Seite 1www.dhpg.de | German CFC-rules: Shareholders´ loan financing – nasty questions Heinrich Watermeyer EMEA Tax Group Meeting 6-7 October 2011, Antwerp

Seite 2www.dhpg.de | Background – different rules Equity financing Loan financing  Different rules for individuals and corporate entities Corporate entity „GmbH/AG“ Foreign corporate entity Individual German shareholder

Seite 3www.dhpg.de | Background – interest payment Shares are private assets As a rule: flat tax on interest; in case of 10 % share in the corporate entity: interest is taxable as ordinary income Foreign corporate entity Shares are business assets: interest is taxable as ordinary income Foreign corporate entity interest loan interest loan Germany

Seite 4www.dhpg.de | Background – interest payment Interest payments to German GmbH/AG lead to ordinary income subject to corporate income tax and trade tax German GmbH/AG Foreign corporate entity interestloan

Seite 5www.dhpg.de | Shareholders´ loan – interest free Intra Germany: No income adjustment Cross border, sec. 1 para. 1 FTTL (Foreign Transactions Tax Law): income adjustment on arm´s length principle German GmbH/AG Foreign corporate entity 0 % interest

Seite 6www.dhpg.de | Sec. 1 para 1 FTTA: 1 If income derived by a taxpayer from a foreign business relationship with a related party is reduced because the taxpayer has based its determination of income on terms and conditions, in particular on prices (transfer prices) that differ from those on which third parties unrelated to each other would have agreed under the same or similar circumstances (arm´s lenghts priciple), then – without prejudice to other provisions – the taxpayer´s income shall be restated to equal that which would have resulted under the terms and conditions as agreed between third parties unrelated to each other.

Seite 7www.dhpg.de | Sec. 1 para 5 FTTA: What is a foreign business relationship? For purposes of paragraphs 1 and 2, the term „business relationship“ refers to any relationship under the law of obligations that gives rise to the income, is not an agreement pursuant to articles of incorporation, partnership, or association, and, with respect to either the taxpayer or its related party, forms part of an activity to which §§ 13, 15, 18 or § 21 of the Income Tax Law is applicable or, in the case of a foreign related party, would be applicable if the activity were carried on in the domestic territory. Issue: Equity replacing loan?

Seite 8www.dhpg.de | Different treatment for domestic and cross border financing EU-discrimination by German CFC-rules? SGI-case (EU-Court) Para. 26 Belgian Income Tax Law with adjustment of interest Interference of EU-rights? Two-tier check according to European Court of Justice Judgement of , Rs. C – 311/08 (SGI), 1. Tier: Is there a breach of the freedom of establishment or the freedom of capital transactions? 2. Tier: If freedom of establishment and freedom of capital transactions: issue-specific check Is there in fact a shareholding with the possibility to exert influence (controlling shareholding)? Is there a minority shareholding only? Freedom of establishmentFreedom of capital transactions SGI Belgium Interest- free loan 65 % Recydem SA Cobelpin SA Lux 34 % Interference justifiable based on balanced apportioning of the basis of taxation and avoidence of abuse „Proof of Exculpation“ has to be possible, para. 1 sec. 1 FTTL

Seite 9www.dhpg.de | Shareholders´ loan Tax recognition of loss in value? German national rules Individuals Corporations Shares and loan are private assets Shares and loan are business assets No deductions for shareholders and affiliated corporations with an interest of more than 25 % Exception: third party test Applicable: since 2008  CFC-rules applicable? Loss in value leads to acquisiton costs for the shares as far as loan was not worthless; point of time when granting the loan is decisive Loss in value is deductable — Tax authorities: partial deduction of 60 % — Tax courts: deduction in fully — Currently pending at the Federal Tax Court  CFC-rules applicable?

Seite 10www.dhpg.de | CFC-rules according to Sec. 1 para. 1 FTTA applicable to German Tax Administration Outbound loans Controlling (majority) shareholder Non-controlling shareholder Case 1: Secured loan Case 2: Non-secured loan, but respective (higher) interest rate Case 3: Group backing Third party test (+) Tax effective (+) Group backing leads to positive third party test No depreciation in value as long as group backing in place Case 1 and 2 equal to controlling shareholder Case 3: no group backing, but assumption (fictious) of secured loan No depreciation „due to secured loan“

Seite 11www.dhpg.de | Effect of applicability of CFC-rules For individuals with business assets no recognition of loss in value tax wise at all, not even 60 % For corporate entities no recognition of loss in value also for periods before 2008 o Different treatment intra Germany and outbound o Not in line with EU-laws (REWE-case) o Violation of non-discrimination rules according to double tax treaties Applicable also additional to the German rules as of 2008: o In case of financial institutes (Sec. 8b para. 7 CTA*) o In case of partnership financing? * Corporate Tax Act

Seite 12www.dhpg.de | Alternative loan financing structure German GmbH I German GmbH II Loan financing Foreign partnership No sec. 8b para. 3 sent. 4 CTA FTTL applicable?

Seite 13www.dhpg.de | Ihr persönlicher Kontakt Dr. Heinrich J. Watermeyer, Partner, Rechtsanwalt, Fachanwalt für Steuerrecht Tel: +49 (0) DHPG Rechtsanwälte Wirtschaftsprüfer Steuerberater D Bonn Godesberger Allee