Attorney General to European Court of Justice: EU Treaty prohibits Germany from levying withholding tax from Canadian pension fund
1 The case facts
On 23 December 2011, College Pension Plan, a registered Canadian pension plan that is tax exempt in Canada, submitted requests for refund of German withholding tax that was withheld and paid at a rate of 15% from the gross dividend income it derived from its German sourced portfolio equity investments. As the Canadian – German tax treaty allows Germany to tax German sourced portfolio dividends at a rate of 15%, and did not (and does not) provide further relief in the form of a refund provision, the requests were based on the position that the German withholding tax is a restriction of the free movement of capital that is prohibited by article 63 of the EU Treaty.
After an (implicit) rejection of the requests by the German tax administration, College Pension Plan appealed before the Munich Fiscal Court. The Munich Fiscal Court referred to the European Court of Justice and requested two “prejudicial questions” (interpretative questions) of EU law to be answered.
After the ECJ’s judgment, which is expected to be rendered by the end of 2019, it will be up to the Munich Fiscal Court to render a final decision, taking into account the (binding) answers given by the ECJ in its judgment.
2 The legal context
German domestic law
Under German domestic tax law, German pension funds are subject to tax on their portfolio investment income. However, they are able to reduce their taxable profit in a tax assessment procedure by deducting the amounts reserved to meet their pension payment obligations, and to neutralize the tax on income from capital through a set-off, and also receive a refund in the event that the amount of corporation tax payable is less than the amount set-off. As German pension funds reserve all or almost all of their annual income from capital for (future) pension payment obligations, generally speaking the total German tax liability on income from capital is zero, or close to zero.
Non-resident pension funds like College Pension Plan that only have German sourced portfolio investment income are not liable to tax in Germany, and therefore not subject to the tax assessment and set-off procedure. As a result, they are not able to deduct the amounts reserved to meet their pension payment obligations, nor are they able to deduct any other expenses relating to the income from capital. To them, the 15% German withholding tax over gross German sourced dividend income is a final levy.
Relevant EU law framework
Article 63 of the EU Treaty prohibits any and all restrictions of the free movement of capital between EU member states, as well as between an EU member state and “third countries” (non-EU member states, such as Canada). A restriction of the free movement of capital may be prohibited if an EU member state treats non-residents less favorable than residents. For example where a member state taxes non-resident while it exempts (or refunds the tax) to residents.
There are two caveats to article 63:
Article 65 of the EU Treaty, which provides that article 63 shall not apply if:
- the situation of non-residents is not objectively comparable to that of residents, or
- the restriction is justified by “overriding reasons in the public interest”
If non-residents are not discriminated (because different treatment of objectively different situations is not discrimination), or if overriding reasons in the public interest are present, the taxation of non-residents is not a prohibited restriction.
Article 64 of the EU Treaty, which provides that article 63 shall not apply to the application of restrictions to third countries which exist on 31 December 1993 under national law or Union law adopted in respect of the movement of capital to or from third countries involving indirect investment – including real estate – establishment, the provision of financial services or the admission of securities to capital markets. Article 64 is know as the “standstill clause”, which grandfathers pre-existing restrictions in specific situations. As a derogation of the fundamental principle of free movement of capital, according to the ECJ article 64 must be interpreted “strictly”. This is also reflected by the fact that its application requires to cumulative conditions to be met:
- The restriction must have already existed on 31 December 1993, and must have remained essentially the same since (i.e. substantial amendments after 31 December 1993 may make an existing restriction a “new” and therefore prohibited restriction); this is also know as the “temporal condition”, and
- The restriction must be adopted in respect of (must relate directly to) direct investment, establishment, the provision of financial services or the admission of securities to capital markets; also known as the “substantive condition”
3 The questions referred by the Munich Fiscal Court
The Munich Fiscal Court referred the following questions to the ECJ:
- Does the freedom of movement of capital under Article 63(1) TFEU in conjunction with Article 65 TFEU preclude legislation of a Member State under which a non-resident institution operating an occupational pension scheme whose essential structure is similar to a German pension fund does not receive any relief from tax on income from capital in respect of dividends received, whereas such dividend distributions to domestic pension funds do not result in any increase in their corporation tax liability, or only a comparatively small one, because the latter are able to reduce their taxable profit in a tax assessment procedure by deducting the amounts reserved to meet their pension payment obligations and to neutralize the tax on income from capital through a set-off, and also receive a refund in the event that the amount of corporation tax payable is less than the amount set-off?
- If the answer to Question 1 is yes: is the restriction of the free movement of capital through Section 32(1) No 2 of the Law on corporation tax permissible with respect to third countries under Article 63 TFEU in conjunction with Article 64(1) TFEU because it relates to the provision of financial services?
In its referral letter to the ECJ, with respect to the first prejudicial question the Munich Fiscal Court considers that it appears that College Pension Plan is in a situation that is objectively comparable to that of German pension funds. In doing so, it draws an analogy with the ECJ’s ruling in the (2012) Commission v. Republic of Finland case (C-342/10). The Munich Fiscal Court further concludes that no overriding reason in the public interest applies in this case. As the Munich Fiscal Court nevertheless refers the question to the ECJ, it is apparently not entirely certain whether College Pension Plan is indeed in a situation which is objectively comparable to that of German pension funds.
