Definition of the basic problem and the rules for corporations resident in Germany
Applying tax privileges at the level of the shareholder to the repayment of nominal capital as well as capital contributions by a corporation is necessary for systematic reasons because the paying in of these amounts did not give rise to any tax-deductible expenses for the shareholder. From the shareholders’ point of view, paying in the contribution merely increased the acquisition cost of their shares in the entity. Consequently, the repayment of nominal capital and/or capital contributions has to be offset against the acquisition cost of the shares in the entity, generally, in a way that does not affect the operating result for tax purposes.
An exception applies to nominal capital arising from a capital increase from company funds where retained earnings are used. Such components of nominal capital have to be separately assessed for tax purposes (so-called separate statement). The repayment of nominal capital is treated like a distribution of retained earnings. While the repayment of nominal capital may be immediately treated as tax-exempt, for the repayment of capital contributions in the context of a profit distribution, however, a specific appropriation sequence has to be followed; here, the so-called distributable profit has to be appropriated first. Furthermore, the tax-free repayment of capital contributions is restricted to the amount that has
been determined in the course of a separate assessment of the contribution account for tax purposes.
Please note: A further advantage of repaying nominal capital as well as amounts from the contribution account for tax purposes is that the entity that distributes the profits does not have to withhold any capital gains tax. This is on condition that the entity that distributes the profits promptly provides the shareholder with a tax certificate that correctly indicates the use of funds from a contribution account for tax purposes.
Repayment of capital contributions from EU corporations
Since the rules for the assessment of the contribution account for tax purposes, in Section 27(1)-(6) KStG, apply solely to corporations in Germany with unlimited tax liability, for many years, there was the problem that foreign corporations were procedurally not able to certify the use of funds from a contribution account for tax purposes. Consequently, shareholders resident in Germany were likewise unable to benefit from the tax-free repayment of capital contributions from foreign corporations. There were concerns here, in particular, in relation to EU law.
Therefore, in 2006, the German SE Introductory Act created a separate assessment procedure for EU corporations (Section 27(8) KStG). The foreign corporation can request a separate assessment of the amount that may be considered as the repayment of capital contributions. The non-extendible deadline for applying for an assessment is however very tight and only runs to the end of the calendar year following the calendar year in which the repayment of capital contributions was made.
In practice, filing an application for an assessment has often proved to be very work-intensive because of the fiscal authority’s stringent requirements with respect to documentary evidence. In extreme cases, this can mean that the foreign corporation has to reconcile – as if in a set of shadow accounts – the differences in its presentation of equity and one based on the German principles for tax accounts and going all the way back to 1.1.1977 (the introduction of the corporation tax imputation system in Germany).
While this is not consistent with Section 27(8) KStG, the fiscal authority also wants to include corporations that are resident in the EEA states within the scope of the application of the rules.
Repayment of capital contributions from corporations in third countries
According to a BFH ruling from 13.7.2016 (case reference: VIII R 47/13), restricting the scope of application of the rules on the repayment of capital contributions to corporations that are resident in Germany and in the other EU member states violates not only the general principle of equal treatment under Article 3, paragraph 1 of Germany’s Basic Law, but also the free movement of capital for third countries that is applicable under EU law. Therefore, the BFH granted shareholders of corporations in third countries the possibility to provide proof, on the basis of their own tax assessment procedures, that the profit distribution by the subsidiary is indeed the repayment of capital contributions. In its ruling from 10.4.2019 (case reference: I R 15/16), the BFH then confirmed this decision.
The key advantage of this ruling for shareholders of a non-EU corporations in relation to the application of Section 27(8) KStG is that the ruling is not tied to the very short preclusion period. Although, in specific cases, the degree of practical difficulties with regard to providing proof could be similarly high. Whether or not tax accounts, for example, can be drawn up under analogous application of German law was left open by the BFH.
In a further, recently published, ruling on this issue from 27.10.2020 (case reference: VIII R 18/17), that concerned a subsidiary company in Austria, the BFH established that the concurrent existence of the assessment procedure in accordance with Section 27(8) KStG, on the one hand, and the ruling on the repayment of capital contributions from third countries, on the other hand, does not constitute unconstitutional unequal treatment. However, from the ruling it is also possible to infer that the lack of an individual possibility to provide proof of repayment of capital contributions within the scope of the assessment procedure for the shareholder in cases in the EU could, potentially, constitute an infringement of the free movement of capital.
Recommendation: The above-mentioned BFH rulings have, so far, not been published in the Federal Tax Gazette (Bundessteuerblatt), which means that they are not generally applied by the fiscal authority. If you already have a situation where the repayment of capital contributions from abroad has been effected or is being planned then, please, do not hesitate to contact us so that the possibilities for applying the latest ruling can be considered.