German thin capitalisation rules have been held to breach EU law because they discriminated against German subsidiaries of overseas parent companies. This was the decision of the European Court of Justice in the Lankhorst-Hohorst case, published in December 2002. This is a significant decision for cross-border tax planning and may affect companies setting up or acquiring subsidiaries in any EU country with thin capitalisation rules, including the UK as well as Germany.
What is "thin capitalisation"?
It is often more tax efficient to finance a cross-border corporate investment with shareholder debt than with equity. This is because interest on debt is generally deductible for tax purposes, whilst dividends and other distributions in respect of equity participations are not deductible. This enables the tax charge to be shifted from the jurisdiction where the investment is made to that of the investor, allowing more flexible tax planning, and, often, a rate arbitrage. This may lead
