In the judgment of L Fund v. Germany, C-537/20 (CJEU 2023) on 27 April 2023, the Court of Justice of the European Union (CJEU) determined that Germany’s tax legislation contravened Article 63 of the Treaty on the Functioning of the European Union (TFEU), which safeguards the free movement of capital. The court found that Germany’s corporate tax exemption for domestic specialized property funds, while excluding foreign specialized property funds from the same benefit, resulted in a less favorable tax treatment for the latter group when they received income from properties in Germany.
The case primarily concerns property funds, yet the ruling carries substantial implications for foreign investment funds that suffered German withholding tax prior to 1 January 2018. This is because Germany’s tax legislation, as applied to the German property fund in the case at hand, extended to all German investment funds and was not exclusive to property funds.
Case Background: L Fund Challenges Discriminatory Tax Treatment of Non-Resident Property Funds in Germany
L Fund, a specialized property fund established under Luxembourg law, generated income from renting and selling real estate properties in Germany between the years 2008 and 2010.
The exemption from corporate income tax for closed-end real estate funds domiciled in Germany is provided under Section 11(1) of the German Investment Tax Act 2004. The tax liability lies with the investor. In the case of domestic specialized property funds with exclusively foreign investors, the income from property received within German territory is directly attributed to the non-resident investors as their own partially taxable income, and the fund is obliged to levy a withholding tax. However, non-resident specialized property funds, like the L Fund, do not qualify for the corporate income tax exemption, and their income from property earned in Germany is subject to taxation at the fund level. Consequently, for both scenarios, the German income earned by non-resident investors is subjected to taxation just once within the country, albeit at different levels.
In July 2013, L Fund filed corporate income tax returns for the years in question, asserting that it was not liable for corporate income tax in Germany. However, the German Tax Authorities disagreed and issued tax notices for those years. L Fund subsequently challenged the notices before the Finance Court of Münster, which essentially upheld the Tax Authorities’ position in its April 2017 judgment. L Fund then appealed to the Federal Finance Court which, in October 2020, sought a preliminary ruling from the CJEU to clarify the compatibility of the German tax treatment of income earned by non-resident property funds from property located in Germany with the free movement of capital, as governed by Article 63 TFEU.
CJEU Ruling: Ending Discrimination – Non-Resident Property Funds Granted Equal Tax Treatment in Germany
The CJEU emphasized that differential tax treatment based solely on the place of residence of the funds could introduce unjustified restrictions on the free movement of capital, by discouraging non-resident specialized property funds from investing in German properties and dissuading German-resident investors from utilizing non-resident specialized property funds for such investments.
The CJEU determined that resident and non-resident specialized property funds are in objectively comparable situations, as the German legislation’s distinction is based solely on the funds’ tax residence. The court emphasized that the overall assessment should consider the aim, purpose, and content of the German legislation, which seeks to implement the transparency principle, ensuring equal treatment between direct investments and those made through investment funds, while taxing income only once for both domestic and foreign specialized property funds. Consequently, the CJEU found that the comparability test should focus on the investment fund level rather than the investor, as both resident and foreign closed-end real estate funds are in comparable situations.
The CJEU determined that Section 11(1) of the German Investment Tax Act 2004, in force until 31 December 2017, violated the freedom of movement of capital under Article 63 of TFEU. The court concluded that Article 63 TFEU precludes German legislation that subjected non-resident specialized property funds to corporate income tax on income from property received in Germany, while exempting resident specialized property funds from the same tax. In summary, the court determined that the way Germany taxes non-resident closed-end real estate funds with exclusively foreign investors violates EU law without justification.
Implications and Key Takeaways: CJEU Ruling Reshapes Tax Landscape for Non-Resident Investment Funds in Germany
The recent CJEU ruling aligns with its established case-law regarding the taxation of non-resident funds and demonstrates the court’s continued commitment to enforcing the Free Movement of Capital within the EU. The case has been referred to the Federal Finance Court for a final decision, but the CJEU’s clear ruling leaves little room for deviation from its judgment.
This ruling holds significant implications particularly for foreign specialized property funds and other non-resident investment vehicles:
- It addresses the discriminatory taxation of foreign real estate investment funds receiving German-sourced income from 2004 to 2017, compared to their German counterparts.
- In relation to foreign non-real estate investment funds, the judgment has positive repercussions for their refunds of German withholding tax levied on dividend income received between 2004 and 2017. Refund applications that were submitted within the four-year statute of limitations are likely to benefit from this ruling. While particularly favorable for EU funds, non-EU funds may still face additional factors and potential counter arguments from the German Tax Authorities. In the event of a rejection by the German Tax Authorities, it is recommended that an objection is filed. Should the objection be denied, the next course of action would involve escalating the matter to the tax courts. Despite the positive ruling, the practical implications for foreign non-real estate investment funds remain uncertain. It is unclear whether the German Tax Authorities and Courts will adhere to the CJEU judgment and initiate refunds or if they will rely on minor differences in the case to non-real estate investment funds and await further litigation.
Next Steps: Navigating the Impact of ECJ Ruling on German ECJ Investment Fund Reclaims
It is crucial to closely monitor the correspondence received from the German Tax Authorities to ensure compliance with objection filing deadlines and court proceedings initiation. WTax remains committed to actively monitoring and keeping informed about any future updates.
For detailed information on the impact of the recent ECJ ruling on your German ECJ Investment Fund reclaims, we encourage you to promptly get in touch with WTax’s regional specialists.