International Taxation WS 2020-2021

Masters in Finance
International Tax Law

Lecture Notes
WS 2020
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Imprint
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44227 Dortmund
www.ism.de
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Module Description
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Module Description
The course „International Taxation “ addresses the following issues (1):
• Taxation principles
• Structural organisation of fiscal adminsitration
• Jurisdiction
• Fiscal Code
• Tax identifiaction numbers
• Tax revenue
• Income tax for residents
• Types of income
• Income tax
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Module Description
The course „International Taxation “ addresses the following issues (2):
• Solidarity surcharge
• Tax on benefits in kind
• Withholding taxes
• Property Sales tax
• Double taxation agreements
• Social Security Contributions
• Corporation Tax
• Trade tax
• Value‐added tax
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Module Description
Learning outcomes
Knowledge: Students have detailed, up‐to‐date knowledge of international

accounting, taxation and commercial law, and know how to apply this broad
knowledge on an international scale successfully in their subsequent profession.
Skills: With the completion of their studies, students will have the conceptual skills
to resolve strategic problems on an international level in the above specified
teaching areas.
Social competence: Students are able to define targets for a team of employees,
when working on commercial, accounting and taxation issues with international
implications. They are able to develop the appropriate means to achieve these
goals, lead competently specialist discussions and lead a department responsibly
through solving complex problems.
Autonomy: Students can categorize, question and independently interpret the
knowledge gained in this module and successfully apply it in their professional
practice.
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Module Description
Type and duration of exam

written exam (120 minutes)
Weight of the mark in the final grade

5.56%
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Literature
Compulsory reading:
Oats, L.; Miller, A.; Mulligan, E. (2017): Principles of international taxation. 6th ed.,
London : Bloomsbury Professional.
Schreiber, U. (2013): International company taxation. An introduction to the legal

and economic principles. Berlin : Springer (Springer texts in business and
economics).
Supplementary reading:
Cortez / Schmidt (2017): Principles of German Taxation

An Introduction for Students and Tax consultants. Weil im Schönbuch,HDS‐Verlag
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Table of Contents
01 Introduction to International Tax Law
1.1 Fundamentals of International Tax Law
1.2 Principles of International Tax Law
1.3 Basic Issues of International Tax Law
1.4 Measures of International Tax Law
1.5 Fundamentals of European Law
02 Double Taxation
2.1 Fundamentals
2.2 Bilateral Measures
2.3 Supranational Measures
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Table of Contents
03 EU Case Law
04 Tax Treatment of Direct Investments

4.1 Forms of Cross‐Border Business Activity
4.2 Direct Investment in the form of a Permanent Establishment
4.3 Direct Investment in the form of a Subsidiary Corporation
05 International Tax Planning using Holding Companies
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01
Introduction to International Tax Law
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Fundamentals of International Tax Law
The term “International Tax Law” includes all standards that regulate cross‐border matters.
Problem
Cross‐border matters are where, for example, income is obtained at home and abroad.
This means that several legal systems will be affected, raising the question of how countries’
jurisdiction is defined:
“Which state is allowed to tax which income?”
And
“Which standards give rise to the right of taxation?”
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This covers both the standards of domestic law and inter‐governmental agreements.
International tax law is growing in importance:

– continued international integration of the economy (globalisation);
– increase in cross‐border business relationships, even where medium‐sized companies are
concerned;
– Unfair competition caused by different tax systems.
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International tax law, strictly speaking, means
– Customary international law
– Double Taxation Agreeements
– Decisions of international courts
Strictly speaking, the provisions of international tax law derive from international law and these regulate
the definition of colliding tax sovereignty claims between countries.
In the broader sense, international tax law also includes provisions of domestic tax law (e.g. Individual
provisions of the German Income Tax Act (EStG), Corporation Tax Act (KStG), Value Added Tax Act (UStG)
and Foreign Tax Act)).
http://www.gesetze‐im‐internet.de/
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01
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Principles of International Tax Law

Due to the sovereignty principle, every country is autonomous in its territorial sovereignty when
it comes to defining its tax claims and exercising its tax autonomy. However, every country is
obliged to recognise and respect the territorial sovereignty of other countries (“Non‐Intervention
in Domestic Affairs”).
 This does not however rule out a country’s right to tax affairs in foreign countries.
Affairs that have their basis abroad may be subject to domestic taxation.
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Principles of International Tax Law
– Universality principle
– Territoriality principle
When the entirety of the revenue earned by a person both at home and abroad is subject to taxation
(global income), this is what is known as the universality principle.
As such, the person in question is subject to unlimited tax liability.
When applying the territoriality principle, a country’s tax claim only includes those events taking place
in its own territory. This is what is known as limited tax liability.
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Basic Issues of International Tax Law
Generally speaking, taxable persons are subject to double taxation when they simultaneously meet the
conditions for unlimited or limited tax liability in more than one country.
A distinction is made here between legal and economic double taxation.
Economic double taxation is when the income of different taxable persons is subject to taxation. Such
is the case in particular if the profits earned by a foreign corporation, which are taxed in that
corporation’s jurisdiction and which are distributed to the shareholder are once again subject to
taxation (dividend taxation).
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Double Taxation
For legal double taxation, the following criteria must be met:
•Taxation by at least two national tax jurisdictions;
•Same tax subject;
•Same tax object;
•Same tax period;
•Similarity of taxes.
Generally speaking, legal double taxation is when taxable persons simultaneously meet the conditions
for unlimited or limited tax liability in more than one state.
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Tax Evasion
Cross‐border tax‐related matters that result in under‐taxation at home.
This generally refers to the improper and abusive reduction of tax by abusing international differences
in tax burdens:
Under‐taxation is therefore the result of a structure that does not match the actual economic
situation.
E.g.: A resident taxpayer changes their residence to a low‐tax state without abandoning their
economic interests at home.
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Tax Evasion
In international tax law, only those tax reductions that are not in keeping with the fundamentals of
uniform and competition‐neutral corporate taxation are classed as under‐taxation.
The following are examples of cross‐border tax‐related matters that result in a reduction of the
domestic tax burden.
– Cross‐border activities between related persons

– Relocation
– Shifting income to foreign corporations
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Basic Issues of International Tax Law
Double taxation and under‐taxation
Under international law, there is no ban on double taxation or under‐taxation!
Double taxation can result in an extra financial burden; the net earnings decrease. The taxable
person may ask whether they should limit their deployment to only one jurisdiction. In this case, only
one instance of taxation would take place and returns would increase.
Under‐taxation, by contrast, grants the taxable person a measure of financial alleviation and a tax
advantage.
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Causes of Double Taxation

Example 1: Unlimited tax liability in the country of residence and limited tax liability in the source
country.
Thomas Mustermann is resident in Ulm and receives income on a flat situated in Switzerland.
Legal consequences
– Thomas Mustermann has unlimited income tax liability in Germany (universality principle).
– In Switzerland, he has limited income tax liability on his rental income (territoriality principle).
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Example 2: Two taxable persons with unlimited tax liability in different countries
Colt Dickson, a US citizen, has lived and worked in Stuttgart for a number of years.
Legal consequences
– Since, as a subjective connecting criterion, the taxable person has chosen Germany as his country of
residence, Colt Dickson has unlimited income tax liability in Germany.
– The USA is built on nationality; as a result, all citizens, regardless of their country of residence, are
subject to unlimited income tax liability.
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Example 3: Tax obligations in different countries
Linda Janssen, who lives in Dortmund, holds shares in a corporation based in Switzerland.
Linda Janssen, Legal consequences

Dortmund
 Double taxation takes place if withholding tax
is levied on the corporation’s dividends in
Dividends
Switzerland (capital gains tax), with the
earnings from that participation being
attributed to Linda Janssen’s income in
Corporation
Germany.
Switzerland
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01
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Measures aimed at Eliminating or Reducing Double Taxation
Unilateral measures
 Bilateral measures
 Supranational measures (EU)
 Multilateral measures
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Unilateral measures (domestic law)

Measures taken by a state that are aimed at eliminating or reducing double taxation:
§ 34 c and § 32b EStG
– Exemption method (resulting from the respective DTT)
– Tax credit method (§ 34c para. 1; § 32d para. 5 EStG; § 26 para. 1 KStG)
– Deduction method (§ 34c para. 2, 3 EStG)
– Lump sum payment (§ 34c para. 5 EStG; lump‐sum remission; foreign activity remission)
– Remission (§ 34c para. 5 EStG)
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Bilateral measures
Measures taken by two countries that are aimed at eliminating or reducing double taxation:
Double Tax Treaty (DTT)
Via
Tax credit method
or
Exemption method
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Tax credit method
The domestic taxation level shall apply, irrespective of where the income originates
Competitiveness in accordance with capital export neutrality
(Neutrality with regard to the country of residence)
Exemption method
Income earned abroad is taxed abroad at the level of taxation of the country in question
Competitiveness in accordance with capital import neutrality
(neutrality with regard to the country where the economic activity is exercised)
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Measures aimed at eliminating tax evasion

– Foreign Tax Act
Regulations
– Cross‐border relationships § 1 AStG
– Extended limited tax liability § 2 AStG
– Exit taxation § 6 AStG
– Controlled foreign corporation rules § 7 AStG
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01
Introduction to International Law
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Fundamentals of European Law

The European Union
The EU is currently made up of 28 Member States with a total of around 500 million inhabitants.
The founding treaties form the basis for cooperation between the Member States.
The European Union does not collect taxes!
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Legal bases
 Treaty on the Functioning of the European Union (TFEU)

The legal bases do not contain a dedicated section on taxation policy;
Tax harmonisation is not an independent objective of the EU

The EU’s objectives are only affected if required in order to comply with the Fundamental Freedoms.
However: The harmonisation requirement for all indirect taxes (VAT, excise duties) is based on article
110 TFEU (Ban on Tax Discrimination in respect of Imports).
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Legal bases
“Internal Market”:
The Fundamental Freedoms and the Competition Rules form the basis
Fundamental freedoms are subjective rights of the individual
Competition Rules:
oBan on restriction of competition (articles 101‐106 TFEU)
oSpecial taxation‐related anti‐discrimination clauses (articles 110 – 113 TFEU)
oFundamental prohibition of state aid that distorts competition (articles 107 – 109 TFEU)
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Consequences for corporate taxation in the EU
The EU does not have exclusive jurisdiction
Inter‐governmental tax differential influences businesses’ choice of location, investment behaviour

and financing methods
Taxation can trigger unfair competition, running counter to the concept of the single internal market
being an area of free competition.
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Double Taxation
2.1 Fundamentals
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Fundamentals
• Generally speaking, double taxation is when taxable persons are subject to double taxation when
they simultaneously meet the conditions for unlimited or limited tax liability in more than one state.
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Origin of Double Taxation

Example 3: Two individuals subject to limited tax liability in different countries
Josef Matula, who lives in Frankfurt, sets up a permanent establishment in Foreign Country I. As part
of its capital, the permanent establishment holds shares in a corporation that falls under the
jurisdiction of Foreign Country II. Double taxation takes place if Foreign Country II levies withholding
taxes (capital gains tax) on the corporation’s dividends and Foreign Country I assigns the profits from
the participation in the corporation to the permanent establishment’s income.
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Origin of Double Taxation
Josef Matula Permanent establishment in

in Frankfurt Foreign Country I
Corporation
in Foreign Country II
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Methods aimed at Eliminating Double Taxation

