Germany must change its tax rules for family foundations based outside the country or face a court case and possible fines, the European Commission said.

Under current German tax rules, if a family foundation – Familienstiftungen –is resident in Germany, beneficiaries must pay tax only on benefits that they receive from it. But if the family foundation is resident abroad, beneficiaries must pay tax on all foundation income irrespective of whether they actually receive the benefits.

The Commission contends that this differing treatment of domestic and foreign foundations is incompatible with two of its key principals, the free movement of capital and free movement of persons.

This follows last year’s ruling of the European Court of Justice in the Cadbury Schweppes case that anti-avoidance provisions should only relate to "wholly artificial arrangements".

The Commission’s request, the second step of the infringement procedure, takes the form of a legal opinion. If the relevant national legislation is not amended, the Commission may decide to refer the matter to the European Court of Justice.