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In our series “Advisory Practice Corporate Income Taxes” we provide a monthly update on current and relevant developments in national income tax law for partnerships and corporations. Our contact persons are included below the article.
Hot Topic: Capital repayments from foreign corporations
Background: As part of the taxation process, in case of payments from corporations to their shareholders, distinction is to be made between taxable (if applicable, tax-exempt according to Sec. 8b Corporate Tax Law [Körperschaftsteuergesetz - KStG]) profit distribution and non-taxable repayment of contributions. The latter reduces the tax book value at the shareholder. A non-taxable repayment of contributions may be a distribution of nominal capital or the return of other contributions. Particularly in case of investments in foreign corporations, the return of capital contributions entails now and again practical and legal issued and discussions within tax audits.
Based on Sec. 27 (8) KStG added in 2006, capital repayments of EU corporations may be treated tax neutrally if the distributing corporations have submitted an application for separate determination of the return of capital contributions to the German Federal Central Tax Office. According to the opinion of the fiscal authorities, this shall also apply to corporations resident in an EEA member state.
In practice, this procedure frequently turns out to be very time-consuming and extremely complex. This is in particular due to the fact that according to the opinion of the fiscal authorities, the foreign accounting of the corporation is to be reconciled with German tax law for several previous years. In addition, the Federal Central Tax Office requests a large amount of information and evidence. However, if the procedure is completed successfully, the return of capital contributions may be tax neutral.
To date, there has been significant legal uncertainty in practice regarding the return of capital contributions for third country corporations.
According to the judgement of the Federal Fiscal Court [Bundesfinanzhof - BFH] in 2016, tax-neutral returns of capital contributions shall be possible also for third country corporations. As Sec. 27 KStG only refers to German cases and cases of EU corporations, the German fiscal authorities deducted by implication that non-taxable returns of capital contributions are not possible for third country corporations.
With the public notice of the Federal Ministry of Finance dated 21 April 2022, the fiscal authorities followed the judgement of the BFH stating that corporations in third countries may also render tax-neutral returns of capital contributions.
Regarding the sequence of use, Sec. 27 (1) sentence 3 KStG shall be applied by analogy for third country corporations. Hence, foreign capital reserves are not directly taxable as it is the case for German and EU/EEA corporations. A withdrawal from a capital reserve and the relevant balance sheet item of the foreign balance sheet are not decisive for the classification as taxable return of capital contribution. The public notice of the Federal Ministry of Finance distinguished between nominal capital repayments and repayments of contributions not made to the nominal capital.
According to the opinion of the Federal Ministry of Finance, repayments are generally tax-neutral. Appropriate evidence, e.g. in particular the resolution on the nominal capital reduction and repayment, is to be provided in order to prove the actual existence of a nominal capital repayment.
The repayment of contributions not made to the nominal capital might qualify as tax-neutral return of capital contribution. However, this is subject to the prerequisite that the amount of the distributable profit, the subscribed capital, and the contributions not made to the nominal capital (e.g. capital reserves) may be derived from the foreign tax balance sheet of the year preceding the distribution to the shareholder. According to the opinion of the fiscal authorities, a tax balance sheet prepared according to German GAAP and a reconciliation statement into German tax law by analogous application of Sec. 60 (2) Income Tax Implementing Ordinance [Einkommensteuer-Durchführungsverordnung - EStDV] is not required. Another prerequisite is that no distributable profit exists (anymore), e.g. retained earnings, retained profits brought forward, net income – these amounts are deemed primarily used pursuant to the tax sequence of use fiction (although, as a matter of fact, the distribution originates from the reversal of a capital reserve in the foreign balance sheet). The following information and documents in German are to be provided by the shareholder for the determination of the return of capital contribution:
In summary, the taxation of a return of capital contributions from a third country corporation on German shareholder level is to be evaluated within an assessment procedure by the competent fiscal authority. This may put third country corporations in a better position compared to shares in EU corporations.
Author: Sabine Najdecki
Lenka Kočerová | 8.10.2024
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