With respect to the second prejudicial question, the Munich Fiscal Court reasons that while the domestic legal provisions for German pension funds may have been changed substantially after 31 December 1993, these provisions do not affect non-resident investors. And the domestic legal provisions that do affect non-resident investors have not changed. The Munich Fiscal Court therefore concludes that the temporal condition has been met and asks the ECJ whether, under the circumstances of this case, the substantive condition is also met. In this regard, the Munich Fiscal Court first confirms that there is no direct investment, establishment or admission of securities in the case at hand, which leaves only the question whether the restriction is “in respect of the provision of financial services”.
Based on established ECJ case law (a.o. Wagner Raith, C- 560/13), in order for a restriction to be “in respect of the provision of financial services” it must concern movements of capital that have a causal link with the provision of financial services. According to the Munich Fiscal Court, this is the case because the major part of the investment returns generated by the pension fund increase not only the value of its assets, but also the value of its provisions for pension payment obligations on the liabilities side, because 100% or at least 90 % of such earnings are credited to the individual pension fund contracts, thus increasing the pension fund’s payment obligations with respect to pension benefits. Consequently, the taxation of dividends distributed to a pension fund established in a third country directly affects the claims that the pensioners have against the pension fund because their claims are reduced by the amount of WHT paid by it, and therefore affects the financial service provided by the pension fund.
4 The AG Opinion
Objective comparability and overriding reasons in the public interest (art 65 TFEU)
On the objective comparability and overriding reasons in the public interest, the AG concludes that:
- Objective comparability must be tested in light of the aim pursued by the domestic legislation that is the subject of the dispute (the German withholding tax)
- The referring Munich Fiscal Court has failed to explain the aim pursued by the domestic legislation
- In view of the arguments brought forward by the parties, non-resident pension funds and German pension funds have common objectives. Like German pension funds, non-resident pension funds such as CPP also have the objective of guaranteeing the pension insurance activity by means of the creation of sufficient capital to cover retirement pension obligations in the future.
- The AG rejects the argument of the German government that CPP is not in a situation that is objectively comparable with German pension fund because non-resident pension funds and resident funds are subject to different taxation techniques. According to the AG, the test relating to the application of different taxation techniques, in order to establish the comparability of situations between a resident taxpayer and a non-resident taxpayer, is based on tautological reasoning. As a general rule, residents and non-residents are subject to different taxation techniques. This ruling only confirms that the situations are different since the resident and non-resident taxpayers are different. In the main proceedings, resident pension funds are "wholly taxable”, whereas income from foreign pension funds is subject only to a "limited" tax obligation covering only income originating in Germany. In the AG’s opinion, the different taxation techniques only reflect this difference. However, this does not mean that the national legislation in question automatically escapes the scope of the free movement of capital.
- In light of the above CPP is in a situation that is objectively comparable with that of German pension funds, and the German withholding tax restricts the free movement of capital.
On the presence of overriding reasons in the public interest, the AG simply states that, in the present case, a difference in treatment between resident and non-resident pension funds can not be justified by any of those reason since the interested parties have not discussed this subject in the legal proceedings.
The standstill provision (art 64 TFEU)
On the application of the standstill provision, the AG concludes that the German domestic law has essentially not changed since 31 December 1993, so the temporal condition is met. However, according to the AG the material condition is not met because there is no causal link between the restriction and the provision of financial services. According to the AG, the category of capital movements involved is the payment of dividends to a pension fund. The AG is of opinion that when a pension fund receives dividends, the causal link between capital movements and the provision of financial services is lacking, as the situation concerns the acquisition of direct investment by an investor who wishes to diversify his assets and better spread the risks. As the European Commission has pointed out, the AG says, the participations of a pension fund and the dividends that it receives serve primarily to accumulate financial assets through greater diversification and a better distribution of risks, in order to guarantee its fulfillment of future pension obligations with regard to its members. Furthermore, the restriction in question is based on the application of the full crediting mechanism, which relates to the taxation of dividend distributions to resident pension funds and which can not benefit non-resident pension funds. In light of the foregoing, the restriction does not apply to capital movements in connection with the provision of financial services to members of the pension fund. Therefore, the standstill provision can not remedy the restriction.
5 Our thoughts and “takeaways”
If followed by the ECJ, this Opinion of the AG significantly increases the chances of success of pending, new, and future claims for refund of German withholding tax by non-German pension funds, provided that - like College Pension Plan - they are objectively comparable to German pension funds and established in a country with which Germany has a treaty for the avoidance of double taxation that contains a provision for exchange of information (since the absence of such a treaty provision might be considered an overriding reason in the public interest that could justify the restriction caused by the German withholding tax). We recommend all non-German pension funds that have incurred German withholding tax in years that have not yet become statute barred (the statute of limitations in Germany for withholding tax reclaims is 4 years) and that have not yet filed claims to file claims (at the very least protective claims) before the end of 2019.