Double taxation reduces the profitability of foreign investments. There is therefore an incentive to
eliminate double taxation by making purely domestic investments (lock‐in effect). From a
macroeconomic perspective, double taxation hampers the efficient inter‐governmental allocation of
production factors.
Also, for purely fiscal reasons, it is desirable to implement measures aimed at eliminating double
taxation since, in the short term, higher long‐term tax revenue can be overcompensated by reduced
economic growth and the resulting reduced taxable profits.
Depending on the degree of cooperation with other countries, there are different options for
eliminating double taxation.
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Methods aimed at Eliminating Double Taxation
Measures aimed at eliminating double taxation
Supranational &
Unilateral Bilateral
multilateral
measures measures
measures
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Double Taxation
2.1 Fundamentals
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Bilateral Measures
Generally speaking, the bilateral measures aimed at eliminating double taxation are Double Taxation
Treaties (DTT). DTT are international treaties between individual sovereign countries. Using a system
of distribution or waiver rules, the contracting parties regulate the exercise of colliding taxation claims.
– If the source country is assigned the unlimited right of taxation, then the exemption procedure
generally applies (subject to the progression clause) (article 23 A OECD MTC).
– If the source country’s right of taxation is partially limited, then the country of residence shall
apply the tax credit method (article 23 B OECD MTC).
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Testing Scheme
Is there a DTT?
No Yes
Is the source country’s right of taxation

Unilateral measures
limited?
Yes
No
Exemption method Tax credit method
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Introduction
• DTT are one of the most important instruments used to eliminate double taxation. Bilateral
agreements have existed since the mid‐19th century. The first DTT was entered into between Prussia
and Saxony on 16/04/1869. In 1963, the OECD’s Committee on Fiscal Affairs was able to present a
model agreement on the avoidance of double taxation with regard to tax on income and capital. This
OECD Model Tax Convention (OECD MTC) from 1963 was to be used by member states as a
negotiating basis. The objective of the model agreement was to achieve greater harmonisation of
the bilateral agreements of the member states by using standard definitions, systems, principles and
interpretation with regard to the conclusion and application of DTT.
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Introduction
• The OECD members are, almost without exception, western industrialised countries with the same
economic interests and a close‐to‐balance flow of capital, goods and services. As such, the OECD
member states have no objection to any restriction of withholding taxation in favour of taxation in
the country of residence, as this is practised in the OECD MA. However, when it comes to economic
relationships between industrialised and developing countries, the restriction of withholding
taxation leads to a unilateral reduction in tax revenue for the developing countries. To take into
account the interests of developing countries, in 1979, the UN drew up a model double taxation
elimination agreement to serve as the basis for negotiations between industrialised nations and
developing countries.
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Introduction
• The UN model bears a strong similarity to the OECD MTC, only differing in terms of its content in
that the developing countries, being as they are typical capital import countries, generally emerge as
fiscal beneficiaries as a result of an enhanced withholding taxation right.
Double Taxation Treaties
OECD Model UN Model
• Broad restriction of withholding • Enhanced withholding taxation

taxation right right
• Basis for negotiations between • Preferential fiscal treatment of
industrialised nations developing countries
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Introduction
DTT are international treaties between two sovereign countries. DTT do not constitute taxation claims,
but rather they restrict existing domestic taxing rights by specifying which of several colliding tax
competencies must withdraw. DTT law performs the function of a legal barrier.
The rules of the DTT have the status of a statutory law i.e. they have the same status as domestic
taxation laws. However, as “lex specialis”, DTT enjoy priority over domestic taxation laws.
Only a more specialised successor law can override the DBA rules (“treaty override”). Such treaty
overrides breach the general rules of contract compliance. The contracting partner is granted a right of
termination.
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The OECD Model Tax Convention
Development and current status
Since the year 2000, the OECD MTC has been revised in a two‐ to three‐yearly cycle.
Amendments were made in 2003, 2005, 2008, 2010, 2014 and 2017.
Since 2008, discussion drafts covering various outstanding issues of international tax law have been
incorporated into new versions of the OECD MTC and OECD MTC commentary by the working parties
of the OECD Fiscal Affairs Committee.
The 2017 update to the OECD Model Tax Convention is on the intranet!
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Structure of the OECD Model Tax Convention

The OECD MTC is broken down into seven sections:
Section I: Scope of the Convention (articles 1 and 2)
This section defines the personal and objective scope, thereby answering the question of which
persons and which tax types are subject to the Convention.
Section II: Definitions (articles 3‐5)
In this section, the Convention, in accordance with its function as an independent set of rules, defines
the terms used in the Convention using its own terminology.
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Section III: Assignment of Income Taxation Rights (articles 6‐21)
This section constitutes the main body of the DTT. The provisions of this section stipulate the extent to
which the source country’s taxation right with regard to the types of income listed is maintained or
restricted. These are what are known as “barrier provisions”.
Section IV: Assignment of Capital Taxation Rights (article 22)
In terms of its function, Section IV corresponds with Section III, referring however to the taxation of
capital.
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Section V: Methods for Eliminating Double Taxation (article 23)
Assuming that articles 6‐22 themselves do not eliminate double taxation, Section V sets out both
methods that can be used to eliminate double taxation: the credit or the exemption method.
Section VI: Special Provisions (articles 24‐29)
Section VI governs certain special circumstances such as mutual agreement procedures or the
exchange of information between the authorities.
Section VII: Final Provisions (articles 30 and 31)
The two last articles of the Convention regulate its entry into force and termination options.
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The Individual Provisions of the OECD MTC
• Barrier provisions for the source country

• Articles 6‐22 OECD MTC
Barrier provisions with a Barrier provisions with an

final legal consequence open legal consequence
“may only” “may” or “may also”
If the barrier provision

If barrier provisions still fail to
is itself an avoidance rule,
eliminate double taxation,
the Methods article shall
the Methods article must be applied
not apply
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Income from Immovable Property (Article 6 OECD MTC)
Paragraph 1 forms the basis for taxation in the source country for the income (source country).
“Income” received by a person resident in a Contracting State from immovable property (including
income from agricultural and forestry undertakings) that is situated in another Contracting State may
be taxed in another state”.
This is what is known as a barrier provision with an open legal consequence. The source country in
which the immovable property is situated receives the unrestricted taxing right. The reason for this lies
in the close economic link between the source of the income and the source country.
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Income from Immovable Property(Article 6 OECD MTC)
Simultaneously, the country of residence is also entitled to an unrestricted taxation right (“may” and
not “may only”). Double taxation therefore can only be eliminated through the country of residence
applying the Methods article (article 23).
In the DTT it has signed, Germany generally exempts income from immovable property subject to the
progression proviso.
When compared with paragraph 1, the remaining paragraphs of article 6 OECD MTC have a purely
explanatory purpose. These paragraphs define, inter alia, which assets “in all cases” constitute
immovable property (affirmative list). By contrast, ships and aircraft are not classed as immovable
property.
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Business Profits (Article 7 OECD MTC)

