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Certified Tax Advisor, Lawyer, Director, National Office Tax & Legal
Senior Consultant, National Office Tax & Legal
Countries enter into double taxation agreements (DTAs) to avoid or mitigate taxation by two or more countries in international business. DTAs do not create new taxing rights but rather limit the national taxing rights of the participating countries. When new DTAs are concluded or existing ones are amended, restrictions may apply that did not previously exist.
In general, Germany treats cases where German tax law excludes or limits taxation of hidden reserves (divestment) as a withdrawal for non-business purposes and subjects the fictitious withdrawal gain to taxation. The Federal Fiscal Court (BFH) ruled in its decision of November 19, 2025 (Case No. I R 41/22) that this divestment taxation can be triggered not only by active action of the taxpayer, but also by legal changes such as the conclusion of a new tax treaty or the amendment of an existing one. In addition, it addressed the timing of the deemed withdrawal transaction in such passive divestment scenarios.
The limited partners of a GmbH & Co. KG (a kind of a partnership with a limited liability company as a partner and natural persons as limited partners) based in Germany also held shares at a Spanish corporation in the legal form of an S. L., more than 50 % of whose assets consisted of immovable property. Under the DTA with Spain, as amended with effect from 1 January 2013, unlike under the previous agreement, gains from the disposal of shares in such a Spanish real estate corporation by a shareholder resident in Germany may be taxed in Spain. To avoid double taxation, the treaty provides for the credit method in such cases. Spanish tax law therefore limits German tax law solely through the application of the credit method, which was not the case under the previous DTA.
German tax authorities regarded the entry into force of the new DTA as constituting a divestment under Section 4 (1) sentence 3 of the German Income Tax Act (EStG) as of 1 January 2013. According to this provision, the exclusion or restriction of German taxing rights in respect of the profit from the disposal of an asset is to be treated as a withdrawal for non-business purposes. Tax authorities therefore taxed, as a notional withdrawal profit, the proportionate share of the net asset value of the Spanish real estate company attributable to the respective limited partner, less the book value of the shares held in it.
The BFH first and fundamentally ruled that a disengagement under Section 4 (1) sentence 3 EStG does not require deliberate action on the part of the taxpayer, but may occur even without any attributable conduct on the part of the taxpayer, for example through the entry into force of a new or amended double taxation agreement. Section 4(1) sentence 3 EStG, by referring to a withdrawal, merely prescribes its legal consequences but does not adopt any of the factual requirements for a withdrawal. The concept that events beyond the taxpayer’s control may lead to the taxation of profits is not alien to the determination of taxable profits. Profit determination is not based on a principle of ‘profit generation through controllable conduct’, but on the principle of causation. Nor do the general provisions of the EStG and the Fiscal Code (AO) (Section 2 (1) EStG, Section 38 AO) contain any requirement that a taxable event can only be brought about by an active act. Apart from that, taxation on the basis of newly concluded or amended double taxation agreements does not occur entirely independently of the taxpayer’s action, since, for example, as in the present case, shareholding constitutes typical and also sufficient action for realising profits.
Nevertheless, the Federal Fiscal Court ultimately decided in favour of the taxpayer, albeit on different grounds: The divestment gain is not to be recognised as at 1 January 2013, when the restriction on German taxing rights took effect, but rather in the preceding assessment period as at 31 December 2012, and thus one legal second before the restriction on German taxing rights took effect. Admittedly, Section 4 (1) sentence 3 EStG contains no explicit provision regarding the time at which the relevant facts are established. However, in accordance with the purpose of the provision as a form of final taxation, the hidden reserves arising in Germany on assets forming part of the business assets are disclosed and taxed. It is therefore appropriate to recognise the hidden reserves accrued up to that point for tax purposes in the final legal second before the loss of German taxing rights.
A case decided on 19 November 2025 (case no. I R 6/23) also ruled in favour of a German GmbH & Co. KG, albeit for substantive legal reasons based on the specific facts of the case and the relevant double taxation agreement with Australia: in this instance, the BFH had already rejected the restriction of the right to tax.
In 2009, the KG had acquired a commercial property in Australia and had since then let it to third parties on an arm’s length basis for the long term. With its income from this property located in Australia, the KG was subject to limited tax liability there. A new DTA concluded with Australia in 2015 came into force with effect from 2017. Among other things, a provision comparable to Article 13 of the OECD Model Tax Convention regarding the taxation of capital gains was inserted, replacing the provision in the previously applicable DTA. The tax office assumed that the previous DTA granted Germany a right of taxation on capital gains from the sale of property, regarded the new DTA as having abolished this right, and assessed a corresponding gain on the basis of the resulting passive decoupling.
However, the BFH rejected the notion of a ‘divestment gain’ because the 2015 DTA with Australia had not resulted in any restriction of Germany’s right of taxation. The BFH explains in great detail that Germany had no right of taxation in respect of a capital gain on the property as early as 2009, when the property was acquired. Consequently, the amendment to the DTA could not lead to a restriction of the right of taxation and therefore had no effect in this specific case.
Note:
Amendments to or the conclusion of new DTAs are generally preceded by years of negotiations between the countries involved. Where amendments or new agreements are foreseeable, it is advisable to examine whether this would result in a situation of passive disengagement and what tax burden would arise.
By no means does every form of exit taxation result in a less favourable tax position compared with the previous agreement: if a double taxation agreement is concluded with a country that applies a higher tax rate than Germany, it may be advantageous from the taxpayer’s perspective for the hidden reserves accrued up to that point to be taxed in Germany rather than later in the other country.