The foreign holding from the point of view of income tax: practical or not?

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In business practice foreign holding companies are useful for many purposes. In this process the motivation to use a holding is often due to factors not connected to tax, i.e. improved investment management through consolidation, central financing, etc. whereby at best the holding will not have a negative effect on tax and the inclusion of a holding seldom achieves a real tax advantage. In any case the advantages and disadvantages should be carefully considered and a tax expert should be consulted in good time.
 
 

 

Definition of the problem

In company magazines we can often read: “Reduce taxes with a foreign holding company”. One can only warn against such general statements. In addition, the guidance into a holding structure should be carefully thought out. Firstly, the inclusion of a holding usually requires one or more restructuring steps. Secondly, the advantageousness of the holding company depends on the legal form of the company. Thirdly, the personal domicile of the entrepreneur is decisively important. Fourthly, the financing of the holding structure has to be thoroughly examined. Fifthly: the non-tax reasons for the holding structure have to be weighed up against the tax consequences.
 
In terms of income tax from a German point of view at the very least differentiation is required between individual case groups and company structures. Differentiation is made according to the investment direction (i.e. inbound versus outbound circumstances), according to the legal form and also according to the place of residence of the entrepreneur.
 

Domestic shareholder with domestic corporation or partnership

If a domestic shareholder has an investment in a domestic operative partnership or corporation and the shareholder would like to include a foreign holding company without moving his place of residence abroad, the usual recommendation is not to do it. It may be well possible under some circumstances to achieve a long-term saving effect when the tax rate abroad is lower than the tax rate at home and when profits are not distributed. This effect, however, is almost completely cancelled if profits are distributed. In addition, the foreign holding company in terms of domestic tax is at best neutral (for a domestic partnership) with a domestic corporation even negative. The fact is that the foreign holding company will routinely not get a reimbursement of the withholding tax held back on the domestic dividends. If the place of residence of the shareholder is abroad the reimbursement of the withholding tax may under some circumstances succeed, but usually the tax relocation cannot be made in a tax neutral way. If the domestic entrepreneur in addition to his domestic investment also wishes to include a further foreign company in the holding company, in individual cases this can be advantageous. However, a detailed examination must be made to establish whether exit taxation due to the relocation of function is applicable.
 

Domestic shareholder with foreign corporation or partnership

If a domestic shareholder has investments in one or several foreign corporations or partnerships and the shareholder would like to include an intermediate holding company abroad, this will usually only result in an advantage for the corporation as far as the holding company is also chosen to be a corporation. This is the main application where it makes sense with regard to tax to have a foreign holding company. In fact in this case on the one hand the long-term saving effect mentioned above can be exploited. On the other hand it is conceivable to choose a country for the intermediate holding which in terms of foreign withholding tax has a practical double taxation agreement with Germany. Within Europe this is not so relevant because in Europe the parent company / subsidiary company directive is applicable anyway. But it is conversely true that foreign partnerships from a German point of view are usually considered to be transparent in terms of tax and therefore the intermediate connection of a further transparent company usually has no advantage. It can even be a disadvantage because then possible subjects such as permanent establishments for management and profit deferrals may have to be discussed with the various financial authorities. On the other hand certain financial flows with partnerships nevertheless allow structures which enable a double dip interest deduction in numerous countries.
 

Foreign shareholder with domestic corporation or partnership

If a foreign shareholder has an investment in a domestic corporation or partnership and would like to include an intermediate holding company abroad, this must also be examined individually. If the place of residence of the shareholder is in the same country as the intermediate holding company, a reduction of German withholding tax for a corporation or partnership according to the respective double taxation agreement should be possible. If the place of residence of the shareholder is in a different country, at the minimum the requirements for corporations acc. to § 50d par. 3 of the German Income Tax Act (EStG) must be observed. For foreign partnerships the German financial ministry is of the opinion that an exemption certificate will not be issued, but despite this if the substance requirements are presented repayment of the German withholding tax is nevertheless possible. Particular caution is advisable with partnerships when a qualification conflict is present and the foreign holding company is not classified as being transparent in terms of tax. The withholding tax reduction can under some circumstances fail due to regulations such as § 50d par. 1 sentence 11 of the German Income Tax Act (EStG).
 

Conclusion

In the consideration process of whether a foreign holding makes sense from the point of view of German income tax, there are essentially three questions which have to be asked. Firstly, can the inclusion of the holding company be made to be tax neutral or will the creation of the new target structure trigger taxes? Secondly, can the holding company structure be used to achieve a tax advantage? This is generally speaking usually only the case when the holding company is a corporation within a company group. Thirdly, if a tax advantage is not possible, can the holding company be set up in such a way as to ensure that at least there is not a tax disadvantage? Due to their complexity, these questions can only be answered with regard to individual cases.
 

Contact

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Prof. Dr. Florian Haase, M.I.Tax

Partner, Office head

+49 40 2292 975 20
+49 40 2292 977 99

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