Germany: New Germany - Luxembourg Tax Treaty

On 23 April 2012 the Federal Republic of Germany and the Grand Duchy of Luxembourg signed a new Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital ("Treaty"). The new Treaty is based on the OECD Model Tax Convention and follows the current German policies on double taxation treaties, e.g. regarding the exchange of information between the fiscal authorities of both contracting states. It is amended by a protocol ("Protocol") that constitutes an integral part of the Treaty.

The new Treaty results in an extensive revision of the currently applicable double taxation treaty dated 1958 ("1958 Treaty"). The new provisions affect, among others, the taxation of funds. Some of the new provisions specifically relate to certain types of funds, e.g.

  • the explicit provisions regarding the entitlement of regulated funds to Treaty benefits.

Other amendments typically affect the taxation of funds, in particular German inbound investment structures used by Luxembourg private equity funds. We would like to draw your attention to the following:

  • change of the withholding tax rate with respect to dividends;
  • increase in taxation of payments on certain hybrid financing instruments;
  • establishment of right to tax with respect to capital gains from the disposition of shares in real estate companies.

I. Entry into Force

The new Treaty will enter into force on 1 January of the year following the completion of the ratification process, i.e. presumably on 1 January 2013. The Treaty will replace the 1958 Treaty which is currently in force.

II. Treaty Benefits for Regulated Funds

The Protocol explicitly states that regulated funds will be entitled to claim Treaty benefits regarding the reduced withholding tax rates applicable to dividends and interest. In this context, the Protocol differentiates between investment companies and investment funds (Investmentvermögen); unlike the nomenclature of the German Investment Act ("GIA"), the term "investment funds" (Investmentvermögen) relates exclusively to funds of contractual type.

1. Investment Companies

Investment companies are entitled to claim a reduction of withholding taxes on dividends and interest payments in their own name (no. 1 para. 2 Protocol). The following entities qualify as investment companies: German Investment Stock Corporation and Luxembourg venture capital investment company (société d'investissement en capital à risque; SICAR), investment company with variable capital (société d'investissement à capital variable; SICAV) and investment company with fixed capital (société d'investissement à capital fixe; SICAF).

The explicit confirmation of the entitlement of investment companies to Treaty benefits is to be welcomed. Such entitlement has been largely recognized under the 1958 Treaty and has been allegedly confirmed in correspondence exchanged between the German and Luxembourg fiscal authorities. However, based on the personal tax exemptions of SICAVs and SICAFs, occasionally the question was raised whether those investment companies were resident in Luxembourg for treaty law purposes.

Luxembourg investment companies are defined exclusively by reference to the regulatory regime; a body corporate is not explicitly required. Nonetheless, under the general rules on the application of double tax treaties to partnerships SICAFs and SICARs organized as partnerships (e.g. a société à responsabilité limitée; SCS) are likely not to be deemed entitled to Treaty benefits.

2. Funds of Contractual Type

Funds of contractual type (i.e. asset pools (Sondervermögen) organized under the GIA and Luxembourg fonds commun de placement; FCP) are entitled to claim Treaty benefits regarding the reduced tax rates applicable to dividends and interest (only) to the extent that their unit holders are resident in the same state as the fund. As a consequence of the fund's eligibility for Treaty benefits the investor's right to a corresponding reduction of source taxation ceases to exist (no. 1 para. 1 Protocol).

The partial entitlement of asset pools (Sondervermögen) and FCPs to Treaty benefits is primarily of procedural importance. Funds of contractual type will be entitled to claim in their own name Treaty benefits available to their investors residing in the same contracting state. However, in particular with respect to mutual funds there is no rule how to determine in which state the fund's investors are resident. The tax treaty between Germany and the U.S. of 2006 contains a similar provision. The German-U.S. treaty provides that the authorities of the contracting state shall establish procedures to determine the residency of their investors (including statistically valid sampling techniques), but such procedures have not yet been implemented.

The provision regarding the entitlement of German funds to Treaty benefits is too narrow insofar as no. 1 para. 1 lit. a) of the Protocol relates only to asset pools (Sondervermögen) managed by a "Kapitalanlagegesellschaft", i.e. a German investment management company (§ 2 para. 6 GIA). To the extent German investors are invested in a Sondervermögen organized under German law, the Treaty benefits regarding the withholding tax deduction should be also available in the case the Sondervermögen is managed by a EU management company, regardless of whether such management company is resident in Luxembourg or another EU member state (cf. § 1 para. 1a German Investment Tax Act).

3. Impact on the German Domestic Law

For purposes of defining the terms investment company and investment fund (Investmentvermögen) within the meaning of the Treaty it is irrelevant whether a Luxembourg investment company or a FCP qualifies as a "foreign investment fund" under GIA. In particular, private equity funds organized as Luxembourg investment companies do not qualify as "foreign investment funds" within the meaning of GIA. Moreover, under German domestic law it is uncertain how to qualify a Luxembourg FCP for German tax purposes. Unfortunately there is no clarification regarding this issue in the Treaty.

