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CJEU decision on German participation exemption regime
Germany – Free Movement of Capital - Third Country - Dividends – Participation Exemption – Standstill Clause
On September 20, 2018, the Court of Justice of the European Union (CJEU) published its decision in the EV v Finanzamt Lippstadt case (C-685/16) concerning the compatibility of the German participation exemption regime applicable to dividends originating in third countries with the free movement of capital. The Court concluded that the German legislation is contrary to the free movement of capital.
In 2008 and 2009, a German subsidiary of the EV group received dividends from its wholly-owned subsidiary resident in Australia. The dividends distributed by the Australian company had previously been received from a sub-subsidiary resident in the Philippines.
The German tax authorities considered that the dividends received by the German company did not fulfill all the conditions foreseen by the German participation exemption regime applicable to dividends received from subsidiaries resident in third countries and denied the exemption.
The German company appealed this decision, arguing that the requirements applicable to nationally-sourced dividends were less strict and that such difference in treatment between domestic and certain cross-border dividend distributions constituted a restriction to the free movement of capital.
The CJEU decision
The CJEU first examined which freedom is applicable in the case of hand: the free movement of capital or the freedom of establishment. Referring in this respect to its previous case law, the Court noted that the German provisions in question do not apply exclusively to situations in which the parent company exercises decisive influence over the company paying the dividends and therefore must be assessed in the light of the free movement of capital. Nevertheless, the Court also highlighted that neither the freedom of establishment nor the free movement of capital would apply if the dividends had been allocated to the non-resident permanent establishment of a German parent company.
The Court then turned to analyzing whether the legislation at issue in the main proceedings provides for different treatment of dividends distributed by a resident company and dividends distributed by a company established outside the EU. As the German legislation subjects the tax deductibility of dividends paid by subsidiaries established outside the EU to stricter conditions than those applying to dividends paid by residents companies, the CJEU concluded that the latter constitutes a restriction on the free movement of capital.
Regarding the “standstill clause”, the Court concluded that the German legislation applies to direct investments and that both its material and personal scope have been significantly modified since 1993. Hence, the restriction on the free movement of capital in the case at hand is not covered by such derogation, as provided for by Article 64 of the Treaty on the Functioning of the EU.
The Court then went on analyzing whether the restriction may be justified in this case. Referring to well-established case law, the CJEU noted that a German company receiving dividends paid by companies established in the same Member State are, in the light of the German legislation at issue, in a situation comparable to those which receive dividends from companies established outside the EU. The Court then turned to assessing whether such restriction may be justified by overriding reasons in the public interest and concluded that the need to prevent abuse and tax evasion is not applicable, as the German legislation introduces a presumption of abuse that cannot be rebutted.
The Court thus concluded that the German legislation creates a restriction of the free movement of capital, as it provides stricter requirements for exempt dividends received from a non-resident company, than those applicable when the paying company is a German resident.
EU Tax Centre comment
The CJEU decision is broadly in line with the opinion of its Advocate General (see ETF 354) and its previous case law on the taxation of outbound dividends. The Court confirmed once again the conditions applicable to the general prohibition of restrictions on the free movement of capital with third countries and shed some light on the application of the standstill clause.
Should you have any queries, please do not hesitate to contact KPMG’s EU Tax Centre (mailto: firstname.lastname@example.org), or, as appropriate, your local KPMG tax advisor.
Robert van der Jagt
Chairman, KPMG's EU Tax Centre and Partner
KPMG in the Netherlands