Germany: Attribution of rental income to permanent establishment, application of CFC rules in third-country situations

The attribution was not in violation of the free movement of capital under EU law even though this treatment restricts the free movement of capital.

The attribution was not in violation of the free movement of capital under EU law.

The German Federal Tax Court (BFH) held that the attribution of interim income generated in financial years 2004 to 2006 within the meaning of German controlled foreign corporation (CFC) rules by an intermediate company domiciled in Switzerland, although restricting the free movement of capital, was nevertheless justifiable and therefore not in contravention of EU law.


Under the CFC rules, if taxpayers subject to unlimited tax liability hold more than half of the shares in a foreign company, the income for which this company acts as intermediary may be liable for tax at the level of shareholders. This applies to income subject to lower taxation (generally income tax of 25%) and qualifying as "passive income.”

The taxpayer (an individual domiciled both in Germany and Switzerland) had his centre of vital interests in Germany as of September 2005. In 2004 to 2006, he was the sole shareholder of a limited liability company (J-GmbH) based in Switzerland. J-GmbH held a property generating rental income that was subject to tax of less than 25%.

At issue was whether the rental income constituted passive income. The taxpayer asserted that the rental income was ancillary income to J-GmbH's primary activity, which focused on commercial property sales and that, moreover, taxation under CFC rules was in violation of the free movement of capital under EU law and the constitutional rule of law.

Court decision

The BFH found:

  • The factual elements for adding the income of J-GmbH under the CFC rules were satisfied. In particular, the income was so-called "passive income" that would not be excluded from attribution.
  • The rental income was not commercially associated with other "active" operations of J-GmbH to such an extent that it could be functionally attributed to these activities. Commercially related activities are to be treated uniformly (functional approach).
  • The activity which is generally considered the main commercial focus is decisive.
  • An activity to be assessed as uniform (according to these criteria) exists in particular when income from auxiliary or ancillary activities to a primary activity is to be assessed.

According to these criteria, J-GmbH's rental income cannot be functionally attributed to any "active" operation.

Rental income must be excluded from attribution when the taxpayer provides evidence that the income would be tax-exempt based on the applicable income tax treaty if it had been received directly by the shareholders subject to unlimited tax liability. However, this was not satisfied in this case because the foreign tax credit method would have been applied to this income.

In conclusion, the court held that the attribution was not in violation of the free movement of capital under EU law even though this treatment restricts the free movement of capital. However, the court found this restriction was justifiable in view of the legal framework in place for the exchange of information between the German and Swiss authorities in 2006 and 2007. Moreover, the court was not convinced of any unconstitutionality. Lastly, the conditions for obtaining a decision from the German Federal Constitutional Court were not satisfied.

Read a June 2021 report [PDF 330 KB] prepared by the KPMG member firm in Germany



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