by Dr Thomas Elser / Dr Frank Thiede
Letterbox companies in countries with limited access for tax investigation authorities have long been known to the German tax authorities as structures for concealing foreign assets. A typical case was the foundation in Liechtenstein, which holds its assets via a Panama company. Neither the invested funds nor the investor ever had to travel to Panama. Comparably popular structures, which have been uncovered through the large number of voluntary disclosures and searches in recent years, have often used the Bermudas (insurance shells), the Cayman Islands or the British Virgin Islands - still exotic holiday destinations that can be combined with high "tax savings". However, there have been a number of developments in the meantime, in particular the regular appearance of new data CDs or USB sticks, which is why even persistent tax evaders should have known that they could not simply rely on hiding in faraway Panama, for example, due to the massively increased pressure and also the change in public opinion.
But what is it actually about? What is a letterbox company and which German tax regulations are relevant? First of all, the existence and tax treatment of letterbox companies in German tax law have been discussed for decades and have been conclusively clarified by supreme court judgements. The German tax authorities already have a comprehensive range of instruments at their disposal to counteract tax evasion and unjustified tax advantages.
The Federal Fiscal Court has consistently confirmed that taxpayers are generally free to organise their financial circumstances. The interposition of a corporation (e.g. a German GmbH or a foreign corporation) is one of the permissible and, from a tax perspective, completely unobjectionable structuring options. The consequence of this interposition of corporations is the tax shielding effect between the source of income and the investor, i.e. the shareholder is only taxed when the corporation distributes to the investor.
This deferral advantage, which arises in the case of profit retention at company level, is particularly effective if the intermediary corporation is not subject to any taxation or only to low taxation in its country of domicile. However, the legislator has also had an effective remedy for this case for decades in the form of Sections 7 et seq. of the Foreign Tax Act: the tax shield effect of the foreign corporation is broken through by means of so-called add-back taxation and the capital gains (and other passive income) realised by the corporation are attributed to the German shareholder as taxable income even without distribution.
It should be noted that, in principle, there are no objections to the use of foreign corporations by German taxpayers. Taxation only upon distribution does not differ from the use of a German GmbH as a legal form. Interest advantages when using low-taxed foreign companies are already adequately countered by the German Foreign Tax Act.
An (offshore) letterbox company is typically understood to be a foreign (low-taxed) corporation that does not have a minimum level of personnel and material substance in its country of domicile. When examining whether this substance is sufficient in a specific case, the business activities of the company must be taken into account. For example, a purely asset-managing foreign company often does not need its own staff or extensive premises. The outsourcing of certain functions (e.g. accounting, asset management) is generally harmless. This also applies to the use of external managing directors.
If this substance test results in the existence of a mere letterbox company in a specific case, no tax advantages can be achieved as a result. From a German tax perspective, these companies are completely negated in accordance with Section 39 of the German Fiscal Code; the assets and their income are attributed to the shareholder. Fictitious transactions are irrelevant for taxation purposes; the hidden legal transaction is decisive for taxation purposes. For abusive structures, Section 42 of the German Fiscal Code also allows the economically appropriate result to be realised for tax purposes if there are no economic reasons for the use of the letterbox company. Many German double taxation agreements also contain abuse clauses and German tax law contains provisions that override certain provisions in double taxation agreements that are favourable to the taxpayer in favour of the German tax authorities (so-called treaty override).
The taxpayer disclosing the circumstances of a letterbox company to the tax authorities can therefore not achieve any tax advantages by using a letterbox company. At the same time, there are many non-tax reasons in favour of using letterbox companies (e.g. protection of privacy, security aspects, the protection of business secrets, the regulation of complex estates, as in the case of Gunter Sachs, or the concealment of flight routes from competitors, as in the VW case). In such cases, the use of letterbox companies is by no means illegal or illegitimate. Lumping such users of letterbox companies together with criminals is completely misguided. In this respect, it is not surprising that the Süddeutsche Zeitung stated the following on 4 April 2016: "In the case of most of the Germans in the Panama Papers, however, it cannot be clarified whether they really defrauded the tax office or whether they declared the income; the tax authorities do not provide any information on this."
In practice, banks, whose core business includes offering investment and financing opportunities, also arrange letterbox companies at the request of internationally active clients In our opinion, this alone does not justify an initial suspicion of aiding and abetting tax evasion against the background of the non-tax reasons mentioned above.
It is essential here that bank employees are bound by internal compliance regulations to comply with both the applicable provisions of the Money Laundering Act and the tax laws and that banking services are linked to corresponding tax information for customers. Banks that have even the slightest indication of possible tax evasion by their customers are obliged under current regulations to report suspected money laundering, which in many cases can also result in corresponding criminal tax investigations.
Almost every bank has now introduced strict internal control mechanisms to prevent the use of letterbox companies for the purpose of tax evasion. This is also due to the fact that banks have the origin of the funds certified when new accounts are opened. For banks in Switzerland in particular, this check now goes beyond the legal requirements in practice. The transfer of previously untaxed funds has also been made more difficult; the receiving bank must regularly enquire about the origin of the funds and the transfer is only approved if it can be proven that the bank client is tax-compliant.
The real problem is therefore reduced to those taxpayers who demonstrably want to deliberately engage in tax evasion and hide taxable income from the tax authorities by using letterbox companies. It is inappropriate to prejudge all users of letterbox companies in this corner.
It should be noted that the opportunities for tax evaders to conceal themselves internationally are becoming increasingly restricted. Since 2014, more than 90 countries, including the EU countries, Switzerland and Liechtenstein, have signed a multilateral agreement to automatically transmit data on the financial accounts of taxpayers resident in another country to that country for tax periods from 2016 onwards, starting in September 2017. In addition, the OECD presented the final 15-point plan against base erosion and profit shifting (BEPS) in Paris on 5 October 2015. In particular, this is intended to close tax loopholes that have been used to legally shift corporate profits to low-tax countries.
French President Hollande has already called for Panama to be put back on the OECD's blacklist of non-cooperative states. Panama has not yet joined the international automatic exchange of information, nor is there a double taxation agreement between Panama and Germany. The German government should utilise public pressure and push for negotiations to ensure that as many countries as possible participate in the automatic international exchange of information. At the very least, corresponding double taxation agreements should be negotiated at a bilateral level that contain the so-called large information clause including administrative assistance.
In the current debate on letterbox companies and tax evasion, a factual approach is preferable to overly bold demands, such as a ban on letterbox companies. Compliance with and consistent monitoring of the laws already in force as well as internal controls at the banks are of crucial importance. When assessing the behaviour of banks and their employees, a strict distinction must be made between the violation of applicable laws and internal guidelines by individual bank employees and a systematic aiding and abetting organisation with the knowledge or acquiescence of the management. In the latter case in particular, the Panama Papers discussion is likely to have highlighted the urgent need for action to establish an effective tax compliance organisation at the relevant institutions.
The WM seminar on 13 June 2016 "Tax Compliance and Investments" in Frankfurt am Main offers an in-depth discussion of the area of investments in general; the programme can be found at https://www.taxgate.com//event/tax-compliance-und-risk-management-bei-kapitalanlagen/.
Dr Thomas Elser and Dr Frank Thiede are tax advisors at TAXGATE, a tax law firm specialising in transactions, investments and tax compliance.