This article concerning the division of tax competencies with regard to business profits is the most
significant article in OECD MTC, given that by far the largest part of international economic activities
falls under this type of income. According to article 7, para. 1 OECD MTC:
“The profits of an enterprise of a Contracting State may only be taxed in that State unless the
enterprise carries on business in the other Contracting State through a permanent establishment
situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be
taxed in the other State but only so much of them as is attributable to that permanent establishment
as per paragraph 2.”
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According to article 7 OECD MTC, not every business activity results in taxation in the source country.
On the contrary, there must be a sufficiently close link with the economy of the source country in the
form of a permanent establishment (permanent establishment principle).
The situation regarding the permanent establishment will therefore determine the taxation level to
which an enterprise’s profits are subject. If the foreign state’s taxation level is lower, setting up a
permanent establishment abroad would appear to be advantageous if the country of residence
exempts the profits. If the foreign state’s taxation level is higher, then setting up a permanent
establishment abroad should be avoided wherever possible from a fiscal perspective.
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What is classed as a permanent establishment is determined by the provisions of article 5 OECD MTC.
According to this article, a permanent establishment is a fixed place of business from which all or part
of an enterprise’s activity is carried out (article 5, para. 1 OECD MTC).
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According to article 5, para. 2 OECD MTC the expression “permanent establishment”, specifically
includes (affirmative list):
– a place of management;
– a branch;
– an office;
– a factory;
– a workshop; and
– a mine, an oil or gas well, a quarry or any other place of extraction of natural resources
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Article 5, para. 4 OECD MTC sets out a Negativkatalog of which establishments are not classed as
permanent establishments. Even if the conditions of para. 1 are met, the facilities listed are not
treated as permanent establishments. As “lex specialis”, para. 4 enjoys priority over paragraphs 1 to 3.
What all the situations on the negative list have in common is that they constitute ancillary or
preparatory activities. Ancillary and preparatory activities are far removed from the actual realisation
of profits, meaning that it is difficult to attribute profits to these activities.
According to article 5, para. 4 OECD MTC, the following are not classed as permanent establishments:
Establishments that are used exclusively for the storage, display or delivery of goods or merchandise
belonging to the enterprise;
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– the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the
purpose of storage, display or delivery;
– the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the
purpose of processing by another enterprise;
– the maintenance of a fixed place of business solely for the purpose of purchasing goods or
merchandise or of collecting information, for the enterprise;
– the maintenance of a fixed place of business solely for the purpose of carrying on, for the
enterprise, other activities of a preparatory or auxiliary character.
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2010 amendment to article 5
In implementation of the OECD report on the tax treatment of telecommunication services, the
following clarifications were incorporated into article 5:
– Commercially operated satellites do not constitute permanent establishments in the “overflown”
states or in the states in which the signals are received
– Roaming agreements should not result in the network operator setting up a permanent
establishment in its roaming partner’s country of residence
– Use of a cable network or pipeline situated in a DTT state do not provide the user with the
authority to dispose of these facilities to set up permanent establishments
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The source country is allowed to tax business profits provided that they can be attributed to the
permanent establishment. This restriction of the source country’s taxation right to this portion of the
business profits requires that the results of the permanent establishment be differentiated from those
of the parent company. Paragraphs 2 to 6 set out how the results of the permanent establishment are
to be defined.
Generally speaking, there are two different methods of allocating profits to a permanent
establishment, both of which were also permitted according to the version of article 7 valid until 2010:
– direct method
– indirect method
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According to the direct method, the profits of the permanent establishment are determined on the
basis of separate accounts kept for the permanent establishment as if it were an independent
enterprise. The application of the dealing at arm’s length principle ensures that profits are not shifted
back and forth between the permanent establishment and the parent company.
According to the direct method, the profit of the permanent establishment are to be determined as if
the permanent establishment were a fully independent enterprise (including with regard to the
parent company). If the transfer prices between the parent company and permanent establishments
do not stand up to the dealing at arm’s length principle, then the attributed profits need to be
adjusted.
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According to the indirect method, the total results of the unitary enterprise are determined according
to the respective domestic profit calculation regulations. Subsequently, the enterprise’s total profit is
allocated to the parent company and the permanent establishment according to specific criteria. The
main issue with this method is finding a suitable criterion for correctly assigning the profit. Corporate
key figures such as turnover, staff costs, material costs and equity can be used as allocation criteria.
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Methods provided up to 2010 :
Permanent establishment profits
Indirect method
Direct method
‐Determining the entire result of the
‐ Fictitious independence of unitary enterprise
permanent establishment
‐ Dealing at arm’s length principle ‐ Allocating entire result according
to specific criteria
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The 2010 version of the OECD MTC completely reworded article 7.
Article 7 was reduced from a total of seven paragraphs to four.
The attribution principle in article 7, para. 1 remained unaltered.
In article 7, para. 2, the unlimited arm’s length principle is postulated (so‐called separate entity
approach).
Result: In the OECD’s view, the indirect method is no longer in keeping with the times and should no
longer be permitted in future DTT.
The ban on the corresponding adjustment in the correction of permanent establishment profits by
the source country is codified in para. 3.
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The so‐called permanent establishment clause, which until 2010 was regulated by article 7, para. 7
OECD MTC, is now found in article 7, para. 4 OECD MTC.
Article 7, para. 4 OECD MTC makes a distinction between the enterprise’s profits and other income.
“Where profits include items of income which are dealt with separately in other Articles of this
Convention, then the provisions of those Articles shall not be affected by the provisions of this
Article”.
Article 7 is therefore ranked lower than the other articles. If, for example, a permanent establishment
obtains dividends and royalties, then the right to tax this income is governed not by article 7 but rather
by article 10 (Dividends) or article 12 (royalties).
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“Separate Entity Approach” = direct method
Dealings between the parent company and the permanent establishment (PE) are feigned and
documented which under civil law are wholly impossible.
So as to ensure that results are properly distinguished, the PE should also remunerate the parent
company for the payment of capital, granting of rights or the use of services (notional arm’s length
remunerations), although in reality there has been no realisation in the market (“self‐dealing”).
The deduction of operating expenses is no longer restricted to original expenses but now includes
fictitious expenses. As a result, the PE can show profits even though the enterprise as a whole has
made losses (and vice versa).
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“Separate Entity Approach” = direct method
NB: Fictitious remunerations are not however liable for withholding tax. The feigned “dealings” only
serve to properly distinguish results between the country of residence and the source country.
By introducing the “Separate Entity Approach”, the OECD’s aim is for its transfer price guidelines to
also apply, without restriction, to the distinction of permanent establishment results, it thus far having
only been applicable to the differentiation of results between associated enterprises.
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Permanent Establishments
Reasons for choosing a permanent establishment
– simple set‐up;
– no pre‐set‐up or predecessor company;
– no minimum capital level;
– simple liquidation process.
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Taxing Profits from a Foreign Permanent Establishment
• In order to eliminate double taxation, only unilateral measures are possible in the event that there is
no DTT:
– Tax credit method: direct crediting of foreign taxes paid to the domestic tax liability (§ 34c, para. 1
EStG)
– Deduction method: deduction of foreign taxes paid when calculating income (§ 34c, paras. 2,3
EStG)
– Lump‐sum method (§ 34c, para. 5 EStG)
If a DTT is in place, double taxation will be eliminated by exempting the results of the permanent
establishment subject to the progression proviso. The profit of the permanent establishment will
only be subject to the foreign tax system of the state in which it is situated.
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Overview
If the business relationships agreed between related persons do not stand up to the arm’s length
principle, then the income is to be determined as if the relationships had taken place between
independent third parties (dealing at arm’s length principle).
The application of § 1 AStG stipulates that
– the business partner be a related person;
– that there be a business relationship with a foreign state;
– that non‐standard conditions be agreed; and
– that the domestic taxpayer must have reduced its income.
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Overview
The rectification scope is determined by the amount of the income reduction. The income of the
domestic taxpayer must be determined as if it had been realised under the conditions agreed between
independent third parties.
According to the wording of the law, § 1 AStG, “shall apply exclusively, irrespective of other
requirements”. This means that the application of other profit adjustment rules is not limited.
§ 1 AStG therefore only applies in a subsidiary fashion and serves as a catch basin if the profit
adjustment option of another rule is not as far‐reaching (cf. concealed profit distribution, concealed
contribution).
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Transfer Prices in International Tax Law
Parent Company
Subsidiary I Subsidiary II
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Fundamentals
There is a lively exchange of services and deliveries between the group companies (internal sales).
Even though, from the group’s perspective, the realisation of profit requires external sales, for tax
reasons, the individual companies need to calculate their profit whereby, because of their legal
independence, group‐internal deliveries and services must also be considered. However, since these
are not traded on an actual market, only transfer prices can be calculated for group‐internal deliveries
and services.
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39
Fundamentals
By using transfer prices, profits may be moved between the group companies.
The transfer price is the price one group company charges another group company for services or
deliveries rendered. It is very difficult to precisely define the transfer prices, since, as a rule, there are
no market prices to serve as objective prices.
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Fundamentals
In particular, western industrialised countries with comparably high tax rates have significantly
tightened the rules on defining transfer prices and those concerning the documentation requirement.
There is disagreement amongst tax experts as to the extent of the scope to which profit shifting can
take place, owing to the definition of transfer prices.
The US Tax Authorities estimate the shortfall in tax revenue from transfer price manipulations at
around USD2.8 billion per annum.
According to a survey carried out by the auditing firm Ernst & Young in 2003, around 43% of the
enterprises surveyed had to adjust their estimated transfer prices.
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Arm’s Length Principle
• The dealing at arm’s length principle requires that the transfer price for a delivery or service
performed between a taxable person and a person related to the same or between associated
enterprises be determined in exactly the same way as it would if the transaction had taken place
between independent third parties.
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Methods of Determining the Transfer Prices

Generally speaking, associated enterprises must determine their transfer prices for group‐internal
exchange of services as if a prudent and conscientious manager would also have agreed with external
third parties.
Owing to the numerous parameters that influence the transfer price, there is no exact calculation
price. Rather, there are only specific bandwidths within which the transfer price must fall.
Within these bandwidths, the taxable person has a certain amount of leeway for shifting profits
between Group companies. Depending on the situation, the taxable person will take the upper or
lower limit as the transfer price that is still acceptable.
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41
Methods
• In practice, three standard methods have been established for determining the transfer price in § 1,
para. 3 AStG:
Determining the
Transfer Prices
Price Comparison Cost‐Plus Resale Price

Method Method Method
There is no priority regarding these methods. However, the method selected

should be the one that best matches actual market conditions and for which
the most reliable data is available.
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a) Price Comparison Method

The price comparison method is the only one that corresponds to an actual arm’s length dealing.
Here, the transfer price for a delivery or service agreed between two associated enterprises is
compared with the market price agreed between third parties for comparable transactions.
The pre‐requisite for this method to apply is that the transactions be comparable e.g. listed goods,
marketable standard products, licence agreements.
In practice, there are frequent problems when it comes to application since, in the specific case in
question, it is often impossible to create comparability between the transactions e.g. for services
which, generally speaking, only take place within groups, there are no external comparison values.
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42
b) Resale Price Method
The resale price method (also known as the sales method), uses as its basis the selling price at which
an enterprise resells goods it has acquired from an associatedenterprise to external third parties.
Starting with the selling price, this price is reduced in a retrograde fashion through the deduction of a
market‐standard profit margin, allowing the transfer price to be obtained.
The main issue with the resale price method lies in determining the market‐standard profit margin. In
this case, independent enterprises engaging in comparable transactions must be used.
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b) Resale Price Method

This method is particularly suitable for enterprises operating in the sales sector where an associated
enterprise makes deliveries to another associated enterprise and these are then sold on to external
third parties.
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43
c) Cost‐Plus Method
The point of departure for this method are the prime costs of the delivering enterprise. The costs are
determined using calculations that the enterprise also uses in its pricing policy with regard to external
third parties.
If no transactions are carried out with third parties, the calculation must be made following economic
principles. In so doing, both direct and overhead costs must be considered.
The prime costs are increased by a market‐standard profit mark‐up. How high this market‐standard
profit mark‐up is must be reviewed in the specific case in question.
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c) Cost‐Plus Method
The cost‐plus method is particularly suitable where there are no market prices for deliveries or
services available as a point of comparison. This is particularly the case with regard to group‐specific
goods and services that are not marketable (e.g. semi‐finished products).
Conclusion: Despite the cooperation and documentation requirements legally enshrined in the
German Tax Benefit Reduction Act (StVergAbG), the taxable person does retain a certain amount of
leeway with regard to transfer prices when it comes to determining these prices. Owing to the
homogeneity of the deliveries and services between the associated enterprises, there is no general
recommendation regarding the method to be applied.
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44
Record‐Keeping Obligation for Transfer Prices
By means of the StVergAbG, the general cooperation requirements of § 90 of the German Tax Act (AO)
are supplemented by a third paragraph. The pre‐requisite for the record‐keeping obligation for
transfer prices pursuant to § 90, para. 3 AO is a
– business relationship in the meaning of § 1, para. 4 AStG
– which contains a foreign element (at least 25%)
– with a related person in the meaning of § 1, para. 2 AStG
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If these pre‐requisites are met, the taxable person must keep records on the type and content of their
business relationship with the related person.
The record‐keeping obligation also includes the economic and legal foundations for an agreement that
complies with the dealing at arm’s length principle regarding prices and other transactions with
related persons.
German Regulations regarding the Documentation of Profit Allocation (GAufzV) of 12 July 2017.
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If a taxable person fails to keep the required records or if these are unusable, a minimum fine of
€5,000 will be imposed.
If such records are submitted late (from the 61st day onwards), the penalty surcharge shall amount to
at least €100 for each full day following the deadline (maximum amount of up to €1,000,000).
In addition, it is presumed that the income liable for domestic tax determined in accordance with § 90,
para. 3 AO will be greater than that declared by the taxable person.
If the presumption made by the taxable person cannot be refuted, then the tax authority is allowed to
make an estimate if the income cannot otherwise be determined.
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Profit Adjustment
If the internal transfer prices cannot stand up to the dealing at arm’s length principle, then profit
adjustments must be made and brought in line with the market transfer prices off‐balance sheet.
Example:
The Swiss parent company charges its German subsidiary excessive prices for a delivery (price
difference of €100,000).
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46
Profit Adjustment
Concealed profit distribution is when an asset reduction takes place or asset multiplication is
prevented, this being arranged by the business relationship, with this having an impact on the amount
of income and, as such, is not an open distribution.
§ 8, para. 3 p. 2 KStG regulates the legal consequences of concealed profit distribution:
In addition, concealed profit distributions and distributions (of any kind) of participation rights through
which the right to participate in profits and to liquidate the corporation’s proceeds is associated, do
not reduce the revenue.
If the annual net profit is too low as a result of a concealed profit distribution, then an off‐balance
sheet add back will take place.
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International Shipping, Domestic Shipping and Air Transport

(Article 8 OECD MTC)
Systematically, article 8 is also part of Business Profits, but, as “lex specialis”, enjoys priority over
article 7. This requirement stipulates that the proceeds from internationally‐operating shipping and
aviation enterprises that earn revenue in a number of countries shall only be taxed in one state. This
should prevent taxation from being fragmented.
“Profits from the operation of ships or aircraft in international traffic may only be taxed in the
Contracting State in which the enterprise’s actual place of management is situated.”
Article 8 only regulates the profits from the operation of ships and aircraft in “international traffic”.
Domestic transport operations within a Contracting State that is not the state from which the
enterprise is managed are not included in article 8.
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Associated Enterprises (Article 9 OECD MTC)
Article 9 OECD MTC regulates the taxation of two associated enterprises in their countries of
residence. Associated enterprises are corporate links between legally independent enterprises that are
subject to common control (control concept).
Article 9, para. 1 allows tax authorities to make profit adjustments if transactions between associated
enterprises do not stand up to the arm’s length principle.
The tax authorities of a Contracting State may make profit adjustments if, owing to conditions that
deviate from those that would have been agreed between independent enterprises”, no profits are
disclosed.
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Associated Enterprises (Article 9 OECD MTC)

