Judgment by the Financial Court of Nuremberg contradicts tax authorities’ view
The court of first instance (Financial Court of Nuremberg, judgment of 12 June 2013, 5 K 1552/11) has issued an important decision for non-EU corporations on the possibility for a tax neutral repayment of capital contributions.
Case: The claimants, a German resident married couple, were shareholders of a US-corporation (T). T transferred its international business to a 100% subsidiary (M1) by way of a spin-off. As a consequence of the spin-off T’s shareholders received one M1 share per T share held by them. The local tax office responsible for the claimants qualified the receipt of the M1 shares as a dividend in kind leading to capital income. Although the capital income contained a repayment of capital which is - in principle - tax neutral, the tax authorities denied a tax exemption due to the lack of a capital decrease and of a formal assessment of the capital repaid.
Decision by the Financial Court of Nuremberg: The Financial Court of Nuremberg held that the attribution of M1 shares to the claimants did not lead to taxable capital income, as the spin-off only led to a reallocation of assets that had already been part of the T shares before the spin-off (comparable to a change of a 100 EUR note into two 50 EUR notes). According to the Financial Court of Nuremberg, Sec. 27 para. 8 sent. 9 of the German Corporate Income
Tax Act (“CITA”) does not alter this assessment, as the claimants had provided sufficient evidence for the spin-off not being a profit distribution. It would infringe the principle of free movement of capital (which is also applicable to distributions by non-EU corporations to EU shareholders), if the German tax authorities requested a formal proof for the capital repayment being financed out of the capital contribution account for tax purposes according to Sec. 27 CITA. In particular, Sec. 27 para. 8 CITA – which was introduced for the proceedings with respect to capital repayments by EU-corporations – is not applicable in a third-country context. At the same time, the lack of a corresponding rule for third country cases shall not lead to the conclusion that a tax neutral repayment of capital shall only be possible in cases of a formal capital decrease.
Practical consequences: The question of non-EU corporations being able to repay capital contributions tax neutrally has been disputed since Sec. 27 para. 8 CITA was enacted.
Sec. 27 para. 8 sent. 9 CITA stipulates that EU-corporations can only repay capital contributions tax neutrally, if they have successfully completed an extensive verification procedure with the tax authorities for the assessment of the use of the capital contribution account for tax purposes. Prior to the introduction of Sec. 27 para. 8 CITA, a tax neutral repayment of capital contributions was possible based on the judicature of the German Federal Fiscal Court, if the applicable commercial and corporate law of the foreign country qualified the payment as repayment of capital. The German fiscal authorities take the view that a tax neutral repayment of capital contributions is no longer possible, as there is no rule corresponding to Sec. 27 para. 8 CITA for non-EU corporations. In practice, this view leads to tax effects that are difficult to comprehend.
Contrary to the German fiscal authorities, the Financial Court of Nuremberg takes the view that a tax neutral repayment of capital contributions is still possible for non-EU corporations. In particular, the requirement of a special verification procedure would lead to an infringement of the EU principle of free movement of capital (which is also applicable in a non-EU context). According to the decision by the Financial Court of Nuremberg, a repayment of capital contributions by a non-EU corporation is tax neutral, if the respective payment is qualified as capital repayment under to the applicable foreign commercial and corporate law.
The decision of the Financial Court of Nuremberg will be subject to review by the German Federal Fiscal Court in the pending revision procedure (BFH VIII R 47/13). Tax assessment notices affected by this subject matter should be prevented from becoming definitive by way of appeals.