III. Dividends

1. General

Generally, the withholding tax on dividends remains unchanged at a rate of 15%. However, under the new Treaty each contracting state is explicitly entitled to enforce the anti-avoidance provisions of its domestic law. In particular, this relates to the domestic anti-treaty shopping provision of § 50d para. 3 of the German Income Tax Act ("GITA"). Under this provision foreign companies without sufficient substance are not entitled to treaty benefits with respect to German source "passive" capital income. As a consequence, German source tax would be levied at the statutory withholding rate of 25% plus solidarity charge.

2. Intercompany Dividends

Under the new Treaty, the maximum withholding rate on intercompany dividends is reduced from 10% to 5%. Moreover, the minimum participation required for the intercompany benefits has been lowered from 25% to 10%.

The Treaty provisions regarding intercompany dividends are likely to become relevant where the requirements of the parent subsidiary directive (e.g. the minimum holding period of one year) are not met. While the application of the parent subsidiary directive requires the same minimum participation as the Treaty, under the parent subsidiary directive the withholding tax is reduced to zero (i.e. no tax is levied by way of withholding).

3. Investment Companies and Partnerships as Beneficial Owners

The Treaty limits the withholding tax rate to 15% in case the beneficial owner of the dividend is an investment company (i.e. German Investment Stock Corporation or Luxembourg SICAR, SICAV or SICAF), a partnership or an individual; the additional reduction applicable to intercompany dividends is not available.

Furthermore, if a Luxembourg investment company qualifies as a "foreign investment fund" within the meaning of GIA the application of the domestic anti-treaty shopping provision of § 50d para. 3 GITA is excluded. It should be noted, however, that private equity funds do not qualify as such foreign investment funds.

4. Real Estate Companies as Distributing Companies

The withholding tax rate is limited to 15% with respect to dividends paid by any real estate investment company which is tax-exempt regarding all or parts of its profits or which can deduct the distributions in determining its profits. Real estate investment companies are, among others, German REIT Stock Corporations.

It is, however, still unclear which other types of companies may qualify as real estate investment companies.

IV. Hybrid Debt Instruments

The Treaty provides for an increase in taxation of payments on hybrid debt instruments issued by German debtors. No. 2 para. 1 of the Protocol reserves the right to tax German source income derived from payments in consideration for profit sharing rights or debt claims (including silent partnerships or profit participating loans) to Germany, provided that those payments are deductible in determining the profits of the debtor. Unlike most German tax treaties such income is not treated as dividend income for Treaty purposes. Hence, such income may be subject to the statutory withholding rate of up to 25% plus solidarity surcharge.

The aforementioned financing instruments are often employed by foreign (e.g. Luxembourg) private equity or real estate funds for their German acquisition structures. Accordingly, it is advisable to critically reconsider repatriation strategies that were employed in the past.

V. Capital Gains; Real Estate Companies

Private equity funds, including real estate private equity funds, typically generate a major portion of their profits from capital gains realized upon the sale or other disposition of equity shareholdings in their portfolio companies.

Germany's right to levy German tax on capital gains realized by a Luxembourg fund upon the disposition of an equity shareholding in a portfolio company with its seat or place of management in Germany has been waived under both, the new Treaty as well as the 1958 Treaty (unless such shareholding is attributable to a German permanent establishment of the fund). Up to now, such waiver has equally applied with respect to dispositions of shares in portfolio companies holding German real estate.

Pursuant to the new Treaty capital gains derived by a resident of a contracting state from the disposition of shares deriving more than 50% of their value directly or indirectly from real estate situated in the other contracting state may be taxed in that other state. The new provision may particularly impact indirect investments in real estate located in Germany.

The new provision is based on the OECD Model Convention. According to the official commentary of the OECD Model Convention, the determination of the company's real estate assets will be done by comparing the value of the real estate situated in a contracting state to the value of all the assets held by the company without taking into account debts or other liabilities of the company; debts and liabilities are likely to be disregarded even if the underlying debt instrument is secured by real estate. Furthermore, the purpose of the company is supposedly irrelevant, i.e. the term "real estate company" includes companies that use the real estate assets from which the shares derive their value to carry on a business (e.g. a hotel).

Under the new Treaty, Germany would have a right to tax also capital gains realized by a shareholder resident in Luxembourg upon the disposition of shares in a Luxembourg real estate company holding German real estate. However, under its domestic law Germany has not exercised its right to tax such capital gains and, as a consequence, no German taxes will be levied.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
De Brauw Blackstone Westbroek N.V.
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
De Brauw Blackstone Westbroek N.V.
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions