IWB functional approach

Internationale Unternehmensstrukturen bergen steuerliche Fallstricke – besonders wenn ausländische, niedrigbesteuerte Gesellschaften Einkünfte erzielen, die passiv sein können, obwohl wirtschaftlich eine aktive Geschäftstätigkeit dahintersteht. Die funktionale Betrachtungsweise bietet hier einen wichtigen Ausweg. Patrick Bubeck and Dr Tobias Stiegler have in the IWB magazine of the NWB publishing house verschiedene Praxis- und Rechtsfragen diskutiert. Sie wünschen sich unter anderem von der Finanzverwaltung, wirtschaftliche Realitäten anzuerkennen. Dieser Blogbeitrag basiert daher auf einem Fachaufsatz in einer bekannten Steuerfachzeitschrift.

What is add-back taxation and who does it affect?

The Taxation of add-backs in accordance with §§ 7-13 AStG was created to prevent taxpayers resident in Germany from avoiding German taxation of income via low-taxed foreign companies. Since 1 January 2024, low taxation has been deemed to exist if the foreign company is taxed at less than %.

The key question is whether the income of the foreign company is active (= non-critical) or passive (= harmful). Incidentally, this question also arises for companies that are subject to the new minimum tax law.

Segmenting vs. functional view: the basic conflict

In principle, the Foreign Tax Act gives priority to the segmented approach: each activity of a foreign company is assessed in isolation. In practice, this often leads to economically related activities being artificially torn apart.

Die funktionale Betrachtungsweise ist die Ausnahme – und sie greift dann, wenn verschiedene Tätigkeiten aus derselben Funktion der Gesellschaft resultieren und im Verhältnis von Haupt- und Nebentätigkeit stehen. Entscheidend sind dabei stets die allgemeine Verkehrsauffassung und das wirtschaftliche Schwergewicht der jeweiligen Tätigkeit.

Who bears the burden of proof?

Eine klare Antwort: der Steuerpflichtige. Er muss darlegen, ob und warum ein funktionaler Zusammenhang vorliegt – sowohl anhand subjektiver Kriterien (z. B. unternehmerische Absicht, Expansionspläne) als auch anhand objektiver Anhaltspunkte (z. B. Umsatzrelationen, Konzernstruktur).

Practically relevant: Corporate financing in the group

A classic scenario in international tax consultancy: A MidHoldCo based in Switzerland generates high profits from active business and uses them to finance its subsidiaries via loans. Is this interest income now passive?

Not necessarily. A state holding company that establishes operating subsidiaries and supports them in penetrating the market does not typically pursue an independent financing objective by granting loans - it acts in the service of the active main business. The Münster tax court confirmed that, from a functional perspective, loans can be allocated to holding activities, even if they generate high interest income in individual years.

Attention: If the granting of loans from own funds exceeds a customary level, the administrative view is that this constitutes an independent main activity - and therefore passive income.

Retained earnings and capital investments: when should caution be exercised?

Many SMEs are retaining profits abroad - for example, to build up a liquidity buffer after the coronavirus pandemic or to finance a major acquisition. The tax authorities quickly see this as an independent, passive investment activity.

The case law is more differentiated here: the purpose of the capital investment is decisive. If the invested capital serves the main business (e.g. as a financing reserve for planned investments), it can be categorised as an active activity. The Düsseldorf tax court categorised interest income from short-term capital investments as an active activity, as its share of total turnover was low.

Rule of thumb: If the passive ancillary income does not exceed 10 % of the income from the main activity, this indicates a lack of independent economic weight - and thus in favour of the functional approach.

What does this mean in practice?

• Documentation is everything: Entrepreneurs should carefully document their business intentions and decisions - investment plans, group structure, use of funds.
• Quantitative analysis: The ratio of passive to total gross revenue provides an initial reliable indication for the argumentation with the tax office.
• Complete transparency required: Angesichts erheblicher Rechtsunsicherheit empfiehlt sich in strittigen Fällen, soweit möglich, eine verbindliche Auskunft nach § 89 AO. Jedenfalls ist nach ständiger Rechtsprechung und Praxis der Sachverhalt umfassend dem jeweils zuständigen Finanzamt offenzulegen.
• Do not rely on any de minimis limit: The tax authorities do not recognise a formal de minimis limit (AEAStG, margin no. 324). The 10-% orientation is an argument - not a legal certainty.

Conclusion

The functional approach is a powerful instrument for protecting economically sensible international structures from excessive add-back taxation. However, it requires the taxpayer to provide a considerable amount of justification. Those who develop their arguments early, completely and consistently - both subjectively and objectively - have a good chance of convincing the tax authorities.