Number 1194 25 May 2011

Client Alert

Latham & Watkins Department

New Double Between Germany and the United Kingdom – Impact on Cross- Border Structures

The revised double tax treaty between of German investors Germany and the UK became effective (e.g. through German closed-end on December 30, 2010. The revised funds) where the investors are taxable treaty applies in Germany from under UK claw-back rules upon exit, January 1, 2011 and in the UK from as such structures may not satisfy April 1, 2011 (corporation tax) or April the subject-to-tax test, restricting the 6, 2011 (income ). It availability of treaty benefits (which differs in a number of respects from were only recently restricted by the the former treaty, importantly, rules German Federal Fiscal Court under aimed at preventing treaty abuse have the subject-to-tax clause of the former been tightened. This Alert focuses on treaty). the impact of the new provisions on “Rules aimed at cross-border structures. Switch-over clause preventing treaty The new treaty introduces switch-over Anti-abuse rules regulations under which Germany abuse have been may substitute the exemption tightened.” Subject-to-tax clause method for a credit-method. These As was previously the case, under apply where the income from a the new treaty, Germany generally located mitigates double taxation by applying in the UK is (mainly) derived from an exemption method. However, passive activities. The taxpayer must under the revised treaty a subject- prove that the gross income does to-tax test must be met according not constitute income from passive to which income is exempted from activities in order to be exempted only if the from taxation in Germany. These income is effectively taxed in the UK. rules include dividend income, The former treaty contained a subject- i.e. dividends are taxed under the to-tax clause but this related only to exemption method only if the relevant income from the sale of real estate. entity is actively engaged in business The revised treaty extends this test activities. It remains to be seen what to all classes of income and tightens proof will be required here as the it such that the test is now met only revised treaty does not give any if the relevant income is effectively guidance in this respect. Although taxed; previously it was sufficient if potentially material, in many cases, the income was generally subject to the effect of this change should be taxation. Existing structures should limited as under the German domestic be reviewed in light of the new rules, participation exemption dividends are including UK real estate investments generally 95 percent tax exempt.

Latham & Watkins operates worldwide as a limited liability partnership organized under the laws of the State of Delaware (USA) with affiliated limited liability partnerships conducting the practice in the United Kingdom, France, Italy and Singapore and an affiliated partnership conducting the practice in Hong Kong and Japan. Latham & Watkins practices in Saudi Arabia in association with the Law Office of Mohammed A. Al-Sheikh. Under New York’s Code of Professional Responsibility, portions of this communication contain attorney advertising. Prior results do not guarantee a similar outcome. Results depend upon a variety of factors unique to each representation. Please direct all inquiries regarding our conduct under New York’s Disciplinary Rules to Latham & Watkins LLP, 885 Third Avenue, New York, NY 10022-4834, Phone: +1.212.906.1200. © Copyright 2011 Latham & Watkins. All Rights Reserved. Latham & Watkins | Client Alert

Main purpose test The revised treaty introduces specific anti-treaty shopping rules under which no withholding tax relief will be available if the main reason for creating or assigning shares or other rights was to take advantage of the reduced treaty rate. Whilst the effect of this from a German tax perspective remains to be determined, as German domestic law already provides for anti-treaty shopping rules, the UK generally includes according provisions in its tax treaties. From a UK tax perspective, particularly, the revised treaty provides an increased ability to attack abusive structures.

Profit Repatriation The previous provisions regarding payments of dividends, interest and royalties have been revised in their entirety, which may impact profit repatriation structures.

Dividends The definition of dividends no longer includes all profit-carrying rights. In particular, certain payments by silent partnerships have been excluded from the definition of dividends (see further below). The definition now includes payments by a German investment fund, so investors in such a fund can benefit from the reduced treaty rates (although dividend distributions from UK companies do not currently attract a withholding tax under UK domestic law). Additionally, distributions from German and UK REITs generally qualify as dividends. Under the revised treaty the following withholding tax rates apply to dividend payments:

Revised Treaty Old Law Participation exemption, i.e. participation 5% 15% ≥ 10% of share capital Free float, i.e. participation < 10% of the 15% 15% share capital

