Germany vs “Sales KG”, March 1980, Bundesfinanzhof, Case No IR 186/76

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The sales company … – (GmbH) was the managing general partner of the plaintiff and defendant, a limited partnership – “Sales KG” – in the years in dispute. The GmbH had a 10/11 share in the capital of “Sales KG”. The limited partner was the Dutchman G. Shareholders of the GmbH with a share of 99% were the … NV (NV) and the … in The Hague (NV L-V). “Sales KG” engaged in wholesale trade in …, which it purchased almost exclusively from NV. It granted its customers rebates, bonuses and discounts in the years in dispute (1962 – 1964).

According to the findings of the tax authorities (FA), “Sales KG” had to pay interest on its goods liabilities after 90 days from 1963. It did not charge its customers corresponding interest. The tax authorities increased the profit of “Sales KG” mainly by adding profits allegedly transferred to the Netherlands. In the absence of suitable documentation, the profit shifting was to be estimated at 3% per annum of the purchase of goods from NV. The tax authorities relied on Article 6 of the Agreement between the Federal Republic of Germany and the Kingdom of the Netherlands for the Avoidance of Double Taxation with respect to Taxes on Income and on Capital and Miscellaneous Taxes and for the Settlement of Other Questions in the Field of Taxation of 16 June 1959 – DBA-Netherlands – (BGBl II 1960, 1782, BStBl I 1960, 382), § 217 of the Reich Tax Code (AO) and § 19 No. 6 of the Regulation for the Implementation of the Corporation Tax Act (KStDV).

“Sales KG” filed an action against the notices and the Fiscal Court (Finanzgericht, FG) amended the challenged notices and partly reassessed the profits of “Sales KG” and the profit shares of the partners. For the rest, it dismissed the action.

The tax authorities lodged an appeal against this decision.

Judgement of the Court

The Court found that the tax court had correctly refused to increase the profit shares (§ 215.2 AO) of “Sales KG” by the profits allegedly transferred to the NV, as the conditions for a hidden distribution of profits (§ 6.1 sentence 2 of the Corporation Tax Act – KStG -, § 19 no. 6 KStDV) between the GmbH and its shareholder, NV in Holland, were not met.

“The requirements for a hidden profit distribution between the GmbH and the NV are not fulfilled. Although the FG did not have to decide on this question from its point of view, its findings are sufficient to exclude a hidden profit distribution in the case in dispute.
According to the established case law of the Federal Fiscal Court (Bundesfinanzhof, BFH), a hidden profit distribution requires that a corporation grants its shareholders pecuniary advantages and that this benefit has its cause in the corporate relationship. The causality of the corporate relationship is given if the corporation would not grant the advantages to a non-shareholder if it exercised the due care of a prudent and conscientious manager (§ 43, paragraph 1 of the Limited Liability Companies Act) (cf. BFH judgements of 30 July 1975, I R 110/72, BFHE 117, 36, BStBl II 1976, 74, and of 3 February 1977, IV R 122/73, BFHE 121, 327, BStBl II 1977, 346, with further references). N.).
The GmbH allegedly benefited the NV by causing it, as managing director and majority shareholder of the KG, to make payments (excessive prices for goods and interest payments) and to waive the passing-on of costs (cf. II 1 a above).
Just as a pecuniary advantage can also be granted directly to a third party and indirectly to the shareholder instead of directly to the shareholder, the person directly granting the advantage does not have to be the GmbH itself; it can also be a third party who grants an advantage to the shareholder at the expense of his own profit. This advantage is granted indirectly by the GmbH to the extent that the reduction in profit of the third party affects its own profit (share), provided that the conditions for a hidden profit distribution are otherwise met. In principle, 10/11 of the KG’s loss of profit affects the GmbH’s profit; for the rest, the limited partner G bears the KG’s loss of profit. The Senate does not need to decide whether the possible loss of profits at the limited partnership is only fully attributable to the limited liability company because it alone caused it. In the case in dispute, there is already a lack of the fundamental prerequisite of a benefit which has its cause in the partnership relationship.
It is not evident, nor has it been shown by the tax authorities, that the prices for the goods purchased by NV were higher than the usual prices for goods …
Similarly, there are no indications that NV would have waived the default interest on the goods and would have partly supported the rebates, discounts and bonuses if it had not been a shareholder in the GmbH …”

“If a transaction, in this case e.g. a possible transfer of profits (cf. German Memorandum on the DTA-Netherlands of 16 June 1959 on Article 6, printed in Handbooks on Double Taxation Agreements, Explanatory Notes on the German-Dutch DTA, text part), cannot already be covered under the domestic tax laws, then the direct application of Article 6 of the DTA-Netherlands would amount to an impermissible extension of the tax liability. The BFH rulings on the progression proviso do not contradict this. The progression proviso does not require a domestic statutory provision for its implementation (apart from the consent law pursuant to Article 59, paragraph 2, sentence 1 of the Basic Law – GG), because it does not create a tax liability, but maintains the existing one (BFH ruling of 9 November 1966 I 29/65, BFH ruling of 9 November 1966 I 29/65, BFH ruling of 9 November 1966 I 29/65, BFH ruling of 9 November 1966 I 29/65, BFH ruling of 9 November 1966 I 29/65). This also applies if the reservation is introduced after it was not initially agreed (BFH decision of 4 October 1967 I 422/62, BFHE 90, 357, 361, BStBl II 1968, 101).
5. The FA’s appeal leads to the annulment of the tax court’s judgement insofar as the tax court determined the GmbH’s share of profits in the 1964 tax year to be lower than applied for. The tax court is bound by the application (§ 96.1 sentence 2 FGO); it may not award more to the limited partnership…”

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BFH-Urteil vom 12-3-1980 I R 186-76 ORG

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