Return of capital contributions by third-country corporations
If distributions by a corporation resident in Germany to its shareholders result from the repayment of capital previously contributed by the shareholders to the corporation, these are generally tax-free, considering the order of use according to Sec. 27 (1) 3 and 5 of the German Corporate Income Tax Act (“KStG”). Whether this also applies to distributions by a corporation resident in a third country (third-country corporation) to its domestic shareholders has been controversially discussed in the past and has been legally regulated in the meantime.
Distributions by third-country corporations up to and including 2022
Since 2006, it has been clarified that corporations with their registered office in the EU or EEA, like in the case of a German corporation, can provide a tax-free return of capital contributions to their shareholders. As a counterpart to the separate assessment procedure for German corporations, EU/EEA corporations must undergo such a procedure, previously regulated in Sec. 27 (8) KStG old version, to be able to make a tax-neutral return of contributions. However, third-country corporations were not covered by this regulation. It was only with effect from 2023 that clarification was provided by the legislator.
However, due to the case law of the Federal Fiscal Court (BFH) in recent years, it was already clarified beforehand that third-country corporations can also provide a tax-neutral return of contributions to their domestic shareholders, although this was not explicitly regulated by law. Third-country corporations benefited from the fact that the strict procedural regulations of the assessment procedure applicable to EU/EEA corporations and the exclusion period of Sec. 27 (8) KStG old version, by which the procedure had to be carried out until the end of the calendar year following the year of the contribution, did not apply to them. Against this background, there may still be a chance for distributions by third-country corporations up to and including 2022 to claim a tax-neutral return of contributions by the shareholder themselves in certain constellations, provided that the shareholder's tax assessments are still amendable.
Distributions by third-country corporations from 2023
With the Annual Tax Act 2022, the return of contributions by third-country corporations was legally regulated. Thus, as from 2023 third-country corporations must also undergo the assessment procedure according to Sec. 27 (8) KStG, so that a return of contributions can be received tax-neutral by the domestic shareholders. An application by the distributing corporation is now mandatory, so that the previously possible shareholder-specific proof is generally no longer possible. The application must be submitted to the Federal Central Tax Office by the end of the twelfth month following the end of the fiscal year in which the payment was made.
Practical notes
As much as the possibility of proving a tax-neutral return of contributions by third-country corporations is to be welcomed, the practical implementation of the formal assessment procedure, which is mandatory since 2023, is associated with some practical difficulties. Meeting the procedural requirements within the twelve-month period in which the application can be submitted can be a significant effort for the foreign corporation. In many cases, despite the connection to foreign commercial law, a reconciliation and shadow accounting according to German tax law will be necessary, which is associated with considerable effort and costs. In this context, it should also be noted that only the foreign corporation and not the domestic shareholders are entitled to apply. Domestic shareholders are therefore dependent on the cooperation of the foreign subsidiary. However, minority or portfolio shareholders regularly have no possibility to influence and enforce the fulfillment of the procedural obligations by the foreign corporation.
Without a successful assessment procedure, the return of contributions will not be recognized as tax-neutral by the German tax authorities since 2023 but will be deemed a (taxable) profit distribution for the shareholder. However, to not lose tax attractiveness for shareholders in Germany, foreign corporations should ensure that they apply for the assessment procedure in due time.
Together with our international RSM network, we support you in overcoming the practical hurdles and fulfilling the extensive application requirements. Please feel free to contact us.
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