CJEU referral on the compatibility with EU law of Germany’s double tax relief switch-over mechanism for foreign permanent establishments
On November 19, 2025, the German Federal Fiscal Court referred a question to the Court of Justice of the European Union (CJEU) concerning the compatibility with EU law of Germany’s double tax relief switch-over mechanism for foreign permanent establishments (case C-738/25).
Under the German controlled foreign corporations (CFC) rules, in general, qualifying passive income of a foreign subsidiary of that meets certain conditions is subject to taxation in Germany. The rule applies when German resident taxpayers directly or indirectly own more than 50 percent of the shares in a foreign corporate subsidiary that (i) is subject to a low rate of taxation, and (ii) earns income from certain passive activities. Exceptions to the 50 percent threshold apply to certain types of passive income of an investment character (i.e., a lower participation may be sufficient to trigger CFC taxation). EU/EEA subsidiaries that carry out genuine economic activities may be exempt from the CFC rules (the “motive test”), as a consequence of a 2008 amendment in light of the CJEU’s decision in case C-196/04.
Whilst a foreign partnership cannot be a CFC for the purposes of the German CFC rules, a foreign permanent establishment may fall in scope of the rules where a German tax resident receives income within a foreign permanent establishment and such income would be taxable as passive income under the rules if this permanent establishment were a foreign legal entity. In those cases, German CFC rules require the application of a treaty-override provision such that the passive income derived through the foreign permanent establishment is subject to the credit method of relief from double taxation rather than through an exemption – the so-called switch-over mechanism. Unlike the regime applicable to foreign legal entities, this provision does not allow taxpayers to demonstrate that the foreign permanent establishment is genuinely established and carries out real economic activities (i.e., there is no “motive test”).
The plaintiff in the case at hand is a German holding company that forms a fiscal unity with its wholly owned German subsidiary, A GmbH. The latter company established a wholly owned subsidiary in Luxembourg, which in turn held interests in several lower-tier subsidiaries. These entities ultimately acquired immovable property. A GmbH and its Luxembourg subsidiary entered into a silent partnership, with A GmbH acting as the silent partner. For German tax purposes, the silent partnership was treated as transparent, with its profits attributed to the German-resident partners. Under the double tax treaty concluded between Germany and Luxembourg, income attributable to a permanent establishment (triggered by the tax transparent partnership) would normally be exempt from German taxation.
However, the German tax authorities classified the income as passive income generated through a foreign permanent establishment located in a low-tax jurisdiction. On this basis, they argued that the switch-over mechanism applies and, consequently, that double taxation relief should be granted under the credit method rather than the treaty-based exemption method. The applicant challenged the tax authorities’ approach, arguing that the inability to prove genuine economic activity and thereby access the exemption method constitutes an unjustified restriction on the freedom of establishment under EU law.
The referring court expressed doubts as to the compatibility of the German rules with EU law. It also noted that the CJEU had already ruled on the switch-over mechanism in case C-298/05, in which the CJEU found those rules to be compatible with EU law. Nevertheless, the referring court took the view that the present case raises a distinct question. In its opinion, the earlier case examined the switch-over mechanism in isolation, without considering its interaction with the CFC rules, which, according to the Court’s case law, must include a motive test in order to ensure compatibility with EU law.
The referring court has therefore asked the CJEU whether EU law precludes a national rule that unilaterally imposes the credit method on income from a foreign permanent establishment, without allowing the taxpayer to demonstrate genuine economic activity, where such a possibility exists in comparable situations involving foreign legal entities.
CJEU referral on Portuguese tax defensive measures with respect to real estate held through tax haven structures
On October 8, 2025, the Tribunal Arbitral Tributário (Portugal) submitted a request for a preliminary ruling to the CJEU (case C-661/25). The request concerns the compatibility with EU law of the Portuguese regime imposing increased taxation on Portuguese real estate assets held by companies directly or indirectly controlled by entities established in jurisdictions included on Portugal’s domestic tax haven list.
Under Portuguese tax law, increased rates of real estate transfer tax (IMT) and municipal property tax (IMI) apply to the acquisition and ownership of Portuguese real estate by entities that are directly or indirectly controlled by persons or entities resident in a jurisdiction classified domestically as a tax haven. The Portuguese domestic tax haven list comprises approximately 80 jurisdictions and is independent of the EU list of non-cooperative jurisdictions, although it partially overlaps with both Annex I and Annex II of the EU list.
The applicants in the case at hand are Portuguese private limited companies established in Lisbon, whose activity consists of the acquisition, sale and management of real estate. Their share capital is indirectly held, through Luxembourg companies, by investment funds established in the Cayman Islands, which are managed by a general partner also established in the Cayman Islands.
In 2018, the applicants acquired several properties in Portugal and benefited from an IMT exemption applicable to properties acquired for resale. As the properties were not resold within the statutory three-year period, the exemption expired and the applicants voluntarily paid the IMT due.
In January 2023, the Portuguese tax authorities conducted tax inspections and subsequently issued additional IMT and IMI assessments at increased rates, on the ground that the applicants were indirectly controlled by entities established in a low-tax jurisdiction, namely the Cayman Islands. The applicants challenged the assessments before the Portuguese courts.
The Portuguese referring court expressed doubts as to the compatibility of the Portuguese rules with EU law and referred several questions to the CJEU, including the below:
- whether Portuguese legislation that applies higher IMT and IMI rates solely because a taxpayer is directly or indirectly controlled by an entity resident in a listed low-tax jurisdiction constitutes a restriction on the free movement of capital;
- if such a restriction exists, whether the objective of combating tax evasion and tax avoidance may constitute an overriding reason in the public interest capable of justifying it;
- if the restriction may in principle be justified, whether the Portuguese regime goes beyond what is necessary, notably where taxpayers are not allowed to rebut the application of the increased rates by demonstrating that the ownership structure is not artificial and is based on genuine commercial and economic reasons. Furthermore, the referring court asked for clarification on whether the assessment of proportionality depends on whether Portugal has an effective legal framework for the exchange of tax information with the relevant low-tax third country that covers the taxes under dispute.
