Under the domestic German corporate income tax regime, dividend distributions are subject to deduction on account of German withholding tax at a rate of 25%. In the case of German corporate shareholders, such a deduction can be refunded on application or set off against other German corporate income tax liabilities of the relevant shareholder. In the case of foreign corporate shareholders, historically a refund has not been available and, accordingly, the deduction on account of German withholding tax could potentially have been an actual tax cost to the relevant shareholder (subject to credit, on account of the deduction, given to the shareholder in its jurisdiction of residence). The position regarding foreign corporate shareholders has recently changed as a consequence of two judgments of the European Court of Justice (“ECJ”). Shareholders of German corporations holding a stake of less than 10% should now be entitled to reclaim almost all German withholding taxes levied on dividends previously received.
- In its judgment C-284/09 of 2011/10/20 the ECJ held that the Federal Republic of Germany had failed to fulfil its obligations under Article 56 Paragraph 1 of the European Contract (“EC”) and under Article 40 of the EEA Agreement in connection with the basis upon which Germany taxed dividends distributed to shareholders domiciled in the EU or the European Economic Area (“EEA”) who held a stake of less than 10% in a German corporation. This was on the basis that dividends paid to such non-German corporate shareholders were taxed more heavily in economic terms than dividends distributed to corporate shareholders established in Germany. The different taxation treatment determined by reference to the tax residence of the recipient was considered by the ECJ to be an infringement of the free movement of capital. It should, however, be noted that in this judgment the ECJ does not provide any statement with regard to the taxation of dividends distributed to shareholders located in a third state outside the EU or the EEA.
- Another recent ECJ decision of combined proceedings (C-338/11 – C-347/11) of 2012/05/10 considered the application of French withholding tax to nationally-sourced dividends distributed to non-French undertakings for collective investments in transferable securities (“UCITS”). The ECJ held that Articles 63 and 65 of the Treaty on the Functioning of the European Union (“TFEU”), which seeks to protect the free movement of capital, must be interpreted so as to preclude domestic legislation of a member state which seeks to levy withholding tax on nationally-sourced dividends paid to UCITS resident outside the member state in question whilst allowing dividends to be paid to UCITS resident within the member state in question free of withholding tax.
- The latter decision extends the scope of the decision C-284/09 in two dimensions. Firstly, it entitles not only corporate shareholders to a refund, but also UCITS. It should be noted that not only UCITS falling within directive 2009/65/EC should be entitled to a refund but also other undertakings for collective investments which are considered to be comparable to a UCITS under the directive, such as the two US applicants in the proceedings C-344/11 and C-345/11 which had the legal form of a Trust Co. Secondly, the territorial scope was extended to a worldwide basis and not limited to EU/EEA investors.
- In both decisions the ECJ did not deal with the procedural issues arising in connection with the pursuit of potential refund claims. This is a matter for domestic German procedural tax law.
- In the meantime, the German Fiscal High court clarified in its decision I R 25/10 of 2012/1/11 that a foreign applicant seeking to obtain a refund of relevant German withholding tax has to file an exemption certificate and to claim a refund based on such an exemption certificate. In circumstances where the foreign taxpayer does not maintain a permanent establishment in Germany, the competent authority to determine such refund claims is the local tax office within the territorial area of responsibility in which the foreign shareholder has invested or, in the case of multiple investments, the territorial area where the most valuable part of the investment is located. As in the case of German corporate shareholders, 5% of the dividend income is regarded as a non-deductible business expense. Therefore, it should be expected that German tax authorities will refund only 95% of the taxes withheld. Any refund claim is time barred after four years following the end of the calendar year in which the tax was withheld. Thus, any filing for an exemption certificate for the tax year 2008 should be filed by 31 December 2012 at the latest.
- According to a recently published decree of the German Federal Ministry of Finance, German tax authorities intend to apply a German domestic anti-treaty shopping rule meaning that refund claims of applicants with low substance will be denied under certain circumstances, especially if the shareholders of corporate applicants with low substance would not be entitled to a refund in case of a direct investment. The legal consequences of the tax authorities’ view need to be analysed in detail on a case by case basis.
- As domestic banks and other financial institutions within the meaning of the German Banking Supervisory Act, and financial enterprises holding the respective shares in a German corporation for sale as well as life and health insurance companies, are not entitled to a domestic German tax exemption in relation to dividend income, the corresponding group of foreign investors should also not be entitled to a refund as described above.