2024-06-26-KPMG_Global-Germany_–_Federal_Tax_Court_Clarifies_Taxation_of_Partners_in_International_Law_Firms_4页_229kb

Germany Federal Tax Court Ruling on U.S. Law Firm Partner Payments

Summary

On June 26, 2024, a KPMG flash alert covered a ruling by Germany's Federal Tax Court (BFH) in case I R 42/20, originally dated December 5, 2023. The BFH clarified that guaranteed payments made by a U.S. law firm to its German partners are exempt from German income tax under the U.S.-Germany income tax treaty, provided these payments are attributable to a U.S. permanent establishment.

Key Details from the Ruling

• Background: The case involves seven German equity partners who received approximate €1.7 million in guaranteed payments in 2008 for their U.S. work days. These payments were U.S.-source and exempt from U.S. federal income tax under Section 707(c) of the Internal Revenue Code.

• Tax Authority's Initial Assessment: Despite U.S. exemption, Germany's local tax office assessed German income tax on these payments, invoking Article 23, paragraph 3(a) of the Treaty for possible reversion of tax rights.

• BFH Decision:

  • The BFH upheld the exemption from German taxation for profits attributable to the U.S. permanent establishment, rejecting the reversion conditions.
  • It ruled that Article 23, paragraph 4(b) ("switch-over clause") did not apply, as the U.S. non-taxation was based on domestic law, not treaty terms affecting the entire profit share.
  • The BFH explicitly rejected the use of post-treaty-force OECD commentary, emphasizing a static interpretation of the Treaty to mirror the wording and guidance at its entry into force.

Why This Matters

• The decision contradicts German tax authorities' official stance on both the application of Article 23, paragraph 3(a) and the approach to treaty interpretation, favoring a static view.
• It provides clarity for international law firm partners, potentially reducing German tax liabilities for payments tied to U.S. operations with a permanent establishment.

Additional Insights from KPMG

• A 2017 amendment to German tax law could influence similar cases from that year onward, but the BFH has not ruled on its application yet.
• Staying informed on updated treaties and domestic laws is crucial for ongoing cases or those filed after 2016.