German Tax Risk: Offshore Companies can be Classified as Foreign Base Companies

Company structures involving companies from certain offshore jurisdictions are subject to strict scrutiny by German tax authorities.

Currently, German tax authorities are critical towards such structures and, in most cases, quickly initiate criminal proceedings against the relevant shareholders. Various Baker Tilly International members have already asked Baker Tilly in Germany to advise their clients on such structures. Companies in countries with favourable tax regimes within and outside of the EU are particularly affected. The key question is: under which circumstance is an offshore company in danger of being classified as a foreign base company which could result in the company’s income being directly attributed to its shareholders?

So-called ’foreign base companies’ are corporations that are formally placed between the taxable entity and the source of income to provide tax savings by shifting income into low-tax countries. In such cases, the fiscal authorities tend to disregard the intermediate company and directly attribute income generated by the company to its shareholders. However, not every corporation established in a low-tax country automatically constitutes a foreign based company. According to consistent case law, this is only the case if there are no economic or other significant reasons for such intermediate company.

To avoid tax evasion by intermediate foreign companies, the legislator included Controlled Foreign Corporation (CFC) rules (Hinzurechnungsbesteuerung) into the AStG (German income tax law in connection with foreign transactions). For this purpose, the structure of an intermediate company was developed of which at least 50% is held in a foreign low-tax country (total income tax burden below 25%) by a person subject to unlimited tax liability in Germany. If the requirements for such CFC rules are met, the intermediate companies income is taxable on the relevant shareholder’s level according to such shareholder’s participation ratio.

If, in addition to the CFC rules requirements, there are further facts identifying the structure as manipulative, the assumption of a misuse of tax planning schemes may be justified and, consequently, the company is considered as non-existent and constitutes a so-called foreign base company. Thus, such company’s income is not classified as the company’s income but as its shareholders’ income. This is the case, for example, if the selected structure does not constitute a typical case under CFC rules, but rather aims to merely avoid taxes. The foreign company’s own business operations required scope is often discussed. Firstly, it must be noted that there is no general answer to such question. The outcome depends on the relevant company’s functions and services rendered. For example, a holding, finance or investment company or a patent administration company require less extensive operations than an operating company. It should be decisive whether the company is equipped, in terms of personnel and functionality, to make all company-relevant decisions. For example, the German Federal Tax Court (BFH) classified the outsourcing of a company’s operating business’ (within the scope of its business purpose) to an agent (Geschäftsbesorger) as legally acceptable. Therefore, the financial authorities’ classic “three-component examination” (“Does the company have business premises, a telephone connection and personnel?”) can be considered obsolete in most cases.

If you have any questions regarding this please do not hesitate to contact sabine.groebner@bakertilly.de from Baker Tilly in Germany.

The above article was produced by Baker Tilly in Germany on 22/11/2017 and has been published with their approval.