OUR INSIGHTS AT A GLANCE
- On 27 April 2023, an important decision was issued by the CJEU striking down a German law according to which a Specialised Investment Fund existing under the laws of Luxembourg is considered partially liable for corporate income tax on German real estate income.
- According to the Court, Article 63 TFEU must be interpreted as precluding legislation of a Member State under which income received from non-resident specialised property funds is subject to corporate income tax, whereas resident comparable vehicles are exempt from such tax.
- Hereafter, we provide you with an analysis of this decision and assess its practical implications.
A few weeks ago, an important decision was issued by the Court of Justice of the European Union (the "Court") striking down a German law according to which a Specialised Investment Fund ("SIF") existing under the laws of Luxembourg is considered partially liable for corporate income tax on German real estate income (Case C-537/20 from 27 April 2023).
Background
The request for preliminary ruling was filed by the German Bundesfinanzhof ("Federal Finance Court"). The claimant in the main dispute was a Luxembourg domiciled closed-end investment fund - a Luxembourg SIF set up as an FCP in the case at hand ("the Fund") with only two institutional investors. In the course of 2008 to 2010, the Fund received rental income and realised capital gains from the properties it held in Germany. In July 2013, the Fund filed corporate income tax returns in Germany for these years in respect of its limited (non-resident) liability to corporate income tax, but stated that, in its view, it should not be liable for corporate income tax in the same way as comparable domestic resident vehicles.
The responsible tax office considered that the exemption available to resident funds can not be applied to foreign funds and issued their assessment with this regard. After appeals to the Munster Finance Court and the Federal Finance Court, a referral was made to the Court.
Legislation in place
According to the German Law applicable at the time, in general, the transparency principle applies i.e. income received by the investors in a domestic fund would be liable to tax and not the vehicle itself. In this way, it is ensured that the income is only taxed once. The investors must pay tax even in cases when the income is retained by the fund. Since the aim is to ensure effective taxation of the income received, this rule is not applied in cases where the investors are exclusively non-residents in Germany. In such cases, although the tax is attributable to the investors, the fund would levy 25% WHT on its distributions. This exclusion is implemented to prevent tax avoidance via investments through German resident funds. However, technically, a domestic specialised property fund would not be subject to tax but levy it on behalf of its foreign investors.
However, a comparable foreign specialised fund is taxed at the level of the fund and cannot benefit from the exemption described above.
The German Investment Tax Act was amended in 2018 with the effect that both domestic and foreign investment funds are now, in principle, subject to corporate income tax in accordance with Sec. 6 German Investment Tax Act. Consequently, there should be no more discrimination against the freedom of movement of capital from 2018.
Question referred
The question asked by the Federal Finance Court is whether the applicable German legislation was a restriction contrary to Art. 63 of the Treaty of the Functioning of the European Union ("TFEU") and if a restriction existed, could it be justified.
Analysis of the CJEU
For the first part of the question, the Court took a methodical approach, analysing first the existence of a restriction of the free movement of capital as provided by Art. 63 TFEU, then analysing the comparability of the Fund and German resident funds.
With regards to the existence of the restriction of the free movement of capital, the Court noted that while resident specialised property funds are exempted from CIT, nonresident funds, such as the Fund, are not able to benefit from this exemption. The taxation of German investors by a German fund can not justify this restriction, as the possibility to benefit from the exemption at fund level is not conditioned upon the actual taxation of all the income at the hands of the investors. Moreover, as the purpose of the transparency principle is to ensure that the income is only taxed once, if the investors in the Fund were German residents, the income would have been taxed twice (once at the level of the Fund and second time at the level of the investors). Therefore, the Court concluded that the legislation in question constitutes a restriction of the free movement of capital.
The CJEU also analysed the comparability of the Fund and German resident specialised property funds.
The principle that has been repeatedly established in CJEU jurisprudence is that a non-resident fund should be entitled to the same tax treatment as a resident fund if it can prove that it is comparable to a resident fund.
The distinguishing criterion within the German legislation in question is solely the place of residence of the Fund. The Court clearly states that the exceptions to the freedom of movement of capital are to be interpreted strictly. Therefore, discrimination, purely based on residency, is not acceptable. While drawing their conclusions, the Court also analysed if the restrictions resulting from the German legislation could be justified under Art. 65 (1)(a) TFEU1 as well as related jurisprudence of the Court.
The Court again systematically analysed the arguments brought up by the German Government (firstly, the need to preserve the coherence of the national tax system and, secondly, the need to preserve a balanced distribution of taxing power between the States).
With regards to the first argument, the CJEU noted that such argument can be accepted if a direct link between the tax advantage and a specific tax levy can be drawn. While the CJEU leaves it to the referring court to analyse this matter, a particular point of attention could be whether all investors in the resident specialised property funds are always taxed with no possibility for an exemption. However, we understand that certain categories of German investors (notably certain pension funds) are exempted from this income tax on real estate income, so we would expect the referring court to find that there is no direct link.
With regards to the second argument (a balanced distribution of taxing power between the States) the Court referred to the previous issued decision in the AllianzGI-Fonds AEVN case (C-545/19) and recalled that such a restriction can be justified if the restriction in question is aimed at protecting the exercise of the taxing right of the Member State. This can not, however, be the case if the Member State chooses not to tax the comparable resident vehicles in the first instance. Therefore, as in previous cases (notably Fidelity Funds and Others, C-480/16), the Court did not accept this argument.
Conclusion
As a conclusion, according to the Court, Article 63 TFEU must be interpreted as precluding legislation of a Member State under which income received from non-resident specialised property funds is subject to corporate income tax, whereas resident comparable vehicles are exempted from such tax.
Although the decision is positive for the taxpayer, it should be noted that wide application to all pending cases might not be possible. In particular, the comparability of each fund in question to a German resident specialised property fund needs to be assessed as well as the specific circumstances of each dispute.
A decision from the referring court following this should shed even more light on the situation.
Footnote
1. The provisions of Article 63 shall be without prejudice to the right of Member States:
- to apply the relevant provisions of their tax law which distinguish between taxpayers who are not in the same situation with regard to their place of residence or with regard to the place where their capital is invested;
- to take all requisite measures to prevent infringements of national law and regulations, in particular in the field of taxation and the prudential supervision of financial institutions, or to lay down procedures for the declaration of capital movements for purposes of administrative or statistical information, or to take measures which are justified on grounds of public policy or public security.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
