Fund Taxation Alert 2024-01

In 2023, the Court of Justice of the European Union (“CJEU”) issued its decision on the case L-Fund (C-537/20) concerning the EU law compatibility of the German corporate income tax applicable to non-resident closed-end real estate funds. 

The plaintiff was a Luxembourg closed-end real estate fund (taking the form of a contractual special investment fund, hereafter “FCP- SIF”) that was subject to a 26,375% taxation until 2007 and 15,825% starting in 2018 (on the basis of the corporate tax reform) in Germany on its domestic income from renting and selling real estate properties in Germany. The fund challenged the decision on the grounds that it was not a taxable entity and, even if it were, it would have to be exempt from tax in the same way than a comparable German resident fund.

In the case at hand, the CJEU indicated that the only criterion of distinction in the German law was the tax residence of the fund. Consequently, the CJEU took the view that resident and foreign closed-end real estate funds were in a comparable situation. Finally, the CJEU ruled that the German tax treatment of income generated by non-resident closed-end real estate funds with exclusively foreign investors from real estate located in Germany violates the free movement of capital.

On October 11th, 2023, the German Federal Fiscal Court (BFH) ruled that a Luxembourg special real estate fund (SIF-FCP) must also be granted tax exemption on its rental and selling income under the German Investment Tax Act (InvStG). Furthermore, in its decision BFH clarifies 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 ruling is particularly important for the decisions still pending before the BFH regarding the question as to whether withholding tax (WHT) applicable on dividend distributions to foreign investment funds is in breach of EU law. The present ruling provides very interesting insights on the arguments put forward by the BFH to assess potential discrimination. We therefore believe that the BFH has all the necessary arguments to also apply this jurisprudence when assessing whether foreign funds should benefit from a refund of WHT applied on Germany source dividend payments received under the old version of the German Investment Tax Act (i.e., before 1st January 2018). In case of a positive decision, settled CJEU case law foresees that late interest will have to be paid on top of any refunded amount. This could have a substantial impact on the refundable amount since in many cases tax payments have been made many years ago (i.e., especially taking into account late interest rate of 0.5% per month).

It is expected that the BFH decision in the two test cases I R 1/20 and I R 2/20 will be issued shortly.

All investment funds that have not yet submitted any refund applications for the periods prior to 2018 should now submit their tax reclaim due to the uncertainty of which time limitation period will ultimately be applied.

In addition, there are good arguments that even for the years from 2018 onwards, non-resident investors are more heavily taxed than resident investors, even if domestic and foreign investment funds will be taxed at 15% from 2018 onwards. This difference in treatment results from the fact that German legislator has only granted German investors a compensation for the WHT suffered by the fund when receiving German source dividends. This leads to a discriminatory tax treatment at the level of the non-resident investors. For this reason, investment funds should submit refund applications for refund years from 2018 onwards as soon as possible.