2 Number 1194 | 25 May 2011 Latham & Watkins | Client Alert

The reduced treaty rates are unlikely from immovable property situated in to be material given the EC Parent/ that state (unless there is substantial and Subsidiary-Directive and UK domestic regular trading of the relevant shares law regarding withholding on on a stock exchange). Accordingly, dividend payments. However, where foreign shareholders may under certain the requirements of the Directive are circumstances no longer be able to effect not satisfied, e.g. because the minimum tax exempt disposals of their shares. holding period is not met, taxpayers may benefit from the reduced rates — this Procedural Aspects may benefit certain pension schemes. The revised treaty also includes certain Interest and royalties procedural rules relating to information The taxation of interest and royalties exchange among other things. Relief remains unchanged, i.e. such payments from withholding tax is granted by way are generally exempted from taxation of reimbursement rather than by way in the source state, however new of reduction of deduction. Effectively, exceptions are introduced. Interest this incorporates the German domestic derived from hybrid instruments in reimbursement procedure into the the form of claims carrying a right revised treaty, avoiding a potentially to participate in profits (including illegal treaty override. The revised income derived by silent partners treaty facilitates the reimbursement (stille Gesellschafter)), from loans procedure by extending the clauses of with an interest rate linked to the person entitled to a refund, a refund borrower’s profits (partiarisches claim may now be submitted by trustees Darlehen) or from profit-sharing bonds or managers of investment schemes or (Gewinnobligationen) shall be taxed the managing partner of a partnership in the state in which they arise and established in a contracting state. This is in accordance with local law. The particularly noteworthy as partnerships relevance of these exclusions from a are generally not eligible for treaty UK tax perspective may be limited, benefits; consequently this change depending on the nature of the may be a key factor when establishing payment as classified for UK taxation foreign partnership structures involving purposes. However, from a German a number of separate investors. tax perspective the use of hybrid instruments may cease to be a viable option for tax-efficient repatriation of profits from Germany to the UK (Germany levies 25 percent (plus solidarity surcharge) withholding tax on such payments).

Capital Gains The revised treaty generally follows the OECD model treaty with respect to treatment of capital gains. However, it is worth noting that the revised treaty allocates the right to tax capital gains on the disposal of shares to the state in which the relevant corporation is located if the corporation derives more than 50 per cent of its value directly or indirectly

3 Number 1194 | 25 May 2011 Latham & Watkins | Client Alert

If you have any questions Client Alert is published by Latham & Watkins as a news reporting service to clients about this Client Alert, and other friends. The information contained in this publication should not be please contact one of construed as legal advice. Should further analysis or explanation of the subject the authors listed below matter be required, please contact the attorney with whom you normally consult. or the Latham attorney A complete list of our Client Alerts can be found on our website at www.lw.com. with whom you normally If you wish to update your contact details or customise the information you receive consult: from Latham & Watkins, please visit www.lw.com/LathamMail.aspx to subscribe to Sean Finn our global client mailings program. +44.20.7710.1000 [email protected] Abu Dhabi Houston Riyadh London Villiers Terblanche C. Timothy Fenn Mohammed Al-Sheikh +971.2. 495.1700 +1.713.546.5400 +966.1.207.2500 Götz Wiese Barcelona London Rome +49.40.4140.30 Jordi Domínguez Daniel Friel Fabio Coppola [email protected] +34.93.545.5000 +44.20.7710.1000 +39.06.98.95.6700 Hamburg Beijing Los Angeles San Diego Henrik Lay Allen C. Wang Samuel R. Weiner Laurence J. Stein +49.40.4140.30 +86.10.5965.7000 Pardis Zomorodi +1.619.236.1234 [email protected] +1.213.485.1234 Hamburg Boston San Francisco David O. Kahn Madrid Kirt Switzer +1.617.948.6000 Jordi Domínguez +1.415.391.0600 +34.91.791.5000 Brussels Shanghai Howard Rosenblatt Milan Rowland Cheng +32.2.788.6000 Fabio Coppola +86.21.6101.6000 +39.02.3046.2000 Chicago Silicon Valley Diana S. Doyle Moscow Kirt Switzer +1.312.876.7700 Mark M. Banovich +1.650.328.4600 +7.495.785.1234 Doha Singapore Villiers Terblanche Munich Mark A. Nelson +974.4406.7700 Thomas Fox +65.6536.1161 Stefan Süss Dubai +49.89.2080.3.8000 Tokyo Villiers Terblanche Hisao Hirose +971.4.704.6300 New York +81.3.6212.7800 New Jersey Frankfurt Jiyeon Lee-Lim Washington, D.C. Hans-Jürgen Lütt David S. Raab Nicholas J. DeNovio Anders Kraft Lisa G. Watts Joseph D. Sullivan +49.69.6062.6000 +1.212.906.1200

Hamburg Orange County Tobias Klass David W. Barby Götz T. Wiese +1.714.540.1235 +49.40.4140.30 Paris Hong Kong Olivia Rauch-Ravisé Joseph A. Bevash +33.1.40.62.2000 +852.2522.7886

* In association with the Law Office of Mohammed A. Al-Sheikh

4 Number 1194 | 25 May 2011