The “dealing at arm’s length principle” serves as a standard for the suitability of transfer prices.
If only one Contracting State makes a profit adjustment (generally speaking a profit increase), then the
profit adjustment made will result in double taxation for the associated enterprise if this does not have
the effect of reducing profits in the other Contracting State.
For this reason, article 9, para. 2 OECD MTC requires the other Contracting State to make a
corresponding adjustment in the amount of the unsuitable portion in order to offset the double
taxation that takes place.
In those DTT actually entered into, the provision of article 9, para. 2 seldom applies since the countries
fear fiscal risks.
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48
Dividends (Article 10 OECD MTC)
Article 10 OECD MTC (“Dividends”) and the subsequent article 11 OECD MTC (“Interest”) differ from
other articles in this regard in that they provide for an analysis of taxes between the country of
residence and the source country.
Article 10, para. 1 confirms the basic rule for the unrestricted taxation right of the country of
residence.
“Dividends paid by a company which is resident in another Contracting State to a resident of the other
Contracting State may be taxed in that other State.”
According to article 10, para. 2, these dividends may, however, also be taxed in the Contracting State
in which the company paying the dividends is resident (source country).
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However, the taxation right of the source country is limited in terms of the amount. Where the
beneficial owner of the dividends is a person resident in the other Contracting State, the tax may not
exceed:
– 5% of the gross amount of the dividends if the beneficial owner is a company (but not a
partnership) that directly holds at least 25% of the capital of the company paying said dividends;
– 15% of the gross amount of the dividends in all other cases.
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In the former case, these are inter‐company dividends and, in the latter, portfolio dividends.
An inter‐company participation is when a company has a direct stake in at least 25% of the share or
nominal capital of the distributing company. In addition, the recipient of the dividends must be a
corporation.
Dividend income from an inter‐company participation are preferable to portfolio participations (cap of
5% vs. 25%). The lower rate of withholding tax compared with portfolio dividends should reduce the
multiple burden of dividends within the Group and promote direct foreign investments.
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• In Germany, capital gains tax (withholding tax, § 43 EStG) is levied on dividends in the amount of
25% + 5.5% solidarity surcharge. In order to benefit from the reduction in withholding tax to 5% to
15%, the beneficial owner of the dividends must be a person resident in the other Contracting State.
The Convention refers to the beneficial owner and not the recipient of dividends, in order to prevent
improper use through the activation of interim entities.
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Interest (Article 11 OECD MTC)
As with dividend income, interest income also follows the concept of an analysis of taxes between the
source country and the country of residence. Taxation in the source country is restricted, with the
country of residence deducting the taxes levied by the source country, meaning that both countries
waive a portion of their tax revenue.
Article 11, para. 1 confirms the basic rule of the unrestricted taxation right of the country of residence.
According to Article 11, para. 2, this interest may, however, also be taxed in the Contracting State
from which they stemmed (source country).
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However, the taxation right of the source country is limited in terms of its amount. The maximum rate
of tax amounts to 10% of the gross amount of interest.
In this case as well, the withholding tax rate is only restricted to a maximum of 10% if the beneficial
owner is a person resident in the other Contracting State. The use of the expression “beneficial
owner” instead of “recipient” should prevent a person resident in the source country from benefitting
from the tax restriction by activating interim entities.
Article 11, para. 3 defines which income is classed as interest.
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51
Article 11, para. 4 regulates the so‐called “permanent establishment proviso”. Interest stemming
from receivables belonging to an operating asset are components of the permanent establishment’s
profit and, as such, are taxed in accordance with article 7 (Business Profits). There is no restriction on
the source country’s taxation right in terms of the amount.
Article 11, para. 5 stipulates that, when interest stems form another Contracting State, generally
speaking, the interest originates in the state in which the person owing the interest is resident.
There is an exception to this principle whereby the interest debt has an economic link to the
permanent establishment. In this case, interest is deemed as having arisen in the state in which the
permanent establishment is situated.
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The aim of article 11, para. 4 is to limit the scope of application of this article in the event that the
agreed interest deviates from the “dealing at arm’s length principle”. Restricting withholding taxation
to 10% of gross interest applies only to that portion of the interest that stands up to the dealing at
arm’s length principle.
“If there exist special relationships between the payer and the beneficial owner or between either of
these and a third party, with the interest therefore exceeding the amount that the payer and
beneficial owner would have agreed to in the absence of these relationships, then this article shall
only apply to the latter amount.”
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Royalties (Article 12 OECD MTC)
According to article 12, para. 2 OECD MTC, royalties are payments of any kind received in
consideration for the use of, or the right to use, copyright of literary, artistic or scientific work, patents,
trademarks, designs or models, secret formulas or processes.
Article 12, para. 1 OECD MTC regulates the tax competency of royalties:
“Royalties arising in a Contracting State and beneficially owned by a resident of the other Contracting
State may only be taxed in that other State”.
In this article, taxation in the source country is excluded. Double taxation is only avoided through
barrier provisions, making any application of the Methods article superfluous.
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The exclusive taxation right of the country of residence with regard royalties is justified by the fact that
the country of residence, from a tax perspective, bears the research and development costs for the
commodity on which the royalties are based.
Generally speaking, treaty practice with developing countries differs substantially from this provision
of the Model Convention and grants the source country a limited taxation right, obliging the country of
residence to credit.
Article 12, para. 3 regulates the so‐called “permanent establishment proviso”. Royalties for rights and
assets belonging to an operating asset are components of the permanent establishment’s profit and as
such are taxed in accordance with article 7 (Business Profits). There is no exclusion of the taxation right
in the source country.
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53
Similarly to article 11, para. 6, article 12, para. 4 aims to limit the scope of application of article 12 in
the event that the agreed royalties deviate from the “dealing at arm’s length principle”. The exclusion
of withholding taxation only applies to those royalties that do stand up to the dealing at arm’s length
principle.
“Where, by reason of a special relationship between the payer and the beneficial owner or between
both of them and a third party, the amount of the royalties therefore exceeds the amount which
would have been agreed upon by the payer and the beneficial owner in the absence of such
relationship, this article shall only apply to the latter amount”.
The portion of the royalties deemed unsuitable shall be included under the income type
corresponding to its nature and shall be taxed in accordance with the laws of the Contracting State
and taking into consideration the other provisions of the Convention.
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Capital Gains (Article 13 OECD MTC)
According to article 13 OECD MTC, the following principle applies:

The Contracting State that has the right to tax capital gains from assets to which, according to this
Convention, is the same State as the one entitled to the right to tax the current income from said
assets.
Article 13, para. 1 states:
“Gains derived by a resident of a Contracting State from the alienation of immovable property referred
to in article 6 and situated in the other Contracting State may be taxed in that other State”.
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Article 13, para. 1 is a barrier provision with an open legal consequence, meaning that double taxation
can only be avoided through the application of the Methods article (article 23). In this case, Germany
applies the exemption method.
Article 13, para. 2 deals with gains from the alienation of movable property forming part of the
business property of a permanent establishment of an enterprise. As in article 7, these capital gains
may be taxed in the State in which the permanent establishment is situated.
“Gains from the alienation of movable property forming part of the business property of a permanent
establishment which an enterprise of a Contracting State has in the other Contracting State may be
taxed in that other State.”
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Similarly to article 8, article 13, para. 3 allows gains from the alienation of ships and aircraft to be
taxed only in the Contracting State in which the actual place of management is situated.
Article 13, para. 5 is a backup regulation.
“All gains from the alienation of any property other than that referred to in paragraphs 1 to 4 may only
be taxed in the Contracting State of which the alienator is a resident.”
Article 12, para. 5 is a barrier provision with a final legal consequence, meaning that avoiding double
taxation does not require the application of the Methods article. Only the country of residence has the
right of taxation. Article 5 is mainly applied to gains from the alienation of participations held in
corporations and securities in private property.
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Income from Employment (Article 15 OECD MTC)
Article 15, para. 1 OECD MTC regulates the right to tax income from employment. Generally speaking,
the residence principle (a barrier provision with final legal consequence) applies to such income. Only
in the exceptional case where work is carried out in another Contracting State may the remuneration
received for said work be taxed in said other State (place‐of‐work principle).
However, according to article 15, para. 2, the place‐of‐work principle is excluded if
– the employee is only resident in the State in which the work is carried out on a short‐term basis
(less than 183 days every 12 months); and
– the remuneration is paid by an employer which is not a resident of the State in which the work is
carried out; and
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Income from Employment (Article 15 OECD MTC)
– the remuneration is not borne by a permanent establishment which the employer has in the
State in which the work is carried out.
The above pre‐requisites must all be met for taxation by the State in which the work is carried out to
be excluded.
As lex specialis to paras. 1 and 2, remuneration for employment that is carried out onboard a ship or
aircraft that operates internationally may be taxed in the Contracting State in which the enterprise has
its place of actual management (barrier provision with open legal consequence). Taxation in the
residence of the crew remains unaffected by this barrier provision, meaning that double taxation can
only be eliminated through the application of the Methods article.
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Directors’ Fees (Article 16 OECD MTC)
As lex specialis to article 15, article 16 OECD MTC regulates the right to tax directors’ fees.
Essentially, the following applies:
“Directors’ fees and other similar payments received by a resident of a Contracting State in his
capacity of a member of the board of directors or supervisory council of a company which is a resident
of the other Contracting State may be taxed in that other State.”
Article 16 is a barrier provision with open legal consequence, meaning that the country of residence of
the person receiving the remuneration avoids double taxation through the application of the Methods
article. In this case, Germany tends to apply the tax credit method.
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Entertainers and Sportspersons (Article 17 OECD MTC)

Article 17 OECD MTC is a special provision for the professional group of entertainers and
sportspersons. The provision states that entertainers and sportspersons may be subject to withholding
tax in the State in which they personally carry out their activity.
It is typical for these professional groups to be resident in the source country for only a brief period
(less than 183 days a year) or for them to have no permanent establishment or fixed business
relationship in the source country. Without this special provision, the source country would have no
link for taxation pursuant to article 15 or article 7.
The aim of para. 2 is to prevent entertainers and sportspersons from escaping withholding tax by
activating interim entities.
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Pensions (Article 18 OECD MTC)
According to article 18 OECD MTC, pensions from private employment (“subject to article 19, para.
2”), may only be taxed in the country of residence of the recipient, notwithstanding the State in which
the employment was carried out.
Article 18 only includes occupational pensions (“remuneration paid in consideration of past
employment”).
Pension payments from an insurance relationship, including those from the statutory social security
scheme, do not fall under the scope of application of article 18, but rather are covered in article 21.
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Government Service (Article 19 OECD MTC)

For remuneration (article 19, para. 1 a) and pensions (article 19, para. 2 a) paid in consideration of
government service, the paying state principle applies. According to this principle, such payments may
only be taxed in the Contracting State in which the paying public body has its residence (barrier
provision with final legal consequence).
The State that funds the remuneration and pensions via tax should retain the right to tax this income.
Article 19 creates an exception to the paying state principle whereby the recipient is a resident of the
other State and is a citizen of said State.
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Government Service (Article 19 OECD MTC)
In practice, this exception typically applies to the so‐called local staff of embassies and consulates. As
regards this group of people, the relationship to the paying state is far less pronounced, meaning that
an exclusive right of taxation in the recipient state would appear to be justified.
If the remuneration from the public coffers is paid not in consideration of fulfilling public service tasks
but rather in consideration of business activities, then such remuneration loses its public character
and is dealt with as private‐sector remuneration according to articles 15, 16, 17 and 18, this in
accordance with article 19, para. 3.
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Students (Article 20 OECD MTC)

