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Germany's highest tax court has rendered a fundamental decision on the tax treaty treatment of income from a so-called "atypical silent participation" (FR 1999, 1361 - 21 July 1999). In response to the court's holding that such income is to be treated like income from a partnership interest, the tax authorities gave notice of their refusal to acquiesce in the judgement.

A silent partnership (stille Gesellschaft) is a form of business association defined and regulated in §§ 230 ff. of Germany's Commercial Code. The essential elements are a contribution (generally cash) by the silent partner to a commercial business owned by another legal or natural person in return for a share of the business profits. The silent partner has no liability to the creditors of the business. Additional terms of the arrangement, including the silent partner's share in losses, are specified by the statute, but may be varied by agreement. An arrangement which adheres to the statutory model is referred to as a "typical" silent partnership. Where this model is modified to give the silent partner certain control rights and a share in liquidation proceeds as well as losses, the term "atypical" silent partnership is used. The silent partner's status then resembles that of a limited partner in a limited partnership (Kommanditgesellschaft).

The case involved a silent partner participation held by a German resident individual in a Swiss AG and was decided under the version of the German-Swiss tax treaty in effect through 1993 prior to addition of a subject-to-tax clause. Switzerland treated the income from the silent participation as investment income subject to reduced taxation. In Germany, the taxpayer reported the income as business profits attributable to a Swiss permanent establishment and hence tax exempt subject to a progression clause.

The tax authorities instead assessed tax on investment income from Swiss sources. However, both the lower court and the Federal Tax Court decided in the taxpayer's favour.

While the Federal Tax Court at times relies on circumstances peculiar to the German-Swiss tax treaty, its reasoning nevertheless applies to German tax treaties in general. The court treats the atypical silent partnership as analogous to a general or limited partnership. The permanent establishment of the business in which the silent partner invests is attributable to the silent partner. Even if the clause on silent partnerships found in Art. 10 (4) of the German-Swiss tax treaty (and in many other German tax treaties) does cover atypical (as well as typical silent) partnerships, the court holds that the silent partner participation is part of the business property of the silent partner's Swiss permanent establishment, hence that the article on business profits governs the income in this event as well.

The refusal of the tax authorities to acquiesce in the decision is indicative of its significance and their resolve to relitigate the issue.

For further information, please send a fax or an e-mail stating your inquiry to KPMG Frankfurt, attn. Christian Looks: Fax +49-(0)69-9587-2262, e-mail You may also send an e-mail to KPMG Germany by clicking the Contract Contributor button on this screen.

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