In the landmark Cadbury Schweppes judgment, the ECJ ruled that it is incompatible with the freedom of establishment if profits are only added because of a lower level of taxation in the country of domicile. This is because companies are free to set up a subsidiary in a low-tax country in order to shift profits. Whether or not this results in tax losses in the home country is not a justification for restrictive measures by the national legislature. Exceptions apply only in the case of clear abuse, such as a letterbox company.
The tax authorities apply the ruling in all open cases. Accordingly, the addition is not made if the controlled company is actually located abroad, irrespective of tax motives. In this respect, Sections 7 to 14 of the AStG are no longer applicable if a company with its registered office or management in an EU or EEA state proves that it carries out an economic activity there..
This requirement (substance) is met in the case of active and sustained participation in the market activity there within the scope of ordinary business activities and in the case of employment of qualified personnel. In addition, it must be demonstrated that the income is generated on the basis of the company's own activities, that in the case of an exchange of services with predominantly related parties, the services are of value-creating significance for the recipients and that the capital resources are in reasonable proportion to the value created.