Double Taxation and Activity Reservations: Important Information Regarding Income from Foreign Permanent Establishments

If a company has a permanent establishment abroad, there is a risk of double taxation—meaning that the same income could be taxed both abroad and in Germany. To avoid this, there are so-called double taxation treaties (DTTs). These determine whether the income is exempt from German tax or whether the tax paid abroad is credited against the German tax.

Generally, the exemption method applies to foreign permanent establishments. However, there are exceptions: If the permanent establishment does not generate “active income,” a so-called “switch-over clause” may apply, and the credit method is used. On July 3, 2024 (Case No. I R 4/21), the Federal Fiscal Court (BFH) clarified important questions regarding these activity reservations.

What are activity reservations?

An activity reservation means that certain income from a foreign permanent establishment is tax-exempt only if it derives from active business activities. This is defined in Section 8(1)(1) to (6) of the Foreign Tax Act (AStG). The BFH clarified that these rules also apply to permanent establishments and that the switch-over clauses must also be applied.

What did the BFH decide?

The BFH ruled that a restriction (teleological reduction) of the activity requirements is not possible. Such a restriction applies only in certain cases where the exemption method must actually be applied under the DTA. However, this was not the case in the matter decided by the BFH.

Open Questions

Unfortunately, the BFH did not address all practice-relevant questions. In particular, it remained unclear how proof of a qualified activity reservation is to be correctly provided. Here, the BMF letter dated December 22, 2023, can be consulted, which contains guidance on proof requirements pursuant to Section 8(2) of the Foreign Tax Act (AStG). However, it cannot be clearly inferred from this that such proof alone is sufficient.

What does this mean in practice?

Companies with foreign permanent establishments should carefully review the relevant double taxation treaties. It is important that all necessary evidence be provided in order to apply the exemption method. Otherwise, the credit method may apply, which is often less advantageous.

The complexity of tax matters for companies with locations in multiple countries is often underestimated. With Trimborn . Partner, you have an experienced advisor at your disposal for complex issues. Our teams at our offices in Düsseldorf and Oberhausen look forward to hearing from you.