Introduction

A new circular letter from the Federal Ministry of Finance (Bundesministerium der Finanzen, BMF) was issued on 26 September 2014 ("BMF letter").  It concerns the tax authority's position on the application of the double tax treaties (DTAs) to partnerships.

The BMF Letter impacts inbound investment structures which were frequently used in the past such as German partnerships used by non-resident taxpayers to avoid withholding tax imposed on German companies.

Changes due to the BMF Letter

One significant change contained in the BMF Letter is that going forward, the German tax authority will assess whether withholding tax is payable by reference to the type of activity the business is engaged in rather than the corporate structure (ie regardless of whether there is a limited company or partnership).

To be taxable in Germany, the business profits are generated from a "business" activity. Whether an activity is considered a business activity depends on German law subject to the respective DTA. Income derived from a commercial business activity or independent personal services is generally deemed to be such business profits. Profits generated through asset management (ie non-trading for tax purposes) are, however, not considered business profits under double tax treaties.

Pursuant to the earlier stance of the tax authority, irrespective of its activities, ie whether the company conducts business or asset management activities, the legal structure could provide a non-resident taxpayer with business profits and a permanent establishment under DTAs. The non-resident taxpayer would hence have generated business profits rather than income with the consequence that, pursuant to the relevant DTA, no German withholding tax would have to be withheld.

The BMF Letter will therefore have consequences on formerly frequently used inbound investment structures involving partnerships or “silent partnerships”, for example, a corporation is established in Germany, usually a limited liability company (Gesellschaft mit beschränkter Haftung, GmbH). Irrespective of whether it carries out business or asset management activities, for the purposes of German tax law, the corporation generates business income due to its legal form. A person based in another country participates in the corporation by means of a “silent partnership”.  For this purpose, the person grants a loan to the corporation in return for a participation in the profits and assets of the corporation. At the same time, the person is granted control and asset-related rights in order to be considered a partner under tax law.  According to the BMF Letter income will be treated based on the actual activity of the corporation.  If the corporation exclusively carries out asset management activities, business profits are not generated within the meaning of Art. 7 of the OECD Model Tax Convention and non-resident taxpayers will therefore not generate any business profits. If this is the case, it is no longer possible to avoid German withholding tax on the income involving partnerships or “silent partnerships”.