In a recently published judgment of 6 December 2021, the Tax Court of Munich decided that the final German withholding tax (WHT) on German dividends to a Canadian pension fund does not violate the free movement of capital under Article 63 TFEU as pension provisions were not formed at the fund’s level.

Relevant German legislation

In a nutshell, resident pension funds are subject to unlimited corporate income tax liability, but the recognition of pension provisions as liabilities de facto exempts their dividend income. Typically, German insurance supervision rules require a pension fund to credit investment income arising from its capital stock directly to the future claims of the fund’s beneficiaries. As a result, incoming dividends do not only increase the pension fund’s assets, but also the actuarial pension provisions on the liabilities side of its (commercial and tax) balance sheet. This treatment under German accounting rules neutralizes the dividend income (almost completely) for tax purposes, meaning that resident pension funds may claim (almost) full reimbursement of the domestic WHT on such dividends in their annual corporate income tax assessment.

 

Nonresident pension funds, on the other hand, are not eligible for an assessment procedure in Germany. For them, the WHT on German dividends is final and may only be reduced under a double tax treaty with their State of residence, without the possibility to deduct any expenses.

Facts of the case

The plaintiff in the case before the Tax Court of Munich was a Canadian trust (College Pension Plan of British Columbia), which had a legal structure comparable to that of a German pension fund. Its purpose was to provide pensions to former officials of British Columbia Province. Between 2007 and 2010, the trust had received dividends from portfolio shareholdings in German stock corporations, which were subject to final WHT (reduced to 15% under Art. 10(2)(b) of the Double Tax Treaty between Germany and Canada). Based on the free movement of capital under Article 63(1) TFEU the trust had applied for a refund of the remaining German WHT burden, which was rejected by the German tax authorities.

CJEU ruling in Case C-641/17

In the court proceeding brought by the Canadian fund against this rejection, the Tax Court of Munich referred a request for a preliminary ruling to the CJEU. In its judgment of 13 November 2019 in case C-641/17, College Pension Plan of British Columbia, the CJEU ruled that the less favourable treatment of nonresident pension funds may indeed form a potential restriction on the free movement of capital unless the difference in treatment concerns situations that are not objectively comparable. According to the CJEU, a nonresident pension fund is in a situation comparable to that of a resident pension fund for the purposes of German dividend taxation if the foreign fund, either pursuant to the law in force in its State of residence or on a voluntary basis, allocates dividends received to pension provisions for its future payment obligations to beneficiaries.

New ruling of the Tax Court of Munich

Based on the CJEU´s decision, the Tax Court of Munich requested the Canadian pension fund to submit evidence for the conditions set up by the CJEU, i.e., regarding (1) the formation of a profit-reducing provision for pension obligations on its balance sheet, and (2) a causal connection between the dividends received and an increase in its corresponding pension provisions. Upon submission of its annual reports for 2007 to 2010 to the Tax Court, it appeared that – contrary to its initial claim – the Canadian pension fund had not formed any provisions for pension obligations on its balance sheets.

 

In the years in dispute, International Financial Accounting Standards (IFRS) were not yet in force in Canada, and the plaintiff had prepared its financial statements in accordance with the “General Accepted Account Standards in Canada” which did not require the recognition of provisions for pension obligations (and neither had the plaintiff formed any provisions on a voluntary basis).

 

What the plaintiff could prove was that actuarially calculated pension obligations were explained in the “Notes to the Financial Statements”, and that in its profit and loss statements it had reported investment income (inter alia, dividend income) and also pension expenses. However, as the Tax Court of Munich pointed out after closer scrutiny, these pension expenses were the payments to the pension beneficiaries in the respective years in dispute and therefore not connected to any future pension obligations. Accordingly, the Tax Court found that there was no comparability between the Canadian fund in question and a German pension fund and dismissed the claim, as it did not consider the conditions set up by CJEU for an unjustified infringement of free movement of capital to be met.

Implications from the judgment of the Tax Court of Munich

According to the rather restrictive view of the Tax Court of Munich, it is not sufficient for a foreign pension fund to ensure that it used all dividend income to meet pension obligations. Rather, the Tax Court strictly adhered to the precise technical requirements pointed out by the CJEU, i.e., whether a foreign pension fund can neutralize its dividend income in the same way as a German pension fund by recognizing corresponding pension obligations on its balance sheets. Actuarially calculated pension obligations merely reported in notes to the financial statements are not sufficient.

 

With regard to WHT refund claims, this judgment indicates that affected non-resident pension funds should verify (1) whether pension provisions have been technically recognized on their balance sheets, and if so, (2) whether there is a causal relation between the calculation of these provisions and the German dividend income received.