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The German International Taxation Act (Aussensteuergesetz) is intended to prevent use of foreign entities to avoid German taxes. One of its core provisions provides that the income earned by an "interposed foreign corporation" (Zwischengesellschaft) will under certain circumstances be attributed to its German shareholders.

Whether a foreign entity is an "interposed foreign corporation" within the meaning of the law depends among other things on the character of the income it earns. The law contains a list of active income categories and provides that a foreign corporation is "interposed" with respect to all other types of income.

When German residents hold shares in a foreign corporation which in turn hold shares in another, the first corporation is not treated as interposed with respect to dividends received from the second provided, among other things, the revenue of the second corporation is derived "entirely or almost entirely" from active sources.

A recently published decision of the Federal Tax Court (30 Aug. 1995 - BStBl II 1996, 122) has interpreted "almost entirely" to mean 90 % or more of the overall gross revenue of the underlying foreign corporation. The tax authorities had attempted to argue that the income of the underlying company should be compartmentalised, i.e. first split up into business segments and then analysed with respect to each segment to see if it was at least 90 % active or not.

The Court rejected this approach. A provision in the corporate tax regulations (A. 76 par. 9 sent. 3 and 4) in which the tax authorities had espoused their view was declared to be without basis in law.

In certain cases, the International Taxation Act is overridden by Germany's tax treaties, while in others it expressly overrides these treaties (i.e. with respect to passive investment income).


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