According to article 20, maintenance and training payments received by a Student from sources not
situated in the host country are not taxed in the host country. The same applies if the student is a
resident of the host country following entry.
The purpose of article 20 is to promote the international exchange of training.
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Other Income (Article 21 OECD MTC)
Article 21 is a backup clause in favour of the country of residence for income that is not covered by
the previous barrier provisions.
“Items of income of a resident of a Contracting State, wherever arising, which are not dealt with in the
foregoing articles may only be taxed in said State.”
This article includes, for example, social security benefits, lottery wins, alimonies or gains from
financial innovations.
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Most important is the article for so‐called third‐state income. Third‐state income is the name given to
income earned outside the territories of both Contracting States. The barrier provisions mainly refer to
the situation whereby a person residing in one Contracting State earns income from the other
Contracting State. Article 21 also applies to income whose source is in third states (“wherever
arising”).
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Article 21, para. 2 once again postulates the permanent establishment proviso:
Other income other than that arising from immovable property and which belongs to a permanent
establishment in another Contracting State may be taxed by that other Contracting State.
Immovable property is not included in the scope of para. 2. This gives rise to the primacy of the situs
principle over the permanent establishment principle.
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Capital (Article 22 OECD MTC)

Article 22 regulates the taxation rights concerning capital. Income not only from capital but also the
capital itself can be subject to taxation.
The following essentially applies:
Whoever has the taxation right or the income from the capital may also tax the capital itself.
Since property taxes no longer exist in Germany, this article is purely theoretical.
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Methods Article (Article 23 OECD MTC)
• Barrier provisions for the source country

• Articles 6‐22 OECD MTC
Barrier provisions with

Barrier provisions with
open legal consequence
final legal consequence
“may” or “may also”
“may only”
If the barrier provision is itself If the barrier provision still fails to

an avoidance provision, eliminate double taxation,
the Methods article does the Methods Article
not apply must apply
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The OECD MTC uses two types of barrier provisions: Barrier provisions with final legal consequence
(“may only”) and barrier provisions with open legal consequence (“may” or “may also”).
Barrier provisions with open legal consequence do not exclude either of the two Contracting States
from taxation. In this case, the country of residence shall retain the taxation right, but double taxation
must be eliminated by applying the Methods article.
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• Methods Article
• Article 23 OECD MTC
Exemption Method Tax Credit Method

Article 23 A Article 23 B
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Progression Proviso
If a taxable person earns income from a State with which Germany has signed a DTT, then the DTT will
stipulate either
•the tax credit method; or
•the exemption method
for eliminating double taxation.
In the case of the exemption method, however, it should be ensured that, despite the exemption of
the foreign income, the tax rate be applied to the tax‐liable income that would have resulted had the
foreign income not been tax‐exempt (taxation according to ability to pay).
This is ensured by the so‐called progression proviso.
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Progression Proviso
The progression proviso applies to the income referred to in in § 32b, para. 1 (3) EStG. However, § 32,
para. 1, sentence 2 EStG contains an exception to which no progression proviso can be applied.
Calculation of the progression proviso stems from § 32b, para. 2 EStG
Notwithstanding domestic tax indemnity, the foreign income is included when determining the
(progressive) income tax rate to be applied.
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Progression Proviso
The progression proviso can have a “positive” or “negative” effect and, as such, can result in an
increase or reduction of the tax rate to be applied to the remaining income.
Application of the progression proviso must result in the remaining income that is subject to German
taxation being subject to the tax rate that would have arisen had the DTT not been in place.
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Progression Proviso
Example:
Thomas Mustermann receives domestic income in the amount of €80,000, as well as foreign income
(non‐dividend income) in the amount of €40,000 from a state with which Germany has entered into a
DTT. The regulation stipulates that the taxation right belongs to the foreign state, with Germany able
to apply the progression proviso. Thomas Mustermann has special expenses in the amount of €8,000.
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Example
Solution:
1. Determining global income (§ 2 EStG)
Domestic income 80,000
Foreign income 40,000
Total income 120,000
Special expenses ‐ 8,000
Income used to calculate tax rate 112,000
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Example
2. Determining German income tax (§ 32, para. 1 EStG)
0.42 × 112,000 − 8.394 = €38,646
3. Determining average tax rate

Average tax rate = 38,646/112,000x100 = 34.5 %
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Example
Applying the average tax rate to the domestic income (progression proviso § 32b, para. 1 EStG)
72,000 × 0.345 = €24,840
Not applying the progression proviso, i.e. fully exempting the foreign income, would result in a
domestic tax burden in the amount of
72,000 × 0.42 − 8,394 = €21,846
If the exemption is made without a progression proviso, the taxable person can reduce their tax
burden due to the progressive income tax tariff by distributing their income to several states (splitting
effect).
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a) Exemption Method:
Article 23 A, para. 1 regulates the exemption method as the first alternative for eliminating double
taxation by the country of residence. According to the exemption method, income that can be taxed in
the source country is exempted from the domestic tax base in the country of residence.
The exemption method results in a burden of the foreign income in the amount of the foreign tax
level. In this manner, the taxable person is treated, in tax terms, in the same way as other competitors
in the source country (capital import neutrality). Exempting foreign income also results in negative
foreign income being exempted from the domestic tax base.
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a) Exemption Method
When it comes to interest and dividend income for which the OECD MTC provides for distribution of
the tax revenue between the country of residence and the source country (articles 10 and 11), then,
according to article 23 A, para. 2, the tax credit method should be applied. Article 23 A, para. 2
provides for a maximum credit amount.
Article 23 A, para. 3 grants the country of residence the option of considering applying the exempted
income in order to calculate the tax rate applicable to the remaining income (so‐called progression
proviso: § 32, para. 1 EStG).
The progression proviso should eliminate a double tax burden by reducing the tax base and by making
use of the progression tariff. The progression proviso has no bearing on corporation tax, since
corporation tax is a linear tariff.
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a) Exemption Method
The purpose of article 23 A, para. 4 OECD MTC is to prevent double non‐taxation.
If the other Contracting State (source country) applies the Convention such that it exempts the income
or capital from taxation, there shall be no exemption on the part of the country of residence.
However, in numerous articles of the OECD MTC, although the source country possesses the right of
taxation (“may” or “”may also”), it does not have to exercise this right. For such case, article 23 A,
para. 4 stipulates that the country of residence shall regain the full right of taxation in order to prevent
any “blank income” from arising as income not subject to taxation.
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b) Tax Credit Method

Article 23 B, para. 1 regulates the tax credit method as a further alternative to eliminate double
taxation by the country of residence. The credit method, as the name suggests, eliminates double
taxation by deducting the foreign tax from the domestic tax debt.
The credit method therefore focusses on the tax debt and not, unlike the exemption method, on the
calculation basis.
An essential feature of the credit method is the maximum credit amount according to article 23 B,
para. 1, sentence 2 and, as a result, only the amount corresponding to the domestic taxes levied on
the foreign income can be deducted. The maximum credit amount allows the State to profit from a
lower foreign tax level while at the same time allowing it to protect itself from the reimbursement of
foreign taxes in the event that the foreign tax level is higher.
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Example
Example 2:
Thomas Mustermann is resident in Germany and earns domestic income in the amount of €90,000
and foreign income in the amount of €30,000 from letting and leasing activity in Spain. He has special
expenses in the amount of €10,000 and paid tax in the amount of €7,500 on his foreign income.
Germany applies the tax credit method to this foreign income.
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Example
Solution
1. Determining global income (§ 2 EStG)
Domestic income 90,000
Foreign income 30,000
Total income 120,000
Special expenses ‐ 10,000
Taxable income 110,000
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Example
2. Determining German income tax (§ 32a, para. 1 EStG)
0.42 × 110,000 − 8,394 = €37,806
3. Determining the maximum credit amount (MCA)

MCA = 37,806 × 30,000/120,000 = €9,451 (>7,500)
4. Deducting the foreign tax:

37,806 − 7,500 = €30,306
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Special Provisions (Articles 24‐28 OECD MTC)

