By Thomas Sauter

This article was first published in International Tax Review July/August 2002, p. 68

For editorial cut-off date, disclaimer, and notice of copyright see end of this article.

A recent decision by Germany's highest tax court revises the interpretation of section 160 of the German Tax Procedure Act (AO or Abgabenordnung) as it applies to mailbox companies resident within the EU.1

Section 160 AO permits the German tax authorities to disallow deduction of otherwise deductible payments where the taxpayer fails upon request to identify the recipient of the payment. While the provision applies by its terms to resident and non-resident recipients, it has frequently been invoked with regard to payments made to foreign resident entities that lack economic substance and may have been interposed for tax evasion purposes.

Under section 160 AO, taxpayers who have reason to believe that they may be dealing with a mailbox company can forfeit the deduction of payments made to their counterparty unless they can identify the economic recipients of the payments. The economic recipients may, but need not, be identical with the company's owners. For instance, in a case involving architectural services channelled though a Swiss mailbox company, the Federal Tax Court (FTC) held that the German taxpayer must name the architects (subcontractors) who performed the actual work (FTC ruling of 25 August 1986, BStBl II 1987, 481). Similarly, a German firm that paid commissions to a Liechtenstein mailbox company in order to be appointed general contractor on commercial construction projects arranged by the Liechtenstein company was obliged to name the brokers, lawyers, architects, engineers, and contractors that the Liechtenstein firm engaged.2

By failing to provide the required information, the German taxpayers in the above cases forfeited their deduction of the sums involved. The courts cited factors that should have signalled to the taxpayers that their foreign counterparty was incapable of performing the contract in question and would have to rely on subcontractors. In such situations, it was considered reasonable to require the German taxpayer to condition its contract with the foreign counterparty on the latter's disclosure of the relevant information.

The FTC's most recent decision on point (dated 17 October 20013) appears to relax the above rules at least where German taxpayers deal with mailbox companies situated in the European Union. The case involved a German construction firm that subcontracted work performed in Germany to an English private limited company. The German firm assembled documentation on the PLC showing among other things that it was duly incorporated in England, registered with the German Chamber of Artisans (Handwerkskammer), entered in the commercial register, and in possession of business liability insurance.

The lower court and the FTC said this was enough on which to conclude that the PLC was not an interposed shell. Disallowance of a deduction under these circumstances would constitute an abuse of discretion by the tax authorities, even though they could show that the PLC was probably a mailbox company (no offices or employees of its own, mailing address with a secretarial service agency, sole director known to serve as the director of multiple mailbox companies, etc.). The FTC held that the taxpayer was under no duty to suspect or discover these additional facts and implied that even they were inconclusive. The FTC noted that the PLC was not situated in a known tax haven, such as Liechtenstein or the Channel Islands, and above all gave weight to the fact that it was a resident of the European Union, hence protected by EU law guaranteeing the free movement of goods and persons and the freedom of establishment.

It has been argued in the German literature that section 160 AO potentially conflicts with the EC Treaty because the sanction imposed by the statute – disallowance of a deduction - is unreasonably harsh since the tax authorities are able to obtain the information they need to prevent evasion of German taxes by less drastic means under the EU mutual assistance directive of 19 December 1977 (77/799/EEC). The FTC's decision may thus be read as an attempt to restrict the scope of section 160 AO so as to avoid a conflict with EU law.

In conclusion, attention is called to the construction work withholding tax that went into effect in Germany on 1 January 2002.4 While the facts of the October 2001 case are not entirely clear, the new withholding tax probably applies in principle to the situation involved, meaning that, in the future, the German taxpayer would be required to withhold 15 % of the gross amount of its payment to the PLC unless the PLC previously obtains a withholding exemption certificate from the tax authorities (new sections 48 ff. Income Tax Law).


1 Federal Tax Court (FTC) judgement of 17 December 2001 (I R 19/01 – IStR 2002, 274). This decision should not to be confused with the FTC's seminal transfer pricing judgement of even date (I R 103/00 – IStR 2001, 745); see article no. 239.

2 FTC judgement of 10 November 1998, BStBl II 1999, 121.

3 See Endnote 2 above.

4 See article no. 247 (KPMG German News no. 1/2002 p. 25).

Editorial cut-off date: 30 June 2002

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