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Repayment of capital contributions by a third country entity

If a corporation whose management and headquarters are in a third country distributes assets to its shareholder then these payments could be treated as repayments of capital contributions even if a contribution account for tax purposes within the meaning of Section 27 of the Corporation Tax Act (Körperschaftsteuergesetz, KStG) is not maintained for the company.

A case of ...

The claimant, a German corporation, had a stake in a US Inc. and, in the past, had financed this company via capital contributions. In the relevant year, the claimant had received payments from the US Inc. that were classified in the USA as “return of capital“. Nevertheless, the local tax office treated the payment as a dividend and added 5% of this payment to the claimant’s profit in the off-balance sheet accounts pursuant to Section 8b(3) KStG. The claimant filed an action against this before the Münster tax court and then won its case at the Federal Fiscal Court (Bundesfinanzhof, BFH) (ruling from 10.4.2019, case reference: I R 15/16).

... distributions exceeding profit ...

Distributions from corporations insofar as they do not derive from the company’s contribution account for tax purposes, within the meaning of Section 27 KStG, constitute neither income from capital assets nor tax-exempt dividends to which the addition of 5% of notional non-deductible business expenses would have to be applied. Although, here the company’s contribution account for tax purposes can only be used to the extent that the payment exceeds the distributable profits that have been calculated for the company for the previous financial year. This rule also applies to EU corporations (Section 27(8) KStG).

... from a third country

Already in 2016, the BFH had decided that, from the point of view of the free movement of capital, the option to repay capital contributions would have to be opened up for corporations in a third country, too. Since, in the above-mentioned case, in the period prior to the “distribution” the US Inc. had not generated any (accounting) profit then, in the case in question, this could only have constituted a tax-neutral repayment of capital contributions that, accordingly, led to a reduction in the book value of the shareholding in the claimant’s accounts and, indeed, despite the fact that the balance of the contribution account for tax purposes of the distributing US Inc. had not been (could not be) determined.

Reconciliation is not necessary

Unlike in the case of domestic (German) or EU corporations – where the repayment of capital contributions is essentially based on the respective balance of the contribution account that has to be separately determined within the meaning of Section 27 KStG and, moreover, on the distributable profits that have to be calculated in accordance with (German) tax principles -, in the case in question, the BFH based its argument on the accounting profit of the US company. In practice, this at least implies a simplification to the extent that a time-consuming reconciliation, including an extrapolation over several years, would not have to be carried out.

Outlook: What remains unclear (since it was not relevant for the decision in the case in question) is whether the principles that were mentioned in the ruling also apply to EEA corporations, or whether the existing statutory provisions for EU corporations should be used (the fiscal authority is of a different opinion, cf. Federal Ministry of Finance on the separate assessment for nominal capital repayments in the case of foreign corporations (Gesonderten Feststellung von Nennkapitalrückzahlungen bei ausländischen Kapitalgesellschaften), case reference: IV C 2 – S 2836/08/10002, published in the Bundessteuerblatt, BStBl 2016 I p. 468, subsection 1.

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