Suitability of the German GmbH & Co. KG from a Liechtenstein perspective
In two judgments in 2015 and 2017, the Administrative Court of the Principality of Liechtenstein (VGH) considered private asset structures (Privatvermögensstrukturen, PVS) under Article 64 of the Liechtenstein Tax Act (SteG). In one of these two decisions, the German legal form of the GmbH & Co. KG (limited liability company & limited partnership) played a central role. This article first explains the main characteristics of a Liechtenstein PVS and provides insight into both of the VGH decisions. The main part of the article looks at whether and in what cases a Liechtenstein foundation is suitable to serve as the limited partner of a German GmbH & Co. KG.
Main characteristics of a PVS
Legal persons such as foundations, establishments, or public limited companies under Liechtenstein law may be used by wealthy private individuals to manage parts of their assets. Such legal persons may be classified as a PVS if they meet the restrictive criteria set out in Article 64 SteG. A key condition is that such legal persons must not engage in economic activities, either themselves or through companies controlled by them. An economic activity exists, for example, when the activity is carried out on the market in competition with other market participants. The term "economic activity" must be interpreted dynamically in strict observation of European (EU/EEA) law.
Legal persons with PVS status may likewise not exercise any actual influence over the management of the company held, unless that company also has PVS status. However, legal persons with PVS status may exercise their rights as stakeholders by way of the general meeting, for instance.
Trust companies without legal personality and trusts are not legal persons and therefore do not qualify for PVS status.
In terms of taxation, PVSs are treated in such a way that there are no fundamental disadvantages compared with a direct investment by a natural person. Accordingly, PVSs are assessed uniformly with a minimum corporate earnings tax of CHF 1800.00 per year. PVSs are exempt from the normal corporate earnings tax and the annual filing of a tax return, but this also means that PVSs generally do not fall within the scope of double taxation agreements.
VGH judgment 2015/009 of 10 April 2015
The facts of this case concerned a foundation with a wholly owned economically active subsidiary. An application by the foundation for PVS status was denied by the Liechtenstein Fiscal Authority in October 2013 on the grounds that making assets available to third parties – in this case, in the form of folk art collections – constituted an economic activity.
In December 2014, the National Tax Commission rejected the foundation's appeal of the denial of PVS status and confirmed the Fiscal Authority's decision. The National Tax Commission justified this in part with reference to its finding that making assets available to third parties constituted an economic activity.
In its judgment on the case, the VGH held that it is irrelevant which assets the PVS holds. The assets may be other than shares or financial instruments, such as precious metals, precious stones, paintings, or vintage cars. The rental, lease, and the like of assets would indeed constitute an economic activity. But the court held that the loan to the subsidiary in the form of folk art collections was not of a commercial nature and therefore did not constitute an economic activity. The absence of a sales market suggested a public-benefit activity. Moreover, it was not evident to the VGH that the foundation exercised any influence over the subsidiary.
According to the reasons given by the VGH, the foundation's failure to disclose beneficiaries is also not a justification for asserting that influence over the subsidiary exists. At least in a first step, it is necessary for an applicant merely to confirm to the Fiscal Authority that the criteria for recognition as a PVS have been met. The Fiscal Authority may impose a burden of proof only where it substantiates the demand for evidence of a certain fact that is relevant for assessing possible influence by the foundation. Consequently, the foundation was retroactively granted the status of a PVS.
VGH judgment 2017/011 of 13 June 2017
The facts of this case concerned a Liechtenstein foundation that was the sole limited partner of a German GmbH & Co. KG. The GmbH & Co. KG was active in the field of property management, generating rental income from real properties located in Germany. The foundation was also the sole owner of a German GmbH which served as the general partner of the German GmbH & Co. KG.
In March 2013, the Fiscal Authority of the Principality of Liechtenstein granted PVS status to the foundation on the basis of its application, effective January 2014, but withdrew this status from the foundation in February 2016 with retroactive effect to January 2014. The foundation was consequently subject to ordinary corporate earnings taxation as of that date.
The reasons given for the Fiscal Authority's decision were essentially that partnerships are not tax subjects in their own right and accordingly must be considered transparent for tax purposes. If, as in the present case, the partners are legal persons, the earnings must be attributed accordingly. Because they are considered transparent, the earnings of partnerships whose partners are legal persons would be considered earnings of those legal persons. Where such a partnership generates rental income, that income would be attributed to the companies, which would then be liable for taxes on that income. Given that in the present case, the GmbH & Co. KG generated rental income, that income would be attributed to the foundation as the limited partner of the partnership. Renting, however, constitutes an economic activity, which is not compatible with the criteria for PVS status. Even through the foundation was only a limited partner and limited itself to its profit participation rights, the amounts to be attributed to the foundation were rental income, and not investment income as would be the case for shareholders.
This reasoning of the Fiscal Authority did not persuade either the National Tax Commission or the VGH. According to the VGH, Article 64 SteG hardly justifies differential treatment of a stake in a capital company and participation in a partnership. In that regard, the VGH followed the reasoning of the National Tax Commission as the lower instance that no distinction should be made whether the foundation participates in a legal person (e.g. a public limited company) or a German GmbH & Co. Attribution of the rental income of the GmbH & Co. KG to the foundation and thus assertion of the existence of economic activity on the part of the foundation would be permissible only if the foundation exercised direct or indirect influence on the GmbH & Co. KG or its management and did not limit itself solely to its participation in distributions and voting rights at the general meeting of partners.
