Under the German Corporate Income Tax Act (Sec. 32 para. 1 no. 2 German Corporate Income Tax Act, KStG), in the case of dividend payments, non-EU pension funds—unlike local pension funds—do not have the right to claim a refund if the withholding tax is higher than the corporate income tax that would have been due in the case of a regular corporate income tax filing procedure. Such difference in taxation between local pension funds and non-EU pension funds may represent an unjustified discrimination under the European freedom of capital movement (Art. 63 – 65 Treaty on the Functioning of the European Union (AEUV)) if the dividend payment would be used by the pension fund for the purpose of reinvesting this dividend payment into the funds capital in order to ensure future payment-liabilities of pension benefits ("reserves").

In the case at hand, from 2007 to 2010, a Canadian pension fund was a shareholder in a German stock corporation (Aktiengesellschaft). During this period, the stock corporation withheld capital gains tax from dividend payments to the fund and paid the withholding tax to the German tax authorities. The pension fund claimed a refund because it would have been entitled to do so if it were domiciled within the EU. After the competent German tax office rejected the fund's application for refund of the withholding tax, the pension fund filed a lawsuit at the fiscal court of Munich (Finanzgericht München, judgment, December 13, 2021 – 7 K 1435/15) that then submitted the case to the European Court of Justice (ECJ). The ECJ clarified under which conditions the German taxation rules violate the European freedom of capital movement.

1. Protection of non-EU-located pension funds by Art. 63 – 65 AEUV

Non-EU pension funds holding shares in EU-located companies are generally included into the scope of protection of Art. 63 – 65 AEUV in the case of dividend payments as the payment of dividends is classified as a movement of capital. The freedom of capital movement guarantees a free movement of capital and payments within the European Union, which is one of the fundamental principles of the EU, as it consolidates the EU domestic market. Unlike other European fundamental freedoms, non-EU Companies generally may be protected by the European freedom of capital movement. The decisive factor in the case at hand to fall into the scope of the protection is the shareholding in an EU-located company.

2. Jurisdiction of the European Court of Justice, the fiscal court of Munich and the German Federal Fiscal Court

According to the European Court of Justice (November 13, 2019 – C – 641/17), the different tax treatment of local pension funds and non-EU pension funds may violate the Freedom of capital movement as guaranteed by Art. 63 – 65 AEUV. For a possible violation of EU law in the case at hand, the non-EU fund must be "comparable" to the local fund. Comparability is determined by the legal treatment of international and national cases under consideration of the laws of the country of residence. Therefore, in this specific case, a non-EU pension fund is comparable to a German pension fund, when the law of its country of residence allows the use of dividend payments for the purpose of creating or increasing reserves. If the non-EU fund has the right to use the dividends for the creation (or increasing) of reserves while taking into consideration the laws of its country of residence (in this case, Canada), the pension fund is comparable to a local German pension fund. In addition, there must be a conditional relationship between the dividend payments and the creation or increasing of the reserves ("Kausalzusammenhang"). The balance sheet of the pension fund can provide indications if such conditional relationship exists.

In the case of pension funds creating reserves for the purpose of future payment-liabilities of pension benefits, the ECJ clarifies that a different treatment of local pension funds and non-EU pension funds (refund of withholding tax) violates the freedom of capital movement.

3. Consequences of this jurisdiction

Any non-EU fund affected by a possible violation of their freedom of capital movement should verify whether a court or the tax authorities have applied the principles, set up by the ECJ indicating a violation of Art. 63 – 65 AEUV, correctly.

4. Practical advice

The decision of the ECJ demonstrates that the German regulations on taxation of non-EU pension funds can lead to an unjustified discrimination under EU law. Before taking any legal action, the following considerations may help to increase the prospects of success:

  • Any profit-reducing use of dividends to create or increase reserves (for the obligation to pay future pension benefits) should be displayed in the balance sheet of the pension fund.
  • Further on, the pension fund should be able to demonstrate the conditional relationship between the dividend payment and the increase (or creation) of the reserves in a convincing way.
  • As older tax assessments might be not correct, pension funds might have claims for reimbursement (as far as the tax assessment is not time-barred). Therefore, it is recommended to prepare any documentation to enforce these possible claims.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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