German Foreign Tax Act Switch-over Clause Requires Majority Shareholding

Germany's Federal Fiscal Court (BFH) has clarified the application of the switch-over clause under Section 20 (2) of the German Foreign Tax Act (AStG) in a decision dated April 8, 2025 (case no. IX R 32/23).

The BFH ruled that the switch-over clause, which shifts taxation from an exemption method to a credit method for income earned by a foreign permanent establishment, requires the German taxpayer to hold a majority stake in the relevant foreign entity or its permanent establishment.

In the case examined, a German corporation held a 30% stake in a U.S.-based partnership involved in intellectual property licensing. Although the partnership's profits were subject to German tax via the credit method, the BFH determined that the switch-over clause did not apply due to the lack of a majority shareholding. The court reasoned this aligns with the provision's intent to prevent tax avoidance by interposing permanent establishments in low-tax countries instead of corporations.

This decision contradicts previous interpretations by tax authorities. The BFH emphasized that applying Section 20 (2) AStG requires the German taxpayer to possess legal or effective control over the foreign partnership, ensuring consistent tax treatment compared to direct ownership of foreign corporations.