EU: CJEU referral on compatibility with EU law of Germany’s double tax relief switch-over mechanism for foreign PEs
Whether switch-over mechanism must include “motive test”
The German Federal Fiscal Court on November 19, 2025, referred a preliminary question to the Court of Justice of the European Union (CJEU) (case C-738/25) regarding the compatibility with EU law of Germany’s double tax relief switch-over mechanism for foreign permanent establishments (PEs).
Summary
Under the German controlled foreign corporations (CFC) rules, passive income earned through a foreign PE is subject to the credit method of relief from double taxation rather than through an exemption (so-called “switch-over mechanism”). Unlike the regime applicable to foreign legal entities, taxpayers subject to the switch-over mechanism are not allowed to demonstrate that the foreign PE is genuinely established and carries out real economic activities (i.e., there is no “motive test”).
The referring court noted that the CJEU had already held that the switch-over mechanism was compatible with EU law in case C-298/05. However, the court found that the CJEU in that case examined the switch-over mechanism in isolation, without considering its interaction with the motive test under the CFC rules. The court thus asked the CJEU whether EU law precludes a national rule that unilaterally imposes the credit method on income from a foreign PE, without allowing the taxpayer to demonstrate genuine economic activity, when such a possibility exists in comparable situations involving foreign legal entities.
Read a January 2026 report prepared by KPMG’s EU Tax Centre