Article 24 (“Non‐Discrimination”) contains the ban on tax discrimination.
– Pursuant to paras. 1 and 2, nationals of a Contracting State and stateless persons in the other
Contracting State shall not be subjected to any taxation which is other or more burdensome than
the taxation to which nationals of that other State in the same circumstances may be subjected.
– The taxation of a permanent establishment which an enterprise of a Contracting State has in the
other Contracting State shall not be less favourably levied in that other State than the taxation
levied on enterprises of that other State carrying on the same activities (para. 3).
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– When calculating business profits, payments of interest, royalties and other fees that an
enterprise pays to a foreign person must be treated in the same way as they would were these
payments made to a national (para. 4).
– According to the fourth discrimination ban (para. 5), enterprises of one Contracting State may not
be subjected to worse treatment owing to the fact that persons residing in the other Contracting
State have a stake in said enterprise.
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If there are difficulties in the application of a DTT, then article 25 sets out an inter‐governmental
mutual agreement procedure for the consistent application of DTT.
Article 26 regulates the exchange of information and confidentiality obligations of the Contracting
States.
Article 27 protects diplomats and consular officers from any restrictions on tax benefits.
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Check Sequence in the case of Unlimited Tax Liability and Foreign
Income with DTT
If a person who is subject to unlimited tax liability earns income from a DTT state, it must be checked
which taxation right the DTT grants the German tax authorities and which double taxation elimination
method, if any, the DTT prescribes. A DTT is checked according to the following model:
The taxable person’s convention eligibility is checked according to article 1 in conjunction with article 4
OECD MTC.
It is checked whether, pursuant to article 2 OECD MTC, the tax in question is a tax on income or capital
(this is typically the case when it comes to income tax and corporation tax).
Assignment of the taxation right depending on the income type is checked (articles 6 to 21 OECD
MTC), as well as the consequences of the Methods article (articles 22 and 23 OECD MTC):
• Income from immovable property (e.g. letting and leasing), article 6: The tax in which said property
is situated may tax it. Exemption through progression proviso in the country of residence, article
23a, para. 1 OECD MTC.
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Income with DTT
• Business profits, article 7: This is income from a permanent establishment situated abroad.
– The presence of a permanent establishment must be checked if there is a DTT according to article
5 OECD MTC. (§ 12 AO is not relevant here, since DTT take precedence, § 2 Abs. 1 AO).
– If there is no permanent establishment, then only the country of residence has the taxation right
(article 7, para. 1, sentence 1, clause 1).
– If there is a permanent establishment, the income of this establishment must be determined
• It must first be checked whether the income is attributable to the permanent
establishment (from an economic perspective).
• If the income is in fact attributable to the permanent establishment, it must then be
checked whether the amount of income was correctly determined.
– According to article 7, para. 2 OECD MTC, the so‐called “separate entity approach”
is typically used.
• The income thus determined may be taxed by the country in which the property is
situated. The country of residence must exempt this using the progression proviso,
article 23 A, para. 1 OECD MTC.
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Income with DTT
• International shipping, inland waterway transport and air transport, article 8: Only the State in which
the place of actual management is situated is allowed to tax. The other State has no taxation right.
• Dividends, article 10: The source country may tax.
– Article 10, para. 2, possibly limitation of withholding tax to 5% or 15%. The country of residence
must deduct pursuant to article 23 B.
• Interest, article 11: Generally speaking, the country of residence of the taxable person has the
taxation right. According to article 11, para. 2, limitation to 10%. The country of residence must
apply to the tax credit method pursuant to article 23 B.
• Royalties, article 12: According to article 12, para. 1, the country of residence of the recipient of the
royalties has the taxation right. The source country has no taxation right. (Note: In fact, in many
cases – by way of derogation from the OECD MTC – Germany has provided for a right to levy
withholding tax on the part of the source country. In such cases, the foreign tax is always
deductible).
• Capital gains, article 13: The requirement must be checked depending on the type of property
alienated. If the country in which the property is situated has the taxation right, then the country of
residence must exempt, article 23 A, para. 1 OECD MTC.
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Income with DTT
• Income from employment, article 15:
– Generally, only the country of residence has the taxation right, article 11, para. 1
– Exception: The activity is carried on in the other State. In this case, said State may also tax (place‐of‐work principle), article 11,
para. 1. The country of residence must then exempt, using the progression proviso, according to article 23 A, para. 1 OECD
MTC.
– Counter‐exception to article 11, para. 2. If the pre‐requisites are met, the taxation right reverts to the country of residence
and the country in which the activity is carried on has no taxation right (183‐day rule).
• Directors’ fees, article 16: The country in which the activity is carried on may tax. The country of
residence shall exempt pursuant to article 23 A, para. 1 OECD MTC using the progression proviso.
• Sportspersons and entertainers, article 17: The State in which the activity is carried on may tax. The
country of residence shall exempt pursuant to article 23 A, para. 1 OECD MTC using the progression
proviso.
If the country of residence has to exempt, then the progression proviso pursuant to § 32b EStG must
be complied with when determining the domestic tax rate.
If the country of residence has to deduct, then the provisions of the credit procedure pursuant to § 34,
para. 1 in conjunction with § 34c, para. 6 EStG shall apply. Limiting deductions to a maximum credit
amount and the per‐state limitation is permitted according to article 23 A, para. 2 OECD MTC. In this
respect, domestic provisions are applicable.
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02
Double Taxation
2.1 Fundamentals
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Supranational Measures
• In order to eliminate multiple burdens in international groups within the EU, the Parent‐Subsidiary
Directive postulates that the country of residence of the subsidiary is not allowed to levy
withholding tax on dividend distributions and that, accordingly, the country of residence of the
parent company must exempt the dividends received.
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Supranational Measures
The pre‐requisites for the application of the Parent‐Subsidiary Guideline are:
– That the parent and subsidiary companies be residents of EU Member States;
– That the parent corporation have a participation of at least 25%;
– That there be a minimum participation period of 24 months.
In Germany, the Parent‐Subsidiary Guideline is implemented by § 43b EStG and § 8b KStG.
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Effects of ECJ Case Law on Income Tax Law
3.2 The European Court of Justice (ECJ)
3.3 Decisions of the ECJ
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Europarechtliche Grundlagen
• Primary European Law

As Primary European Law, international treaties are at all times directly
applicable law in Germany via ratification acts.
• Secondary European Law
Regulations, directives, decisions, recommendations and opinions are
Secondary European Law, which is subordinate to primary law (article 7 Treaty
on the EC (TEC)).
Only those regulations which the remaining secondary law requires be
implemented into domestic law are directly applicable.
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• Collision between primary and secondary European law and national tax
law
• The ECJ stipulates that primary and secondary community law shall enjoy
primacy of application over domestic legislation.
(Case “Costa/ENEL“, 1964)
• Germany’s Federal Constitutional Court (BVerfG) in any case recognises the
primacy of community law over purely regulatory standards such as taxation
laws.
(BVerfG Decision 22, 293, 1967)
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• According to article 93 TEC, there is a harmonisation requirement when it comes

to indirect taxes.
• In the area of direct taxes, there is no provision that requires harmonisation of
regulations in the internal market.
• Article 94 TEC does however standardise legislative alignment of regulations
that have a direct impact on the functioning of the internal market. These
include all legal standards of Member States and, as such, also include the
provisions of German income tax law.
• According to settled ECJ case law, fiscal sovereignty in the area of direct taxes
rests with Member States.
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Tax policy is a feature of national sovereignty, as well as being a component of a

country’s economic and financial policy since it contributes to the financing of public‐
sector spending and the redistribution of income. In accordance with the subsidiarity
principle, certain aspects of direct taxes […] are a matter purely for the Member
States.
(European Commission, Directorate‐General for Taxation and the Customs Union,
Education and Culture, 2000)
• The subsidiarity principle applies.
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• The primary law for the area of direct taxes that is relevent to domestic tax law:
Fundamental Freedoms according to the Treaty on the EC

• Free movement of workers, articles 39‐42 TEC
• Freedom of establishment, articles 43‐48 TEC
• Freedom of services, articles 49‐55 TEC
• Freedom of capital and payment transfers, articles 56‐60 TEC
• General freedom of movement, articles 18 TEC
• Free movement of goods, articles 28‐30 TEC
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• Free Movement of Workers, article 39‐42 TEC
Every worker has the right of employment in every Member State, whereby
equal treatment with regard to employment, remuneration and other working
conditions must be ensured.
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• Freedom of Establishment, articles 43‐48 TEC
Natural and legal persons are granted the right to engage in ongoing
employment in another Member State under the same conditions as nationals
of that State.
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• Freedom of Services, articles 49‐55 TEC
Restrictions on movement of services within the Community for nationals of

Member States residing in a Community Member State other than that of the
recipient of the service are … prohibited.
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• Freedom of Capital and Payment Transfers, articles 56‐60 TEC
Capital and payment transfers between Member States shall not be subject to
any restrictions.
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• In addition to the fundamental freedoms, there is the general ban on

discrimination pursuant to article 12 TEC:
Any discrimination on the basis of nationality is prohibited
• Article 18 TEC ensures the Freedom of Movement of EU Citizens:

Every EU citizen has the right to move and reside freely within the territory of
the Member States.
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• Interpretation of EC law and EC‐compliant interpretation of domestic law
• The aim is to ensure that domestic law is interpreted in compliance with

community law
• Procedure:
– the EC law (fundamental freedoms/directives) must first be interpreted;
– the respective domestic tax law standard must then be interpreted in a
manner compliant with EC law according to the same rules of
interpretation.
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Rules for Interpreting Primary and Secondary Law
• Interpretation against the backdrop of community law
• Abstract interpretation according to the pan‐European wording
• Historical interpretation
• Systematic/teleological interpretation
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• Check the compatibility of domestic tax standards with the fundamental

freedoms.
The fundamental freedoms guarantee subjective rights upon which the citizens
and enterprises of Member States can rely directly when it comes to cross‐
border matters.
• Check sequence:
– Scope of protection of a fundamental freedom that is encroached upon
– Restriction by a fiscal measure
– Justification options
– Proportionality
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Community Secondary Law:
• Important directives for the legislative alignment of taxation in the Member

States:
– Parent‐Subsidiary Directive (1990)
– Mergers Directive (1990)
– Interest Directive (2003)
– Interest/ Royalties Directive (2003)
– Code of Conduct for Business Taxation
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• Generally speaking, directives have no direct effect.
• These should be implemented by domestic legislators within a certain time

period.
• In the event that this period is not adhered to, the taxable person shall enjoy no
primary law protection.
• According to settled ECJ case law, however, the taxable person should be able to
directly rely upon the directive under the following conditions:
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• The provisions of the directive accord the taxable person rights which it can
assert against the Member State.
• The provisions of the directive must be unconditional in terms of content and

sufficiently precise.
• The Member State has falied to perform its implementation obligation in a

timely or proper fashion, or said implementation was defective in terms of
content.
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03
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The European Court of Justice
• According to article 220 TEC, the European Court of Justice (ECJ) shall have a
monopoly on interpretation in all instances of doubt concerning EC law.
• The aim of this is to ensure uniform application and interpretation of the TEC in
all Member States.
• The ECJ rules on

– Preliminary rulings
or in
– Infringement procedures
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• Preliminary rulings (article 234 TEC)

• If, when ruling on a domestic procedure, it comes to the interpretation of
European law, then
– the court (of lower instance) may submit to the ECJ
– the court of last instance must submit to the ECJ
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• Infringement procedures at the request of the Commission

(article 226 TEC)
– If, in the Commission’s view, a Member State has breached an obligation of
this Treaty, then it shall make a statement to that effect.
– If the State fails to comply with this statement within the period stipulated
by the Commission, then the Commission may call on the Court of Justice.
• Infringement procedures at the request of a Member State
(article 227 TEC)
– Every Member State may call upon the Court of Justice if, in its view,
another Member State has breached an obligation of this Treaty.
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• Infringement procedures (article 226 TEC)

• Current example:
– The Commission instigated an infringement procedure against the Federal
Republic of Germany due to the taxation of unrealised capital gains of
material participations when an enterprise left Germany for another EU
Member State.
– In view of this, § 6 AStG shall be amended.
– Federal Ministry of Finance letter of 8 June 2005: Tax is set pursuant to § 6
AStG and, at the same time, is deferred without interest.
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Decisions of the ECJ
Werner (ECJ, judgement of 26/1/1993)

• Facts:
The German national Werner lives with his family in the Netherlands. He
established himself in Germany as an independent dentist. He earned income
from self‐employment. Since Werner has no fixed residence in Germany, he is
subject to limited tax liability. The German tax office prevented Werner from
splitting income taxation between himself and his spouse since this does not
apply in the context of limited tax liability.
• Point of law: Does this infringe freedom of establishment?
• Judgement:
– Taxation is not illegal under EU law.
– This is a case of discrimination against nationals.
– As such, this is exclusively a point of domestic law.
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Schumacker (ECJ, judgement of 14/2/1995)

• Facts:
Schumacker lives with his family in Belgium. He earns income from employment
in Germany. In addition to other restrictions, Schumacker was not granted the
option of splitting income taxation between himself and his spouse in the
context of taxation as a person subject to limited tax liability.
• Point of law: Is this an infringement of the free movement of workers?
• Judgement:
– The provision on free movement of workers prohibits nationals of one
Member State working in another Member State from receiving worse
treatment than the nationals of the Member State in the same position.
– As such, the provision opposes the application of German regulations.
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Eurowings (ECJ, judgement of 26/10/1999)

• Facts:
The German corporation Eurowings leases an aircraft from an Irish corporation.
The lease payments were deductible as operating expenses for the purposes of
corporation tax. However, for the purposes of trade taxes, such expenses would
only be deductible if the leasing company was based in Germany. If based
abroad, half of this would be a trade tax add‐back according to
§ 8 (7) of the German Trade Taxes Act (GewStG), resulting in trade tax arising.
• Point of law: Does the add‐back provision breach the ban on the free movement
of services?
• Judgement: Freedom of services is opposed to the German standard.
• Note: The provision can no longer be applied in cross‐border EU cases
(coordinated German Federal State decree BStBl 2000, 486).
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Lankhorst/Hohorst (ECJ, judgement of 12/12/2002)

