Distributions by corporations to their shareholders are taxable in accordance with Section 20 (1) no. 1 sentence 1 or 9 EStG and are subject to capital gains tax, meaning that they are initially subject to 25% plus solidarity surcharge. In the case of distributions from the profits generated by the company, this seems legitimate. However, in the case of the return of contributions made by the shareholder, which have been made with capital that has already been taxed and are merely repaid, it does not seem appropriate to tax the return again. For this reason, unlike dividends, the return of capital contributions is tax-exempt in accordance with Section 20 para. 1 no. 1 sentence 3 EStG. However, in order to be able to differentiate between a taxable dividend and a tax-free return of capital contributions, the concept of the tax contribution account in Section 27 KStG - a type of tax shadow account - was introduced.
According to the wording of the law, this option was initially only available to companies with unlimited tax liability in Germany (Section 27 (1) to (6) KStG) and, since 2006, to companies with unlimited tax liability in the EU (Section 27 (8) KStG, old version). With the Annual Tax Act 2022 ("JStG 2022"), Section 27 para. 8 KStG was amended to the extent that this option was also made available to all corporations from third countries from the 2023 assessment period.
This blog post is intended to provide an overview of the regulation and its challenges, particularly for foreign applicants.
Timing and background to the introduction of Section 27 (8) KStG
Initially, the possibility of tax-free repayment of contributions from the contribution account was only limited to corporations with unlimited tax liability in Germany. This was widely criticised as it made investment in domestic corporations more attractive than foreign ones and thus constituted an infringement of the free movement of capital. The introduction of Section 27 (8) KStG in 2006 only partially remedied this criticism, as the scope of application was extended, but only to corporations that were subject to unlimited tax liability in an EU member state. The BFH therefore ruled in its judgement of 13 July 2016 that a repayment of contributions may also be claimed by a company that is domiciled in a third country and does not maintain a tax deposit account within the meaning of Section 27 KStG. The judgement of 10 April 2019 also ruled that the legal situation applicable from 2006 must allow payments from the assets of a company domiciled in a third country to be qualified as a repayment of contributions. In a letter dated 21 April 2022, the Federal Ministry of Finance commented on the BFH rulings and confirmed the application of the return of capital contributions within the meaning of Section 27 KStG. As a result, paragraph 8 was amended with the JStG 2022 to the effect that corporations or associations of persons that are not subject to unlimited tax liability in Germany are now also listed as beneficiaries. From the 2023 assessment period, these can now carry out a repayment of contributions as part of the separate assessment procedure within the meaning of Section 27 para. 8 KStG in order to prevent unjustified taxation of the repayment of contributions. Accordingly, all foreign companies are now covered by the personal scope of application of Section 27 (8) KStG, insofar as they provide services within the meaning of Section 20 (1) nos. 1 and 9 EStG.
Determining the return of capital contributions and challenges that arise in practice
Pursuant to section 27 (8) sentence 2 KStG, the repayment of capital contributions is to be determined in accordance with paragraphs 1 to 6 and sections 28 and 29 KStG. Accordingly, the reference values are also used here as in the domestic case. Therefore, the performance rendered by the foreign company in the current financial year of the repayment of contributions, the balance of the (notional) tax contribution account at the end of the previous financial year, the balance of equity, including subscribed capital, at the end of the previous financial year and the distributable profit at the end of the previous financial year must be determined. The calculation of the return of capital contributions is explained below using a numerical example for better understanding:
Performance rendered in 2023 in the amount of EUR 250,000
less distributable profit as at 31 December 2022, which is calculated as follows
Equity according to the tax balance sheet as at 31 December 2022 EUR 450,000
less nominal capital -EUR 100,000
less the balance of the notional tax contribution account
contribution account as at 31 December 2022 -EUR 200,000
= distributable profit -EUR 150,000
Taxable in accordance with section 20 (1) nos. 1 and 9 EStG EUR 150,000
Amount of the tax-free return of capital contributions EUR 100,000
However, the possibility of a tax-free return of contributions is always limited to the balance of the tax contribution account.
What appears simple in theory, however, harbours major challenges in practice. As section 27 para. 8 KStG, in contrast to normal domestic cases, does not, for example, provide for a separate annual determination of the balance of the tax contribution account, the balance of the tax contribution account must be determined for each application by applying section 27 para. 1 to 6 KStG analogously as a dependent tax base. It is essential to note that the reference values must be determined in accordance with the legal principles applicable to domestic corporations and therefore with the help of corresponding reconciliation calculations in accordance with German tax law (or on the basis of German tax balance sheets). The foreign commercial balance sheet must therefore be analysed to determine whether, in terms of reason or amount, only items that are also provided for under German commercial and tax law principles have been taken into account. This also applies to the determination of favoured contributions within the meaning of German regulations. For this purpose, it is necessary to know the local accounting regulations of the foreign company, if necessary with the involvement of local experts. Determining and documenting this can involve considerable effort, especially as the observation period often spans several years and in some cases goes back to the founding of the foreign company, which leads to the further challenge of being able to obtain all the necessary documents.
This is just one of many challenging aspects. The application regulations and possible exchange rate fluctuations can also cause problems.
Conclusion
It is pleasing that all companies, regardless of their place of residence, are able to apply for the tax-free return of stock. However, an application is often very time-consuming, particularly due to the fact that it is based on German tax accounting regulations, as corresponding reconciliations and considerable documentation must be prepared.
From a purely business point of view, before a repayment of capital contributions is made - depending on the amount - it should be weighed up whether an application in accordance with Section 27 (8) KStG is worthwhile at all or whether the costs of the application outweigh the benefits of the tax-free repayment. On the other hand, it is advisable to ensure that all necessary documents and calculations are collected and processed on an ongoing basis as soon as a foreign company is founded or acquired, as the capital requirements are often considerable, particularly in the start-up phase, in order to avoid a high administrative burden as far as possible in the event of a subsequent repayment of capital contributions.
