What are treaty shopping and anti-treaty shopping regulations?
The term “treaty shopping” (or directive shopping) originates from U.S. treaty law and refers to tax structures implemented to benefit from tax relief under a treaty or benefits provided by a directive. The term anti-treaty shopping regulations refers to national provisions by which the legislator seeks to avoid an abuse of treaty shopping.
Treaty shopping is particularly important in the context of reducing withholding tax. A taxpayer, who is not covered by the treaty, uses a corporation covered by the treaty and establishes it as an intermediate company. Foreign income directly goes to that intermediate company and only indirectly to the taxpayer not covered by the treaty. In this way, he can benefit from the advantages granted by a double taxation treaty or directive.
By way of illustration: German company with a foreign parent
A German corporation distributes profits to its foreign parent. The domicile of that foreign parent is selected in a country where it profits from the advantages granted by a double taxation treaty and/or a directive. The shares in the foreign holding company are held by an individual not entitled to benefit from said advantages granted by the double taxation treaty or the directive. In the cases, the European Court of Justice (ECJ) had to decide in December 2017, the shares were held by individuals resident in Germany and/or Singapore.
In the past, the German legislator has tried to prevent this practice. Hence, under the pertaining national regulation, the tax exemption or tax relief is prohibited in case of abusive or merely artificial structures.
European Court of Justice rules that German regulation breaches Union law
This regulation breaches Union law, according to a recent ECJ decision. But the decision only concerns a former version of the regulation. Whether the ECJ will also overturn the present regulation is still open. The judgment is expected in the near future. There is reason to assume, however, that this regulation will equally fail to meet the court’s requirements.
Federal Ministry of Finance implements ECJ decision
Last April, the Federal Ministry of Finance responded to the ECJ’s judgement by publishing a letter on the EU-law compatible application of the national anti-abuse regulation. This letter largely implements the ECJ’s decision. The regulation found unlawful by the court is no longer applied. The corresponding follow-up regulation remains applicable with certain limitations.
Recommendation: Keep rejection decisions against refund of withholding tax open
Applications for refunds of, or exemptions from, withholding tax need to be newly evaluated against the background of the ECJ’s decision and the letter from the German Federal Ministry of Finance.
With respect to applications for refunds of, or exemptions from, withholding tax under the former legal situation (i.e. as of the 2007 assessment period) the following applies: To the extent that proceedings are still pending, a refund of withholding tax should be applied for. The Federal Central Tax Office will no longer reject such applications by making reference to the national anti-abuse regulation.
Concerning the respective applications as of the 2012 assessment period the following applies: Until the decision by the ECJ, rejection decisions against the refund of withholding tax should be challenged and kept open.