The Supreme Court of Germany issued a ruling on December 1st, 2022 concerning the European Court of Justice (ECJ) reclaim submitted by the College Pension Plan of British Columbia, a Canadian pension fund. The Supreme Court dismissed the appeal against the rejection of the ECJ reclaim by the Federal Tax Court of Munich in December 2021, which meant that the German withholding taxes levied on dividends could not be refunded. The Supreme Court justified its decision by asserting that the Federal Tax Court of Munich had fulfilled the requirements outlined by the ECJ.
This legal dispute has its origins in the ECJ case of November 13th, 2019 (C-641/17), in which the Court of Justice of the European Union (CJEU) determined that Germany’s taxation rules for foreign pension funds were in violation of European Union (EU) law.
Understanding the Legal Case: Key Facts and Litigation Progression
The College Pension Plan, a registered Canadian pension plan with tax-exempt status in Canada, submitted requests for a refund of German withholding tax on December 23rd, 2011. The requests were related to the 15% German withholding tax imposed on the gross dividend income derived from its German investments received between 2007 to 2010. The College Pension Plan’s argument was based on the premise that the German withholding tax represented a restriction on the principle of the free movement of capital, which is prohibited by Article 63 of the Treaty on the Functioning of the European Union (TFEU). This position was taken considering the fact that the Double Tax Treaty (DTT) in force between Canada and Germany permits Germany to tax German-sourced portfolio dividends at a rate of 15%, without providing any further relief.
Subsequent to the German tax authority’s tacit rejection of the requests made, the College Pension Plan lodged an appeal with the Federal Tax Court of Munich, which subsequently referred the matter to the ECJ and raised two “prejudicial questions” relating to EU law that needed to be addressed.
Understanding Methods of Taxation for Pension Funds: German vs Non-Resident
Non-resident pension funds, such as the College Pension Plan, that receive German-sourced portfolio investment income are not subject to tax liability in Germany. Consequently, they are not eligible for the tax assessment and offset procedure, which is available to resident German pension funds. German domestic tax law subjects German pension funds to taxation on their dividend income. However, under this procedure, the German pension funds can reduce their taxable profit by deducting the amounts reserved for pension payment obligations and neutralizing the tax withheld on income from capital via a set-off against corporation tax. If the amount of corporation tax payable is less than the set-off amount, German pension funds may receive a refund.
This implies that dividends paid to non-resident pension funds are subject to a 15% German withholding tax, which is regarded as a final levy. In contrast, German pension funds can minimize their overall tax liability on income from capital by reserving their annual income from capital for pension payment obligations. Thus, dividends paid to resident pension funds receive more favorable treatment compared to those paid to non-resident pension funds.
Key takeaways from ECJ Ruling
The ECJ rendered a ruling on November 13th, 2019, regarding the College Pension Plan (C-641/17) case. It concluded that the German dividend withholding tax imposed on the College Pension Plan violated the free movement of capital and represented a prohibited restriction, provided that the College Pension Plan, similar to German pension funds, used the dividend income for pension liability provisioning. This included adding the dividend income to the pension liability reserve, whether voluntarily or in accordance with the laws of its state of residence, Canada. However, the ECJ deemed the question of pension liability provisioning to be a matter of fact and referred it back to the referring Federal Tax Court of Munich for further consideration.
Federal Tax Court of Munich Rules Against College Pension Plan in Referral Case
On December 6th, 2021, the Federal Tax Court of Munich issued a decision on the referral case concerning College Pension Plan. The Court found that the College Pension Plan had failed to make adequate provisions for pension liabilities in its financial statements and did not designate dividends to these provisions in a manner comparable to German pension funds.
According to the information presented, the Federal Tax Court has determined that the College Pension Plan’s circumstances are dissimilar to those of a German pension fund. Therefore, the Court decided that a non-refundable withholding tax was appropriate. In response to this decision, the College Pension Plan filed an appeal with the German Supreme Court.
German Supreme Court Upholds Federal Tax Court of Munich’s Decision in College Pension Plan Appeal
On December 1st, 2022, the German Supreme Court issued a ruling in the College Pension Plan’s appeal case, confirming the Federal Tax Court of Munich’s decision and denying the withholding tax refund.
The Supreme Court’s decision was based on the finding that the College Pension Plan had complied with Canadian accounting regulations applicable during the years in question, however, it failed to establish provisions for pension benefit obligations on the liabilities side. While the company reported income from investments and contributions in the profit and loss statements, it recorded only the pension benefits paid in the respective year as expenses, implying that income from investments had not been reduced by allocations to provisions for future pension benefit obligations.
The Supreme Court concluded that the accounting technique was significant and emphasized that Canadian accounting principles should be determinative, given that they are factual. Therefore, the Supreme Court deemed the Federal Tax Court of Munich’s decision consistent with the ECJ’s ruling of November 13th, 2019, without the need for interpretation since it deemed the ECJ’s guidelines to be clear.
The Aftermath of the German Supreme Court Ruling on ECJ Reclaims by Pension Funds
The aforementioned ruling by the Supreme Court effectively concludes the protracted litigation involving the case for a duration of 11 years, without any remaining avenues for further appeal. Nonetheless, it is important to acknowledge that while the decision is binding on the College Pension Plan, different clients’ situations may vary, potentially resulting in a different outcome for them.
The recent Supreme Court decision raises doubts on the extent of comparison between German and non-resident pension funds as determined by German courts, considering the ECJ ruling of November 13th, 2019. It is possible that if this issue were to be presented to the ECJ, they may conclude that the German courts’ approach to comparability was too restrictive, potentially violating EU law principles by making it impossible for foreign pension funds to demonstrate comparability.
Despite the unfavorable ruling for College Pension Plan, clients who allocate dividends to pension provisions either voluntarily or as per domestic law and meet the remaining comparability requirements may still be found objectively comparable to German pension funds. However, WTax acknowledges that the stringent and restrictive requirements for comparability set by the German courts will make proving these claims more onerous.
What’s Next: Assessing the Impact of German Supreme Court Ruling on ECJ Pension Fund Reclaims
WTax would like to emphasize that despite the unfavorable Supreme Court ruling, we still consider German ECJ reclaims viable for foreign pension funds that are considered comparable.
Please contact WTax’s regional specialists today for further information on how the latest Supreme Court ruling affects your German ECJ Pension Fund reclaims.