In reaction to a 2011 decision of the European Court of Justice (ECJ), Germany changed its tax regime for portfolio dividends for corporate shareholders in March this year. In order to comply with EU law, portfolio dividends from corporations are now subject to tax no matter where the corporate shareholder is resident. If corporate shareholders resident in the European Union or European Economic Area (EEA) did not obtain full exemption from dividend withholding tax in the past, the new law provides for a refund claim for those withheld taxes. Non-German corporate investors that have not applied yet should consider applying for a refund.
A German (stock) corporation is required to withhold corporate tax and solidarity surcharge at a rate of 26.38 per cent on any distribution of dividends to corporate investors with stakes of less than 10 per cent (so called portfolio dividends). In the past, a German resident corporate investor could credit 95 per cent of the withheld tax against its corporate tax. This resulted in a total corporate tax burden on the dividends of 0.79 per cent. A non-German resident corporate investor, however, could only achieve a refund of a portion of the withheld tax based on the Double Taxation Convention (DTC) applicable between Germany and its EU Member State of residence.
As most German DTCs provide a reduction for portfolio dividends down to 15 per cent, this withheld tax of basically 15 per cent was definitive in Germany. Furthermore, the definitive German withholding tax was in many cases not, or only to a small portion, creditable.
On 20 October 2011, the ECJ ruled in European Commission v Germany (C- 284/09) that the German regime infringed EU law. The ECJ decided that the final and definitive effect of German withholding tax on dividends distributed to non- German corporate investors constituted a violation of the principle of free movement of capital for corporate shareholders resident in the European Union or European Economic Area.
General Tax Liability for Future Portfolio Dividends
There was a lengthy discussion on how to react to the ECJ decision with regard to future portfolio dividends. The draft bill debated after the ECJ decision attempted to achieve compatibility with EU law by granting a general tax exemption for portfolio dividends under certain circumstances. Fiscal constraints prevailed, however, and resulted in the general approach Germany often takes if it has to comply with EU law. The law for German residents was tightened, instead of the law for non-residents being adjusted.
On 27 February 2013, the Conciliation Committee of both chambers of the German Parliament agreed on a proposal. They proposed full taxation of portfolio dividends paid out to the shareholders of a German corporation who own stakes of less than 10 per cent at the beginning of the calendar year of the distribution. This applies regardless of whether or not the shareholder is resident in Germany. The proposal was approved by both chambers of the Parliament and the new law is applicable on all portfolio dividends distributed on or after 1 March 2013.
The new law therefore establishes a general tax liability for portfolio dividends and eliminates the basis for additional dividend-withholding tax refund claims by non-resident EU portfolio shareholders in the future.
Reimbursement of Past Withholding Taxes
With regard to past portfolio dividends, there will be a reimbursement of withholding taxes for corporate investors resident in the European Union and the European Economic Area if applications for a reimbursement were, or will be, filed.
The new law sets out the formal requirements for the refund procedure. Only corporations with both a registered office and a centre of effective management within the European Union and the European Economic Area (not necessarily in the same country) that are subject to limited tax liability in Germany, but to unlimited tax liability in the European Union and the European Economic Area, are entitled to a refund of withheld taxes. A certificate of residency and liability for corporate income tax in the EU or EEA country of residence will therefore be required.
The German Parliament acknowledged that although the local authorities are competent to handle the refund procedure, reimbursement applications need to be handled by a centralised body. Refunds will therefore be handled by the Federal Central Tax Office in Bonn.
Reimbursements will only be granted for periods not subject to the applicable statutes of limitation. A four-year period beginning at the end of the year the dividends were received has to be observed, i.e., applications for dividends received in 2009 have to be filed by the end of 2013.
Under the new law, a refund of past withholding taxes is limited to investors with tax residence within the European Union or European Economic Area. This may still infringe the EU principle of free movement of capital, which is the only EU basic freedom also granted to non-EU/EEA investors. US investors should therefore also consider action.
Tax Exemption for Capital Gains and Trade Tax Liability Unchanged
The current 95 per cent tax exemption of capital gains realised by a corporate shareholder through the sale of a corporate shareholding remains unchanged. This also applies to sales of portfolio participations, i.e., stakes of less than 10 per cent in a corporation.
The general trade tax liability on dividend income on holdings also remains unchanged. Unlike for corporate income tax purposes, for trade tax purposes dividend income is only exempt from trade tax for stakes of 15 per cent or more or if the requirements under the EU Parent- Subsidiary Directive are fulfilled.
Consequences for Tax Planning
There are several structuring options available to avoid the new taxation regime; one option is to acquire additional shares. As the minimum requirement of 10 per cent in the German corporation has to be fulfilled at the beginning of each calendar year, however, the acquisition of more shares would not help for this year. Acquisitions of more than 10 per cent made during the calendar year are treated for this purpose as having been acquired at the beginning of the year and shareholders are deemed to own a 10 per cent participation for the entire year. As the percentage at the beginning of the calendar year is decisive, it also should not matter if shares are disposed of during the calendar year. As long as the stake in the distributing corporation was 10 or more per cent at the beginning of the calendar year, dividends should be tax exempt.
As capital gains are still tax exempt regardless of the participation ratio, corporate investors could focus on generating income from capital gains instead of dividend income. This could be done by retaining dividends, as non-distributed profits increase the value of the participation (known as ballooning).
It should also be noted that shares in the same company but held by different members of a tax group are not added together. Groups with extensive, dispersed investments should therefore consider a reorganisation of their holdings.