• Facts:
A German limited liability company (GmbH) is the subsidiary of a Dutch parent
company and the sub‐subsidiary of a corporation also based in the Netherlands.
The parent company extended a loan to the German sub‐subsidiary under
conditions that do not stand up to the dealing at arm’s length principle. The
German tax office therefore treated the interest payments as concealed profit
distributions according to the (old) § 8a KStG.
• Point of law: Does (old) § 8a KStG breach freedom of establishment?
• Judgement: The Court views this as a breach since, were it a purely domestic
case, there would be no presumption of concealed profit distribution.
• Note: This judgement was the trigger for amending the regulatory standard.
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Gerritse (ECJ, judgement of 12/6/2003)

• Facts:
A musician residing in the Netherlands receives a fee for an appearance in
Germany. In accordance with the DTT and the regulation in § 50a, para. 4 EStG,
this fee was taxed on the basis of a 25% lump sum. In fact, operating expenses
incurred were not considered.
• Point of law: Is this a breach of free movement of services?
• Judgement: The German standard contravenes community law insofar as it
prevents the person who is subject to limited tax liability from deducting
operating expenses which a person subject to unlimited tax liability would be
able to deduct.
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Lasteyrie du Saillant (ECJ, judgement of 11/3/2004)

• Facts:
Mr Lasteyrie moved from France to Belgium. At this point in time, he held
securities containing hidden reserves. Those hidden reserves were taxed at
the time he left France.
• Point of law: Does this taxation breach freedom of establishment?
• Judgement: The principle of freedom of establishment must be interpreted as
meaning that a Member State is not allowed to introduce a ruled aimed at
preventing tax evasion according to which latent increases in value are taxed if
a taxable person moves their tax residence abroad.
• Reference: Infringement procedure against Germany on the basis of § 6 AStG
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Manninen (ECJ judgement of 7/9/2004)

• Facts:
The Finnish national Manninen receives dividends from a Swedish company. He
was denied the option of deducting the corporation tax paid by the Swedish
company as part of his Finnish taxation since Finland only allowed deduction of
Finnish taxes.
• Point of law: Is this a breach of free movement of capital?
• Judgement: The provision on free movement of capital is opposed to any
regulation according to which the claim of a person subject to unlimited tax
liability in one Member State for tax credit on the dividends paid to them by
stock corporations is excluded if the companies in question are not based in said
State.
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Schempp (ECJ, judgement of 22/7/2005)

• Facts:
The German national Schempp pays alimony to his former wife, who lives in
Austria. Recognition of this alimony as special expenses (real splitting) was
refused on the grounds that there was no evidence to prove that the payments
to the recipient were being taxed. Alimony payments are not taxed in Austria.
• Point of law: Is this a breach of freedom of movement?
• Judgement: The standard does not impair the claimant’s freedom of movement.
Indeed, it was his wife’s change of residence that resulted in his negative fiscal
consequences. EU law does not however guarantee the nationals of EU Member
States (EU citizens) that the change in residence of another person will be tax‐
neutral for said person.
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Ritter‐Coulais (ECJ, opinion of 01/3/2005)

• Facts:
Mr and Mrs Ritter live in France and earn income from employment in Germany.
At their request, pursuant to § 1, para. 3 EStG, they were subject to unlimited
tax liability in Germany. They requested that losses incurred in France from
letting and leasing be taken into consideration, which the German tax office
refused to do in accordance with . § 2a EStG.
• Point of law: Is this a breach of the freedom of establishment/ free movement of
capital?
• Opinion:
– In the view of the Advocate General, the failure to consider the losses
incurred in France contravenes freedom of establishment.
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Marks and Spencer (ECJ, Opinion of 14/4/2005)

• Facts:
Marks & Spencer maintains loss‐making enterprises in various Member States. It
ceased its loss‐making activity and submitted an application for its foreign
losses to be offset. According to UK law, group relief with regard to enterprises
based in the UK is allowed. Since the loss‐making companies were not based in
the UK, the German tax office did not allow the losses to be offset.
• Point of law: Is this a breach of freedom of establishment?
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Marks and Spencer (ECJ, Opinion of 14/4/2005)

• Opinion:
– The Advocate General considers cross‐border offsetting of losses to be
fundamentally prohibited under European law.
– However, he did propose that it be ruled that a loss offset option in the
country of residence should be excluded if there was a possibility of the
subsidiary offsetting losses – even in the distant future – in its country of
residence.
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CLT‐UFA (ECJ, Opinion of 14/4/2005)

• Facts:
A Luxembourg‐based company maintains a branch office in D. It was subjected
to 42% corporation tax, taking into account the income of the branch office as
a person subject to limited tax liability. Has it earned the income in a German
subsidiary, the distributed profit would only have been subjected to
corporation tax of 30%.
• Point of law: Does this impair freedom of establishment?
• Opinion: The Advocate General considers this to be a breach of community law
and, in view of the fact that this is an old law, proposes that , proposes that the
domestic court apply to the profits of the branch office the tax rate it would
have applied to the distributed profits of the subsidiary.
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04
Tax Treatment of Direct Investments
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Forms of Cross‐Border Business Activity
• When taxing the international business activity of an enterprise, the deciding factor is the structure
chosen to handle its foreign business.
• Generally speaking, foreign activities begin with setting up cross‐border trading relationships with a
foreign country, without setting up a permanent base in said country (direct business/ export).
• The next step is to make direct investments overseas in order to move economic activities to the
foreign territory. Direct investments can take the form of setting up a permanent establishment or
founding a foreign corporation or partnership.
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Chart
Forms of Business Activity Abroad
Trading relationships with no fixed Activities with a fixed base

base abroad abroad (direct investments)
Foreign trade Permanent Subsidiary Subsidiary

(direct business) establishment corporation partnership
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Direct Business
• “Direct Business” means the cross‐border commercial exchange of services without setting up a
fixed base abroad.
• The following are features of direct business:
– direct exchange of services between a domestic enterprise and its foreign customers;
– on the basis of performance relationships regulated by contract law; and
– no fixed base abroad.
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Permanent Establishment
• A permanent establishment is where business activities are carried out abroad via a fixed business
establishment that does not have its own legal personality and which directly serves the enterprise’s
activity.
• The following are features of a permanent establishment:
– legally‐dependent (foreign) branch of a domestic enterprise;
– economic independence;
– permanent nature of the business establishment/ facility.
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Subsidiary Corporation
• As independent legal entities, subsidiary corporations are legal persons that may engage in legal
transactions on their own behalf.
• The link between a foreign subsidiary corporation and a domestic parent company gives rise to an
international group.
• The corporation is taxed irrespective of whether the shareholders are taxed (separation principle).
• The following are features of a subsidiary:
– legally‐independent enterprise unit;
– economic independence;
– separation principle.
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Subsidiary Partnership
• Typically, partnerships only have limited legal capacity. In international tax law, they are equal to a
legally‐dependent permanent establishment in most industrialised countries.
• Although the subsidiary partnership determines its own profit, the partners are taxed directly in the
amount of their share of the partnership’s profits. The result of this transparency principle is that it
is not the company which is taxed, but rather the partners. The allocation of profits has no bearing
on taxation.
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05
Main Features of the Foreign Tax Act
5.1 Shifting of Income
5.2 Extended Limited Tax Liability
5.3 Exit Taxation
5.4 Controlled Foreign Corporation Rules
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Extended Limited Tax Liability
If a natural person moves their residence abroad, they are no longer subject to unlimited tax liability
on their global income in Germany; instead, their tax liability is limited only to their domestic income.
To make it difficult for domestic taxable persons with relatively high income to evade tax in Germany,
§§ 2‐5 AStG introduced extended limited tax liability.
Extended limited tax liability affects German nationals who, after moving to a low‐tax territory, retain
material economic interests in Germany.
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Such taxable persons must pay tax on the entirety of their German income i.e. their domestic income
in the meaning of § 2, para. 1, sentence 1 EStG in Germany for the ten years following their move.
The purpose of the extended limited tax liability is that not only the domestic income listed in § 49
EStG will be liable for tax, but also the income listed in § 2 EStG.
In addition to the income referred to in § 49 EStG, income from the letting and leasing of movable
property in Germany or income from “speculative transactions” in the meaning of § 22 (2) EStG also
fall under the extended limited tax liability.
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Only natural persons who,JM1 in the previous ten years prior to the end of their unlimited tax liability
pursuant to § 1, para. 1 sentence EStG, were subject to unlimited income tax liability as Germans for a
total of at least five years and who are resident in a foreign territory in which they are only subject to
low taxation but who still have material economic interests in Germany are affected by the extended
limited tax liability.
According to § 2 para. 2 AStG, low taxation is when
there is a more favourable tax rate; or
there is a liberal tax system.
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A more favourable tax rate is where the income tax paid by an unmarried person with a taxable
income of €77,000 in the foreign territory is more than a third lower than the German income tax.
According to § 2 para. 3 AStG, material interests in Germany are where
– the taxable person earns income from business in Germany; or
– the non‐foreign income amounts to more than 30% of total income or exceeds €62,000; or
– the property whose proceeds do not constitute foreign income amounts to more than 30% of
total property or exceeds €154,000.
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Folie 195
JM1 I think there's a missing number here.

Jamie Melly; 18.09.2018
04
Tax Treatment of Direct Investments
4.2 Direct Investment in the Form of a Permanent Establishment
4.3 Direct Investment in the Form of a Subsidiary Corporation
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Direct Investment in the Form of a Subsidiary Corporation

Reasons for choosing a subsidiary corporation
– option of reducing liability;
– legal independence: Option of entering into legal contracts on its own behalf;
– option of retaining earnings in the subsidiary
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Taxation of Profits from a Foreign Subsidiary Corporation (No DTT)
• Generally speaking, profits are taxed at the time they are earned by the subsidiary corporation, with
the domestic shareholders being taxed once again when these profits are distributed, since both the
subsidiary corporation and the shareholder are both subject to unlimited tax liability in their country
of residence.
• Furthermore, generally speaking foreign withholding tax is incurred since the domestic shareholder
with dividends in the country of residence is subject to limited tax liability in the country in which
the distributing subsidiary is resident.
• As regards direct investments in the form of a subsidiary corporation, there is therefore the risk of
the distributed profits being subject to triple taxation.
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a) Dividend Income – Natural Persons as Shareholders
• A distinction must be made as to whether the participation is held in private or business assets
– in the case of private assets, settlement tax is applied
– in the case of business assets, the partial‐income method is applied
• In the case of dividend income from business assets, the following measures are possible to
eliminate double taxation in the event that there is no DTT:
– Tax credit method: Direct crediting of foreign tax paid to domestic tax debt (§34c, para. 1 EStG);
– Deduction method: Foreign tax paid is deducted when determining income(§ 34c paras. 2 and 3
EStG);
– The lump‐sum method (§ 34c, para. 5 EStG) is not permitted in the case of dividend income.
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b) Dividend Income ‐ Corporation as Shareholder
• In Germany, domestic and foreign dividends to corporations have been tax‐free since the
introduction of the partial‐income method pursuant to § 8b, para. 1 KStG. If – as is the case with
natural persons – half the distribution amount were subject to taxation, the dividends, in the case of
additional distributions, would be reduced to zero by the resulting additional taxation (so‐called
cascade effect).
• In order to prevent an accumulated tax burden on the same distributed profits in the case of
shareholding chains between corporations, the investment income must be exempted from
corporation tax by other companies.
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b) Dividend Income ‐ Corporation as Shareholder
• However, § 8b, para. 5 KStG, provides for a lump‐sum deduction ban in the amount of 5% as non‐
deductible operating expenses, meaning that only 95% of the gross dividends remains tax‐free. Since
§ 3c, para. 1 EStG expressly does not apply, those expenses actually incurred in an economic
connection with the participation can be claimed without any restriction.
ISM 2020 202
101
Chart
Corporation makes a distribution

to
Natural persons* /
Corporations
individual enterprises
Partial‐income method Tax‐free pursuant to