In its judgment, the VGH set out to interpret Article 64 SteG in conformity with European law, i.e. Article 61(1) of the EEA Agreement. For that purpose, and without prior referral to the EFTA Court, the VGH found that the tax privileges granted to Liechtenstein foundations under Article 64 SteG did not contradict the prohibition of state aid under Article 61(1) of the EEA Agreement solely and per se on the basis of the fact that the foundation participated in a partnership engaging in economic activity. According to that reasoning, Article 64 SteG does not rule out classification as a PVS where a foundation participates in a partnership.
Against this backdrop, the general question arises as to whether and in what cases there are advantages to the structuring option discussed here – in the form of a Liechtenstein foundation as a limited partner of a German GmbH & Co. KG.
Uses of a Liechtenstein foundation as a limited partner of a German GmbH & Co. KG
The following discussion will examine the taxation of a German GmbH & Co. KG and the uses that arise in practice for a Liechtenstein foundation to serve as a limited partner of a German GmbH & Co. KG.
The GmbH & Co. KG is a structure in which, as a rule, a GmbH with limited liability becomes the sole partner with liability (general partner) of a limited partnership. Despite coming close economically to a capital company, the GmbH & Co. KG is still a partnership and is treated accordingly under tax law.1 This entails tax transparency, with income attributed to the partners investing capital – in the case of a GmbH & Co. KG, this generally means the limited partners, who participate only in terms of capital and do not assume liability (limited partners).
Whether, from a German tax perspective, a GmbH & Co. KG generates income from a trade business or not must be answered in two stages. In a first stage, the nature of the activity must be assessed. If that activity is considered not related to a trade – as in the case of long-term rental of domestic real property – a second stage considers the structure of the company. § 15(3)(2) of the German Income Tax Act (EStG) provides options in this regard, given that the question of whether the income of a GmbH & Co. KG relates to a trade depends on the way in which the management is structured. By authorising a limited partner to manage the GmbH & Co. KG, where applicable together with a general partner, the characteristics of a trade can be avoided.
In the case of a domestic partnership engaged in a trade, or a domestic partnership with the characteristics of a trade, increases in the value of domestic real property are subject to taxation, irrespective of how long the property is held. Moreover, income in such cases is in general subject to the trade tax, to the extent that the expanded deduction for property does not apply. For current taxation, as well as the taxation of profits from sale, this results in a combined tax rate for the corporate tax and the trade tax of about 30% where a corporate entity serves as the limited partner.
For a GmbH & Co. KG without the characteristics of a trade in which a Liechtenstein foundation serves as the limited partner – even where the foundation is structured for tax purposes as a PVS – the increases in value of domestic real property are assessed only within the speculation period of 10 years. At the same time, income from the renting and leasing of domestic real property is in principle not subject to the trade tax if it is a long-term rental without the characteristics of a trade. Under the principle of limited tax liability, the foundation thus generates income from the ongoing rental and lease of domestic real property pursuant to § 8(1)(1) of the Corporate Tax Act (KStG) in conjunction with § 49(1)(6) EstG. In the case of the sale of domestic real property after expiry of the speculation period of 10 years, the sales profit is tax-exempt. Moreover, the trade tax is generally not assessed on current profits from the rental and lease or on profits from the sale. This means that the tax rate for current profit allocations to the foundation is about 16%.
In this connection, however, § 15 of the Foreign Tax Act (AStG) must also be considered, which in turn might result in taxation for the foundation beneficiaries on the basis of an imputed distribution in cases where the beneficiaries have a link to Germany. Especially in light of the circumstances in which the Federal Fiscal Court (Bundesfinanzhof, BFH) has recently scuttled such foundation constructs – most recently on 5 December 2018 (Az. II R 9/15) – caution is called for. Often, it is possible to take structuring measures that avoid these adverse legal consequences. This must be examined on a case-by-case basis, however.
In summary, participation of a Liechtenstein foundation in a GmbH & Co. KG can be a useful structuring option where the GmbH & Co. KG is designed to manage assets and consequently generates income from the rental and lease of domestic real property. Such a structure may also make sense if an investment is long-term, i.e., the domestic real property is to be held for longer than 10 years, and if as a result the increases in value are tax-exempt. This structure is accordingly not recommended for investors domiciled in Germany in particular.
Furthermore, it is irrelevant for tax purposes whether the Liechtenstein foundation is subject to ordinary corporate earnings taxation in Liechtenstein under Article 44 SteG or is treated as a PVS under Article 64 SteG: Both alternatives lead to the same tax result. Under ordinary corporate earnings taxation, the rental income generated in Germany is excluded in Liechtenstein under Article 48(1)(c) SteG and fully allocated to Germany. Under both options, in principle only the minimum corporate earnings tax of CHF 1800.00 per year is assessed pursuant to Article 62 SteG. Unlike PVSs, however, foundations subject to the ordinary corporate earnings tax must submit annual tax returns.
Dr. Marco Felder and Daniel Blöchle are happy to answer any questions you may have.
*Daniel Blöchle is a tax partner at PwC Nuremberg.
1Rödding in Lüdicke/Sistermann, Unternehmensteuerrecht, 2nd ed. 2018, § 3 Rechtsformwahl, paras. 108, 109.