Tips for avoiding an accidental unlimited tax liability of a foreign corporation
Oliver Biernat
by Oliver Biernat
The following case involves Germany on one side, but this example may be applicable for many other jurisdictions. The tips given below may be generally helpful to avoid unintended tax liability in similar cases.
The case
German investor M is the sole shareholder of German company M-GmbH, which holds 100% of a Luxembourg corporation. In addition to M, who is based in Germany, Lux Sarl has a local managing director who is based in Luxembourg. During a tax audit of M-GmbH, the German tax auditors become aware of M's managing director activities for Lux Sarl and therefore wish to tax the worldwide income of Lux Sarl under unlimited corporate income tax liability due to the management in Germany (cf. Section 1 (1) KStG).
Possible tax consequences
Basic consequences:
Tax return obligation for corporate income tax and trade tax purposes in Germany;
Possible allocation of permanent establishment profits for the purpose of determining the German management permanent establishment result.
Special features:
Possible examination of taxation rights for other income (Art. 10 ff. OECD Model Tax Convention);
Possible obligation to withhold and pay German withholding tax on dividends pursuant to § 121 (1) No. 1 EStG (German Income Tax Act);
Possible loss of treaty protection due to dual residency (e.g. DTA USA).
Answer
The answer will depend on each individual case. The main question to be solved is if the place of management is really located in Germany. According to Section 10 of the German Fiscal Code (AO), this requires that the centre of business management is in Germany. According to established case law of the superior fiscal court in Germany (BFH), this depends on the ongoing management of the day-to-day business relevant to the company.
More details such as “weighting in the case of multiple managing directors”, and the “separation of management into commercial and technical tasks” can be found in the Application Decree for the German Fiscal Code (AEAO).
Tips
Below you will find a general checklist with tips for practical use (based on an FGS webcast by Engelen/Tcherveniachki dated 25 April 2024 and added from our own experience) that can be used to check and document that foreign corporations (with their registered office abroad) do not unintentionally establish their place of management in Germany if a shielding effect from German taxation is to be maintained:
Appointment of a locally resident person as managing director
Ensure the managing director has the necessary professional qualifications and experience to effectively manage the company's business.
The local managing director should be authorised to sign contracts on behalf of the company. Furthermore, contracts should not be signed in Germany.
Document that the local managing director makes operational decisions significant for the day-to-day running of the company.
Ensure that domestic managing directors only perform supervisory or control functions and do not make any operational decisions.
In cases of equivalent managing director tasks among several managing directors, it should be regulated in a legally secure manner that the foreign managing director is given the right to make the final decision within the framework of rules of procedure.
Recording management actions
Keep records of important meetings and phone calls made by the managing director.
Keep copies of important emails and other correspondence sent or received by the managing director.
Documentation of physical presence
Document the managing director's travel expenses to prove their physical presence on site.
Keep booking receipts that prove the managing director's presence at various locations.
Keep detailed calendar entries documenting the activities and presence of the managing director.
Equipment and staffing on site
Ensure the company has leased sufficient premises that can be used as an office.
Provide adequate office equipment and workstations for the managing director and any employees.
Ensure the premises have telephone and internet connections.
Be able to present a bill by your local provider proving the consumption of gas, water, and electricity.
The local managing director should have a business card stating their position and the address of the office. The director should also be shown on the website as the main decision maker.
Ensure employees with the necessary qualifications are employed on site and have appropriate employment contracts.
Accounting
The company's bookkeeping should be carried out on site.
The company's annual financial statements should be prepared on site.
The company's tax returns should be prepared and filed on site.
Keep all relevant documents and records on site and archive them properly.
If you fear the client will not avoid a place of management in Germany, the client must be warned about the tax risks.
Oliver Biernat is the founder and managing partner of Benefitax. He is a German chartered accountant, certified tax advisor, and specialist advisor for international taxation, with more than 20 years of experience. From 2008 until 2024, he has chaired GGI’s International Taxation Practice Group (ITPG), increasing its size to more than 570 experts from 90 countries in the process. Contact Oliver.
Benefitax GmbH Steuerberatungsgesellschaft Wirtschaftsprüfungsgesellschaft is a tax consultancy and public auditing company located in Frankfurt, which is widely recognised as the financial centre of Germany. Benefitax predominantly serves German entities of foreign multinational groups, mid-sized German companies with cross-border activities, and wealthy private individuals.
GGI member firmBenefitax GmbH Steuerberatungsgesellschaft WirtschaftsprüfungsgesellschaftFrankfurt am Main, GermanyT: +49 69 256 227 60
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