German Court grants participation exemption for capital gains

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Overview

The German Federal Tax Court ruled, in a recently published verdict, that capital gains realized by a foreign corporation upon the disposal of shares in a German corporation are fully exempt from German corporate income tax, and not effectively only 95% exempt. This exemption is available, provided the capital gains are not realized through a German business, such as a permanent establishment (PE).

The decision is relevant for foreign corporate taxpayers for whom a tax treaty does not provide a German tax exemption for capital gains.While the decision provides relief from the effective 5% tax burden, it remains to be seen how the German tax authorities and legislature will react to the decision.

The takeaway

According to the decision, capital gains realized by foreign corporate taxpayers are exempt fully from German corporate income tax when not realized through a German PE or other business.

The decision is relevant when a tax treaty exemption is not available. The commonly accepted view is that the 5% add-back already should not apply to treaty-exempt capital gains. Thus, relevant situations are those in which no tax treaty is applicable, or an applicable treaty does not preclude taxation of capital gains from the disposal of shares ─ for example, due to specific treaty rules for capital gains from the disposal of shares of ’real-estate rich’ corporations.

PwC will monitor how the German tax authorities and German legislature react to the decision. The German tax authorities could accept the decision and grant the full exemption in comparable cases. However, the German legislature could change the rules so that the effective 5% tax burden would apply when the foreign corporate taxpayer does not have a German business.

Contact us

Michael Urse

Partner, International Tax Services, PwC US

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