsidiaries to C Ltd. were considered passive income and benefited from low taxation in Cyprus.
The German parent took the view that German CFC rules did not apply because of the decision of the Court of Justice (“ECJ”) in Cadbury Schweppes in 2006. Based on that decision, anti-abuse rules like the CFC legislation at hand should not apply to subsidiaries located in the EU/EEA if the taxpayer can prove that the construction is not (wholly or partial) artificial and not mainly aimed at avoiding domestic tax (i.e. the subsidiary carries on genuine economic activities).
The Lower Fiscal Court of Münster held that the German CFC rules were applicable, because the interposing of C Ltd. to receive royalties constituted a wholly artificial arrangement and no genuine economic activities were carried on in Cyprus.
The Federal Financial Court Decision
The Federal Financial Court sets aside this decision by the Münster Court. According to the Federal Financial Court, CFC legislation does not apply if the taxpayer can prove that the arrangement is not (wholly or partly) artificial and not mainly aimed at obtaining a fiscal advantage (subjective criterion) and the subsidiary carries out genuine economic activities (objective criterion). The Federal Financial Court held that economic activities were carried out in Cyprus and the case at hand falls outside the scope of the German CFC legislation.
What are the implications of this Decision?
It is interesting that the case at hand concerned the years 2007 and 2008. In 2008, as a response to the aforementioned Cadbury Schweppes case in 2006, the German CFC legislation was amended. After the amendment, the German CFC rules should not be applicable if inter alia the subsidiary carries on genuine economic activities and the passive income is derived with those activities.
The Federal Financial Court followed the road of Cadbury Schweppes and subse-quently implemented para. 8 (2) German Foreign Tax Act. In case of a fixed place of business comprising of offices, staff and equipment, as well as genuine economic activities, the necessary physical and personal substance was acknowledged. However, by now this is applicable only with respect to companies domiciled in the EU. In the pending ECJ case (ECJ C-135/17) the Federal Financial Court raised inter alia the question whether the above mentioned substance and activity test shall be applicable for non-EU companies as well.
This case is furthermore interesting as it interrelates with recent case law from the ECJ about the scope of the European anti-abuse doctrine. On September 7, 2017, the ECJ handed down its decision in the Eqiom and Enka case (C-6/16) and on December 20, 2017, the ECJ handed down its decision in the joined cases Deister Holding (C-504/16) and Juhler Holding (C-613/16) concerning the German Anti-Treaty shopping provisions. It will be interesting to see how this anti-abuse doctrine in the case law from the ECJ will further develop and whether this will change from 2019 when the General Anti-Abuse Rule (GAAR) in the Anti-Tax Avoidance Directive (ATAD) will become applicable in all EU Member States.
Talk to the Authors
For more information, please contact the authors: Dr. Gijs Fibbe (Baker Tilly Berk, The Netherlands), Ines Pauksch (Baker Tilly Germany) and Sara van Middelkoop LL.M. (Baker Tilly Berk, The Netherlands).