August 2024 German Court Ruling Reshapes Tax Strategy for Luxembourg Funds | Goodwin

A Key Ruling With Broad Implications

On August 22, 2024, Germany’s Federal Fiscal Court (Bundesfinanzhof) published a decision that refocuses attention on the complexities of cross-border taxation, particularly for Luxembourg-based funds investing in Germany. This ruling, in conjunction with the 2023 amendments to the Luxembourg-Germany Double Tax Treaty (DTT), highlights the need for businesses to carefully reassess their tax strategies in a shifting regulatory environment.

German Court Ruling: Key Points

The court considered whether a Luxembourg société d’investissement à capital variable (SICAV) should receive a refund on withholding taxes applied to dividends distributed by German companies. The applicant consideration that the German tax rules under the former Investment Tax Act unfairly discriminated against foreign funds, violating the EU’s principle of free movement of capital.

In a decision favoring the SICAV, the court affirmed that foreign funds must be granted the same tax benefits as domestic funds under EU law. This outcome enables Luxembourg-based funds to claim refunds on improperly withheld taxes, along with accumulated interest.

Practical Implications of the German Court Ruling for Luxembourg-Based Entities

• Reassess your eligibility: Ensure that your fund structures comply with EU principles to qualify for tax benefits.
• Evaluate tax positioning: Review cross-border transactions to confirm alignment with Luxembourg and German tax obligations.

Alignment Between the German Court Ruling and the 2023 DTT Amendments

Given the court’s focus on the treatment of obligations for collective investment (UCIs), this ruling closely aligns with the recent amendments to the Luxembourg-Germany DTT, which clarifies the application of withholding tax rates and eligibility criteria for funds. Both developments address the evolving landscape of cross-border tax rules and reinforce the need for Luxembourg-based entities to stay vigilant.

Key Changes in the DTT Include:

1. Limited benefit of Article 10 for UCIs:

The protocol restricts the benefit of Article 10 for dividends paid by German REITs or comparable Luxembourg entities, as well as dividends paid to UCIs. In these cases, the withholding tax rate is set at 15% rather than the reduced 5% rate available to companies that directly hold at least 10% of the distributing company’s capital.

2. Eligibility of UCIs:

The protocol provides specific tax advantages for UCIs, explicitly recognizing them as tax residents in their state of establishment and treating them as beneficial owners of their income.

• For Germany: UCIs include any investment fund under the German Investment Code.
• For Luxembourg: This includes funds regulated under the UCIs (2010), SIFs (2007), and RAIFs (2016) laws as amended.

3. Broader recognition of other investment vehicles:

The protocol allows for the inclusion of other investment vehicles, provided by them:

• Are widely held (potentially “in free float”)
• Hold a diversified portfolio of securities or primarily invest in real estate for regular rental income
• Are subject to investor protection regulations in their state of establishment

4. Exclusion of partnerships and clarification for fonds commun de placement (FCPs):

UCIs structured as partnerships are explicitly excluded from the definition of eligible vehicles for treaty benefits. However, parliamentary documents clarify that FCPs can still benefit from the new provisions.

Navigating the Evolving Tax Landscape

The recent decision by Germany’s Federal Fiscal Court and the amendments to the Luxembourg-Germany DTT underscore the importance of adhering to the EU’s overarching tax principles, particularly the free movement of capital and nondiscriminatory treatment of foreign funds. These developments are part of a broader trend toward tightening cross-border tax regulations to create a more harmonized and fair tax environment across the EU.

For Luxembourg-based funds, this evolving landscape requires a thorough reassessment of their tax strategies to ensure they are in full compliance with both national regulations and EU standards. The court’s decision highlights the necessity for all entities operating within the EU to be vigilant in aligning their structures and practices with the principles of equal treatment and transparency that underpin the Union’s regulatory framework.

A proactive approach is crucial in this context. Regularly reviewing and adjusting cross-border arrangements in light of new interpretations and rulings will help businesses stay compliant and avoid potential disputes. Maintaining alignment with both EU directives and specific member-state regulations will be key to mitigating risks and ensuring a robust tax strategy.

Moving Forward: A Proactive Approach

The German court ruling and the 2023 DTT amendments present both challenges and opportunities for Luxembourg-based entities. To stay ahead of these changes:

• Consult with experts: Engage with local tax advisers to ensure compliance with the latest legal standards and adapt your tax strategy accordingly.
• Stay updated: Monitor legislative changes and court rulings to maintain an advantageous position in cross-border transactions.

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