Landmark ECJ and Federal Fiscal Court Decisions Challenge German Tax Treatment of Foreign Investment Funds

In a preliminary ruling procedure, the ECJ had to comment on the conformity of the German taxation of a foreign real estate investment fund with EU law. This was based on a complaint by a real estate investment fund established under Luxembourg law that generated income from the rental and sale of property located in Germany. According to Sec. 11 of the German Investment Tax Act (ITA) (in its version valid until the end of 2017), a tax exemption from German corporate income and trade tax applied to domestic, but not to foreign investment funds. Following a referral from the German Federal Fiscal Court, the ECJ decided that such a regulation was contrary to EU law due to a violation of Art. 63 TFEU. The unequal treatment between domestic and foreign investment funds is not justified as i) the objective of the provision to eliminate double taxation cannot always be achieved and ii) a Member State that does not tax domestic income of resident funds cannot justify the taxation of non-resident investment funds on income from domestic sources with the need for a balanced allocation of tax sovereignty.

In turn the German Federal Fiscal Court (FFC) now has issued a decision in the case underlying the ECJ decision (BFH I R 23/23 (I R 33/17). The FFC comments at length on the prerequisites a vehicle has to satisfy in order to qualify as an investment fund from a German tax perspective. First and foremost, an entity needs to qualify as “other special-purpose vehicle with no own legal capacity” within the meaning of sec. 1 para. 1 No. 5 CITA.

If an investment vehicle is not dependent under civil law, the assets belonging to it are generally either co-owned by the investors or owned by the investment company under civil law. It is not decisive for the tax assessment whether the assets are co-owned by the investors or by the investment company. A trustee position of the investment company is also not relevant. Rather, it is essential that sec. 1 para. 1 no. 5 CITA stipulates that an entity that cannot be the owner of assets under civil law due to a lack of legal capacity can also be a corporate tax subject to which the assets are attributed for income tax purposes. It is therefore decisive whether the assets belonging to the investment vehicle are owned (economically) by the investors according to tax law standards. If the assets are attributable to the investment vehicle, it is necessarily a fund, as this means that the assets are independent in an economic sense. If the investor has no direct access to the individual assets and cannot decide on their use for the purpose of generating income, and if the capital management company alone decides on the acquisition, sale, realisation and use of the assets, there is sufficient economic independence. Accordingly, the income from these assets is also allocated to the fund. Furthermore, the investors' right to redeem units must not result in the fund not continuing to exist and the investors' right to redeem units must not be structured in such a way that it enables the investor to realise the assets tied up in the investment fund at any time. This is particularly the case if the right of redemption is excluded for a certain period of time (here: 10 years).

In a second step the FFC held that any (at least EU resident) vehicle that classifies as an “other special-purpose vehicle with no own legal capacity”, which is structurally similar to an investment fund under German law should be able to claim the tax exemption according to sec. 11 para. 1 sen. 2 ITA. The court further stated that the ECJ decision leaves no room for an interpretation preserving the validity of the wording of sec. 11 para. 1 ITA other than deleting the phrase “domestic”, At the same time the strict binding of tax law to the language of the law (Sec 85 German General Tax Code) prohibits expanding Sec 15 ITA pursuant to which real estate income realized by domestic Spezial-Immobilienfonds , from properties located in Germany is to be allocated pro rata to the investors in the fund as their own real estate income such that the phrase “domestic” is to be deleted.

As a result, investment funds which have real estate income from properties located in Germany can and should file an objection against their corporate income tax assessments up to and including the 2017 assessment period, which have not yet become final, and – if the objection is not upheld – file an appeal with the tax court within one month of receiving the objection decision.

In addition, foreign investment funds that have accrued German withholding tax (e.g., on dividends paid by German resident corporations) were able to extend their application for a reduction in tax based on a DTA regulation to the Federal Central Tax Office to full refund of German withholding taxes relating to withholding taxes withheld until year end 2017. These extensions had to be filed with the German tax authorities by year end 2022 at the latest, to keep these claims from becoming time barred. If the application is rejected, an objection should be filed within one month of receiving the decision and - in the event of a rejection of the objection – an action should be brought before the tax court within a further month of receiving the negative objection decision.