tax

Tax Pitfalls of Cash Repatriation and Possible Solutions

In typical private equity structures, regular cash repatriations are less commonly envisaged as the investment’s value is realized upon exit. However, even in such cases it is at times of advantage to repatriate equity upfront. Especially in the context of long-term investments, periodical cash repatriations during the investment period are frequently in demand.

Inbound investments into Germany

Investments by foreign private equity investors in German companies are typically implemented through a European holding company (e.g. Lux TopCo) and two German holding companies in the legal form of a GmbH (German BidCo as an acquisition vehicle and German HoldCo allowing a share pledge to banks or for recapitalisation purposes). For strategic investments or add-on acquisitions, investors usually build on already existing holding structures.

The extraction of cash (e.g. from a recapitalisation or profits generated by the portfolio company) from a German GmbH to a foreign shareholder can be structured in several ways:

1. Profit distributions and withholding tax

While profit distributions by German GmbHs are generally subject to withholding tax (WHT), profit distributions to foreign shareholders can – in whole or in part – be exempted from WHT based on EU law, an applicable DTA, or domestic law. However, certain challenges in claiming the relief may arise from the anti-abuse provision of § 50d para. 3 EStG, as last revised in 2021 (refer to blog post).

In a private equity set-up, the strict relief requirements can usually only be met if the fund in question can demonstrate an appropriately established business in the relevant EU member state (e.g. Luxembourg), possibly with substantial staff, management of multiple investments via an investment platform, etc. Strategic investors should typically be able to provide the required evidence more easily. However, even if the requirements are met, the WHT relief requires a formal exemption or reimbursement procedure that takes several months.

In some cases, a feasible alternative could be a partnership structure where cash is up-streamed via a withdrawal. If, for example, the German top holding is a GmbH & Co KG (HoldKG) with own commercial activities and a German permanent establishment, it should be possible to credit the WHT on the profit distribution to HoldKG within its annual tax assessment procedure. A subsequent cash withdrawal by the foreign limited partner from HoldKG’s capital account should not be subject to German WHT. As part of the assessment, the profit distribution attributable to HoldKG’s permanent establishment should effectively only be taxed at approx. 1.5% (provided minimum participation thresholds are met).

2. Return of capital

Insofar as distributions are made from the German GmbH’s so-called ‘tax contribution account’, they are free of WHT (non-taxable repayment of capital contributions). The tax contribution account shows all contributions exceeding the GmbH’s nominal capital at the end of each financial year (developed and reduced by any distributions). Distributions by the GmbH to its shareholder, however, can only be sourced from the tax contribution account to the extent that they exceed the „distributable profit“ determined at the end of the previous business year (fictitious order of use).

Accordingly, to enable a WHT free distribution at German HoldCo, both sufficient capital reserves need to be available (e.g. from past contributions) and the distributable profit must be close to zero (i.e. the German HoldCo must not have received any dividends in the previous year and must not be part of an income tax group) as per the last balance sheet date. Considering the above, precise timing and an analysis on a case-by-case basis are particularly important.

3. Buy-back of Shares by the Company

Under certain conditions, the acquisition of own shares by a company is treated as a reduction of the nominal capital, i.e. tax-neutrally (cf. BMF letter of 27 November 2013). A proportionate repurchase of own shares could, considering older case law, be regarded as a dividend and thus subject to WHT. However, in case of a disproportionate repurchase at arm’s length conditions, the transaction should not be subject to WHT and expenses in connection with the acquisition should be tax deductible. If an excessive purchase price is paid, adverse tax consequences might derive from the assumption of a deemed profit distribution.

At shareholder level, the sale of shares to the company itself is treated as a disposal taxed in line with general principles. According to the currently applicable law, capital gains realized by foreign shareholders from shares in a German GmbH are entirely tax-exempt, provided that the foreign shareholder does neither maintain a German permanent establishment nor a German representative. However, a certain minimum of economic substance at shareholder level is required to benefit from such capital gain taxation (not only relevant for dividends).

4. Shareholder loan

Interest-bearing shareholder loans offer a flexible solution to up-stream excess cash to the shareholder. The mere repayment of principle does not trigger any taxes and thus offers more flexibility than, for example, the return of capital. Also, Germany currently does not levy WHT on interest from ordinary loans (e.g. not profit participating, not secured with German real estate).

Apart from the general restrictions on interest deduction, namely compliance with arm’s length conditions in the low interest rate environment, interest barrier rule, and the 25% add-back for trade tax purposes, the EU’s Anti-Tax Avoidance Directive (ATAD 2) needs to be considered when analysing cross-border interest payments. In Germany, the deduction of cross-border interest payments is challenged by § 4k EStG (German implementation of ATAD 2) as of 1 January 2020. For purposes of a potential tax shield on interest expenses, intra-group debt instruments need to be analysed in their entirety and thus, if relevant, across several participation levels.

Key take-away

The preferred and at the same time tax-efficient method of cash repatriation strongly depends on the investor’s or fund’s individual circumstances (strategic integration, composition of investor base, investment and financing structure, flexibility requirements, economic substance in individual jurisdictions, etc.) as well as on the envisaged investment horizon or exit strategy. To achieve the best possible cash repatriation for the investor, the objectives must be communicated at an early stage and already considered when establishing the acquisition structure.

  • Geschrieben von

    Matthias Full ist Steuerberater, Diplom-Kaufmann und Partner am Standort München. Sein Tätigkeitsschwerpunkt liegt im Bereich Transaction Tax (Private Equity und M&A). Ferner berät er zu Themen des Internationalen Steuerrechts sowie des Konzern- und Unternehmenssteuerrechts.

    T +49 89/80 00 16-823
    matthias.full@fgs.de

     

    Anne-Catherine Lorek ist Steuerberaterin am Standort München.

    T +49 89/80 00 16-146
    anne-catherine.lorek@fgs.de