The L Fund case is a significant example of the complexities involved in cross-border taxation, particularly in relation to investment and pension funds. At the heart of the case lies the issue of tax treatment for non-resident closed-end real estate funds operating in Germany. This case not only highlights specific concerns for foreign investment funds but also addresses broader issues of discriminatory tax regulations, advocating for fairer treatment in international investment scenarios. 

Background

The L Fund is a specialized property fund based in Luxembourg, operating as a Fonds Commun de Placement (FCP) under Luxembourg law. Between 2008 and 2010, it generated income from the rental and sale of real estate in Germany, making it subject to German tax legislation. Central to the case is Section 11(1) of the German Investment Tax Act 2004, which exempts domestic closed-end real estate funds from corporate income tax. However, this provision requires that domestic funds with foreign investors partially withhold tax on the income generated, while non-resident funds like the L Fund do not receive such exemptions and are taxed directly at the fund level. This approach results in different tax burdens, depending on the fund's residence status, sparking concerns about the fair treatment of non-resident funds. 

The legal journey began when the L Fund filed tax returns in July 2013, contesting its tax obligations in Germany. The German Tax Authorities issued tax notices for the relevant years, leading to a series of legal disputes. Initially, the Finance Court of Münster upheld the tax authorities' position in April 2017, which prompted the L Fund to appeal to the Federal Finance Court. Seeking clarity and a resolution, the Federal Finance Court referred the matter to the Court of Justice of the European Union (CJEU) for a preliminary ruling in October 2020. 

Findings of the Court

In its decision on April 27, 2023, in the L Fund case (C-537/20), the CJEU ruled that Germany’s tax legislation infringed upon the free movement of capital under Article 63 TFEU. The court considered the taxation of non-resident specialized property funds with exclusively foreign investors in Germany discriminatory, as it subjected them to corporate income tax on income from property received in Germany while exempting resident specialized property funds from the same tax. 

The CJEU conducted a legal analysis based on Article 63 of the Treaty on the Functioning of the European Union (TFEU), emphasizing the need for an overall assessment of the circumstances of investment funds. This assessment takes into account the aim, purpose, and content of German legislation, which seeks to implement the transparency principle, ensuring equal treatment between direct investments and those made through investment funds. The objective is to tax income only once for both domestic and foreign specialized property funds. 

The court’s comparability test focused on the investment fund level rather than the investor, deeming both resident and foreign closed-end real estate funds to be in comparable situations. This approach aimed to ensure fair and non-discriminatory tax treatment of investment funds, regardless of their tax residence. 

The CJEU concluded that Section 11(1) of the German Investment Tax Act 2004, effective until December 31, 2017, violated the freedom of movement of capital under Article 63 of TFEU. This violation stemmed from the legislation subjecting 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. The differential tax treatment, based solely on the place of residence of the funds, introduced unjustified restrictions on the free movement of capital. This disparity discouraged non-resident specialized property funds from investing in German properties and dissuaded German-resident investors from utilizing non-resident specialized property funds for such investments. 

Implications

The German Federal Fiscal Court (BFH) implemented the ruling in the national case of L Fund (I R 23/23) by granting tax exemption to the Luxembourg special real estate fund on its rental and selling income under the German Investment Tax Act (InvStG). The BFH clarified that the tax exemption should be granted to the plaintiff fund irrespective of whether the investors are subject to tax on income derived from the fund. This implementation aligns with the CJEU interpretation of Article 63 safeguarding the free movement of capital.  

The significance of this case in the fight for equal tax treatment between foreign and national investment funds is substantial. The BFH's ruling signifies a notable development in tax jurisprudence as it aligns with the CJEU's interpretation of Article 63 of the TFEU. By granting tax exemption to the foreign specialized property fund, the BFH has addressed discriminatory taxation of foreign real estate investment funds receiving German-sourced income and has demonstrated a commitment to enforcing the Free Movement of Capital within the EU. This decision holds favorable implications for pending ECJ refund applications by foreign investment funds that incurred German withholding tax on their dividend income before 2018. It also sets a precedent for the fight for equal tax treatment between foreign and national investment funds, signaling a tendency of the German Federal Fiscal Court to employ substantive arguments over formal ones, which is considered advantageous in a broader context. 

Broader Significance

The discriminatory legislation highlighted in the L Fund case extends beyond property funds to encompass all German investment funds. Section 11(1) of the German Investment Tax Act 2004, which provides a corporate tax exemption for domestic specialized property funds while excluding foreign counterparts, results in less favorable tax treatment for foreign investment funds earning income from German properties. This inequitable tax treatment affects all foreign investment funds, not solely property funds, as it pertains to the taxation of income earned by non-resident investors from German property, regardless of fund type. 

Furthermore, the absence of differentiation in income sources within Section 11(1) of the German Investment Tax Act 2004 opens the door for similar arguments regarding German withholding taxes on dividends distributed by German corporations to foreign investment funds from 2004 to 2017. This implies that principles of non-discrimination and the free movement of capital can challenge the discriminatory taxation of dividends received by foreign investment funds from German corporations. Demonstrating that the German withholding taxes on dividends violate EU law and result in unequal treatment allows foreign investment funds to seek refunds and contest the discriminatory taxation of dividend income, aligning with court rulings and reinforcing the commitment to enforcing the Free Movement of Capital within the EU. 

Similarly, the court decision in the L Fund case provides a precedent for foreign pension funds to combat discriminatory regulations regarding dividend taxation and prove eligibility for withholding tax exemption on dividend payments. By leveraging arguments akin to those used in the L Fund case, foreign pension funds can assert their right to equal treatment and eligibility for withholding tax exemption on dividend payments. The ruling underscores the necessity of non-discrimination between domestic and foreign investment funds and underscores the applicability of the principles outlined in Article 63 of the Treaty on the Functioning of the European Union (TFEU) in challenging discriminatory taxation of dividends.