Outbound investments: Tax-neutral repayment of capital from foreign corporations – Federal Ministry of Finance creates clarity
If a shareholder invests taxed funds in a corporation, the mere re-distribution of the investment amounts must not be subject to taxation again by the shareholder. Otherwise, even without any generation of new profits by the corporation, there would be double taxation of the mere return flow of capital at the level of the shareholder.
The current Corporate Income Tax Act takes account of this fundamental requirement for proper income taxation by allowing a tax-neutral repayment of capital from domestic corporations (GmbH, AG) to the extent that payments are made from the nominal capital or from the so-called tax contribution account pursuant to Sec. 27 KStG. For this purpose, the balance of the tax contribution account is also determined separately on an annual basis.
Similarly, foreign corporations domiciled in a member state of the EU may, upon application, make a tax-neutral return of capital contributions (Sec. 27 (8) KStG). Although no tax deposit account is established for these companies, the return of deposits can nevertheless be determined by applying the principles applicable to domestic companies, although in practice this is quite time-consuming.
Problem of Third Country Companies
In contrast, the treatment of the return of capital contributions from foreign corporations that are not domiciled in the EEA (so-called third countries, such as Switzerland or the USA) has been controversial for years and has now been the subject of several supreme court decisions (cf. e.g. BFH v. 13.07 2016, VIII R 47/13). For these companies, no tax deposit account is established as a basic requirement for a tax-neutral repatriation of deposits. Likewise, unlike for EEA companies, the law does not provide for the possibility of tax-neutral repatriation of assets upon application.
In practice, the associated risk of double taxation in the case of capital reflows taxable as dividends without preferential treatment has led to a high degree of legal uncertainty and nonsensical adjustment measures. For example, in the case of investments in foreign funds within the framework of so-called side letter agreements, the fund managers were obliged not to contribute the capital of downstream foreign corporations to the capital reserves, but only to invest in the nominal capital or alternatively to grant shareholder loans (cf. e.g. Elser, Ausländische Private Equity Fonds – Steuerliche Aspekte aus Sicht des deutschen Anlegers, in: Wassermeyer/Richter/Schnittker (Hrsg.): Personengesellschaften im Internationalen Steuerrecht, Chapter 9, 2nd edition 2015).
Federal Ministry of Finance creates clarity
Fortunately, the Federal Ministry of Finance (BMF) has now issued a statement on the above-mentioned topic in its letter dated April 21, 2022, taking into account the individual case law that has been issued in this regard, which now ensures generally applicable legal certainty. The main points regarding repayments of capital contributions from third-party corporations can be summarized as follows:
Nominal capital repayments are generally tax-neutral at the level of the shareholder. They do not result in taxable dividend income, but in a mere reduction of the shareholder’s acquisition costs for his investment in the foreign company. However, in the case of previous capital increases from company funds (e.g. conversion of capital reserves into nominal capital), Section 7 (2) KapErhStG must be observed, according to which the capital reduction leads to taxable dividend income within five years of the capital increase. The actual existence of a reduction and repayment of nominal capital must be proven by appropriate documents (foreign balance sheet, shareholders’ resolutions, register entries or similar).
The repayment of contributions not made to the nominal capital (e.g. to capital reserves, share premium, etc.) may also be tax-neutral. This is to be derived from the foreign commercial balance sheet preceding the year of distribution to the shareholder. Fortunately, the tax authorities do not require either a commercial balance sheet prepared in accordance with German law or a reconciliation statement to German tax law in accordance with Section 60 (2) EStDV.
It should be noted, however, that in accordance with the treatment of distributions from domestic companies, no direct access to the contributions is possible, but rather, in accordance with the sequence of use of Section 27 (1) KStG, the retained earnings must first be distributed subject to tax.
Fortunately, these regulations are also applicable at shareholder level in the case of distributions from EEA companies, if the company itself has not made an effective application in accordance with Section 27 (8) KStG.
Your TAXGATE team will be pleased to support you in collecting your deposit repayments from foreign shareholders tax-free in Germany, taking into account these new principles.