German tax court decides on 100% exemption of gains from the sale of shares in German companies

The High Tax Court in Germany ruled that gains derived by a foreign company from the sale of shares in German companies are tax fully exempt under German domestic tax law, in contrast to the view taken by the German tax authorities that have argued for a partial tax exemption.

Foreign companys sale of shares in German companies

Foreign MNEs often use foreign holding companies that directly hold shares in German companies.  A sale of these shares might become necessary in the course of a divestment, an international group restructuring, a post-M&A integration or even due to the lack of business functions (‘substance’) in post-BEPS times when conducting intercompany transactions with German affiliates.

In a recent case, a Bermudan company had sold its shares in a Germany company, for which it filed (too late) a German tax return. The selling foreign company correctly did treat this sale as being subject to a German income tax liability for the capital gains derived from the sale of the shares in the German company (Sec. 49(1) of the Income Tax Act). The less controversial question is whether all these capital gains are subject to corporate income taxes of 15%, increased to 15.825% by 5.5% solidarity surcharge taxes under German domestic tax law. Preferably, they are tax exempt. However, it is very controversial to which extent they are exempt, to 100% or, in fact, only to 95%?

Court confirms domestic tax exemption for capital gains from the sale of shares

In the German tax return, the foreign seller declared that the capital gains from the sale of company shares are tax exempt for corporate income tax purposes under German domestic tax law. This view has also been taken by the German tax authorities and Lower Tax Courts. As expected, the German High Tax Court concluded that such capital gains are tax exempt under Sec. 8b(2) of the Corporate Income Tax Act if the seller is not a natural person but a company.

This part of the court decision is less important if a tax treaty between Germany and the residence country of the foreign selling company is in place, since gains derived from the sale of shares in German companies are normally tax exempt in Germany pursuant to Art. 13 of German tax treaties. However, if the foreign seller does not reside in a tax treaty country or a tax treaty is not applicable for some other reasons, the – now confirmed in the high courts – application of the domestic tax exemption is of key importance.

Court rules in favor of domestic 100% exemption for capital gains from the sale of shares

During the administrative appeal, the foreign selling company argued in favor of a full tax exemption of the capital gains, while the German local tax office and subsequently the Lower Tax Court considered the capital gains from the sale of company shares only as, in fact, partially tax exempt (95%) for corporate income tax purposes. Such partial tax exemption of capital gains from the sale of company shares apply in a pure domestic context in Germany.

In the light of the wording of Sec. 8b(3) of the Corporate Income Tax Act, the High Tax Court concluded that the capital gains are fully tax exempt (100%) under German domestic tax law, unless the foreign selling company has a permanent establishment located in Germany, to which the shares are allocated. This also increases legal certainty if the foreign selling company resides in a tax treaty country, although that was not the case in the court proceeding at hand.

Impact for foreign companies selling shares in German companies

It is still uncertain whether the German tax authorities will generally apply this decision for all other cases (by its publication in the Federal Tax Gazette), i.e. 100% tax exemption, or will limit its application to the decided case at hand.

In any case, foreign selling companies have to file German tax returns for the sale of shares in German companies, even if zero capital gains are to be declared. However, the court clarified that no administrative fine applies for late filings by foreign sellers if the capital gains are fully tax exempt.