(§ 3 (40) d EStG) (§ 8b, para. 1 KStG)
*performing business activities
ISM 2020 203
Taxation of Profits from a Foreign Subsidiary Corporation (DTT)
a) Dividend Income
• As regards the absence of presence of a DTT, taxation of dividend income differs only in terms of the
amount of foreign withholding tax. If there is a DTT, taxation tends to be lower.
• By contrast, in Germany, taxation of corporations and natural persons is identical and follows the
same regulations.
ISM 2020 204
102
05
International Tax Planning using Holding Companies
ISM 2020 205

Initial Position
• Markets that are dynamic and which differ from one another (internationalisation) influence a
strong trend towards the formation of large enterprises (e.g. expansion)
Consequences
• The larger and more complex the enterprise, the harder and slower it is to tax; this is particularly the
case with heterogenous business segments if these differ from one another in terms of products,
markets, added value priorities or sector structure.
• Inertia and sluggishness can result in market opportunities not being seized (promptly) or in the
company being blindsided by the risks associated with the operating business activity.
Objective
• To realise competition potential such as market proximity, flexibility, innovativeness, transparency
and employee orientation.
ISM 2020 206
103
What constitutes a holding company?
True Group
• Where several dependent enterprises are amalgamated under the common management of a
controlling enterprise (§ 18, para. 1, sentence 1 AktG)
Associated Companies
• These lack the common management feature: Legally‐independent enterprises (subsidiaries) are
majority owned by another enterprise (parent company)
• The parent company’s role is limited to controlling the enterprise as a whole
• Operational activity is carried out exclusively by the respective subsidiary.
Objective
• To decentralise the enterprise as a whole.
ISM 2020 207

• Types of Holding Companies
• Pure asset holding company
• Financial holding company
• Management holding company
• Advantages
• Subsidiaries are manageable, capable and specialised units (transparency)
• Performance contributions from individual business divisions can be allocated precisely (effective
control)
• Partial operations easy to sell
• Streamlined, flexible business processes
• Enterprise risk is shifted to the subsidiaries
ISM 2020 208
104
• Disadvantages
• The uniform orientation of the enterprise as a whole can be endangered

• Raising capital for subsidiaries results in capital commitment
• Risks of abuse brought about by the personal responsibility of management in subsidiaries
ISM 2020 209

• Fiscal Aspects
• Generally speaking, the use of holding structures is motivated by economic, not fiscal reasons:
strategic enterprise planning
• Tax planning using holding companies regularly involves setting up so‐called “intermediate holding
companies”
• Problem
• By setting up an intermediate holding company, an additional level of taxation is created: Danger
of the same economic substratum being registered for tax multiple times
• However
• Through activating holding companies, there also exists the option of controlling the level at which
the profits/expenses are incurred
• Objective
• To control and reduce the group tax rate
ISM 2020 210
105
Alternative Structures
Repatriation Strategies
‐ The interim holding company is situated in a country in which the profits are either not subject to
taxation or are only liable to a limited extent;
‐ Use of a favourable “DTT network”: The countries have double taxation agreements with low
withholding tax rates (“treaty shopping”) or use EU directives (“directive shopping”);
‐ Extended dividend routing results in a lower withholding tax burden!
ISM 2020 211
1. Repatriation Strategies (e.g. according to Dorfmüller, IStR 09, 826)

Initial Event Variation
Germany 95%
95% corporation tax
corporation tax Germany exempted
exempted
No crediting of Sweden Withholding
withholding tax tax 0%
Withholding Bolivia
tax 12.5%
Withholding
Bolivia tax 0%
ISM 2020 212
106
1. Transforming the Type of Income

By activating the holding company, the assignment to the type of income
is changed.
• Example 1
The dividend income liable for tax in the

recipient country becomes exempted
permanent establishment income;
Structure liable to be taken up; close Vss. of recognition
by the financial authorities.
ISM 2020 213
Example 2: Granting interest‐bearing loans in a share deal purchase

Initial Event Variation
The AG in Dtl. Plans to acquire Inc 2.
Corp. AG sets up Inc
Germany 1 provides it
Corp. Loan with financial
Germany power for the
acquisition
Inc 1 USA Loan interest is
tax‐deductible
Loan interest
Inc 2 USA Tax
not tax‐
deductible consolidated
Inc 2 USA group
ISM 2020 214
107
1. Moving Profit Realisation Route

The aim is to “amalgamate” the results of the different group companies.
Profit and loss of the individual companies

should be offsettable.
Measures?
ISM 2020 215

• Country Comparison
• The classic locations for holding companies are
• Luxembourg
• The Netherlands
• Switzerland
But also include
• Cyprus and Austria
Background
• Tax law in these countries provide special privileges for holding companies; (“competition
between tax systems”)
Objective
• To attract investments to their sovereign territories in order to create jobs and to generate
tax revenue.
ISM 2020 216
108
• Criteria list for tax‐ efficient holding company locations
• Political stability
• Dense “DTT network”
• Tax planning cooperation between financial authorities (“ruling” practice) e.g. Netherlands,
Luxembourg
• Exemption from withholding tax for interest, dividends and royalties
• “International Intercorporate Privilege”
• Less severe anti‐avoidance rules (AStG, CFC Law; subject‐to‐tax clauses)
• Special tax benefits for royalties, finance companies
• Modern, liberal and internationally‐focussed company law
• No taxes on capital (wealth tax, business capital tax,..)
• Flexible reorganisation law
ISM 2020 217

• Limits of tax planning using holding structures
• A pre‐requisite for tax planning using holding structures is that said structure be recognised by both
domestic and foreign financial authorities
Monitoring of abuse by the German financial authorities

• § 42 AO
• § 50 d, para. 3 EStG
• AStG
Risk
• That a change to the tax environment may require restructuring; The location decision must be
constantly reviewed!
ISM 2020 218
109
The Apple Inc. Case
Apple Inc. USA
Cost sharing Apple Operations

agreement International.
Ireland
Apple Distri‐ Apple Retail
Apple Sales Int.
butions Int. Holding Europe
Apple Sales Int.
Apple Retail
Germany Germany
China
Foxconn
ISM 2020 219
• Taxation situation
• In the financial year 2011/2012, Apple achieved group sales of USD 156.5 billion
and a net profit of USD 41.7 billion.
• North and South America profits were taxed normally in the US. Tax payments in
the US amounted to USD 6 billion in 2012.
• By contrast, profits from Europe and Asia were not subject to any taxation in the
US, with a total tax burden of between only 1‐2%.
ISM 2020 220
110
• Tax Planning: “Base Erosion and Profit Shift”
• Intangible assets are held by low‐taxed holding companies or royalty trusts
• Problem: Developments are made in the US;
• Solution: Via a cost sharing agreement, the Irish companies become “Apple
Operations Europe” and “Apple Sales International”
• Product manufacturing carried out in China by contract manufacturers; Apple
International Sales in Ireland taxes the purchasing and manufacturing process
• Taxation of earned income in Ireland (12,5% corporation tax); The company has no
place of management in Ireland and is only subject to limited tax liability; The Apple
companies have an “understanding” with the Irish financial authorities whereby tax
is not allowed to exceed 2%.
ISM 2020 221

• Tax Planning: “Base Erosion and Profit Shift”
• The products are sold by “low‐risk” distributors in high‐tax countries; the companies only
generate small sales margins, meaning that next to no income tax is incurred.
• How come there is no corporation tax in the US? Corporation tax is avoided by abusing
the check‐the‐box voting right: The corporations are then classed as being transparent
and, from the US perspective, in tax terms there is only one enterprise, which
manufactures and sells its own commodities.
• Income of Apple International Operations is not taxed in Ireland because the company
has no place of management in Ireland; no taxation takes place in the US, again because
the company has no place of management in the US: From the perspective of the US,
board meetings held in the US are not enough; the company is stateless!
ISM 2020 222
111
• Apple International Operations is not subject to unlimited tax liability in any country;
it does not submit tax returns; profits are not allocated to any tax jurisdiction
• These profits go untaxed, so‐called “floating income”.
• Avoiding tax‐liable repatriation of profits to the US: In the event of a distribution made
by the US parent company, the dividends are liable for full taxation in the form of US
corporation tax;
• Liquid funds remain in the Irish company
• How does Apple satisfy shareholders’ dividend requests? Apple issues bonds
ISM 2020 223

• Base Erosion and Profit Shift (“BEPS”)
• This is understood as being legal tax planning carried out by multinationals that is classed as
aggressive.
• Public reaction: “Legal Public Enemies” (Stern article dated 14/3/2014);
• As a gesture of goodwill in the UK, Starbucks announced that it intended to pay GBP 20 million;
• Measures aimed at combating this phenomenon: OECD BEPS Report (February 2013)
ISM 2020 224
112
Thank you for your interest!
ISM 2020 225
113

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Masters in Finance

International Tax Law

Scripts cannot be cited in academic works.

ISM International School of Management

The course „International Taxation “ addresses the following issues (1):

The course „International Taxation “ addresses the following issues (2):

Knowledge: Students have detailed, up‐to‐date knowledge of international

Type and duration of exam

Weight of the mark in the final grade

Schreiber, U. (2013): International company taxation. An introduction to the legal

Cortez / Schmidt (2017): Principles of German Taxation

International Tax Law

04 Tax Treatment of Direct Investments

05 International Tax Planning using Holding Companies

Fundamentals of International Tax Law

International tax law is growing in importance:

Fundamentals of International Tax Law

Principles of International Tax Law

International Tax Law

– Cross‐border activities between related persons

Under international law, there is no ban on double taxation or under‐taxation!

Causes of Double Taxation

Causes of Double Taxation

Linda Janssen, Legal consequences

Measures aimed at Eliminating or Reducing Double Taxation

Unilateral measures (domestic law)

Measures aimed at Eliminating or Reducing Double Taxation

Double Tax Treaty (DTT)

Tax credit method

Measures aimed at Eliminating or Reducing Double Taxation

Measures aimed at eliminating tax evasion

Fundamentals of European Law

The European Union does not collect taxes!

 Treaty on the Functioning of the European Union (TFEU)

Tax harmonisation is not an independent objective of the EU

Fundamentals of European Law

Inter‐governmental tax differential influences businesses’ choice of location, investment behaviour

International Tax Law

Origin of Double Taxation

Josef Matula Permanent establishment in

Methods aimed at Eliminating Double Taxation

Measures aimed at eliminating double taxation

International Tax Law

Is the source country’s right of taxation

Exemption method Tax credit method

Double Taxation Treaties

OECD Model UN Model

• Broad restriction of withholding • Enhanced withholding taxation

Structure of the OECD Model Tax Convention

Structure of the OECD Model Tax Convention

• Barrier provisions for the source country

Barrier provisions with a Barrier provisions with an

If the barrier provision

Income from Immovable Property (Article 6 OECD MTC)

Business Profits (Article 7 OECD MTC)

Business Profits (Article 7 OECD MTC)

Business Profits (Article 7 OECD MTC)

Business Profits (Article 7 OECD MTC)