Withholding Tax Relief on Dividends

Withholding tax relief on German dividends: the short answer

Withholding tax relief is a practical necessity for foreign shareholders of German companies. German corporations must withhold capital gains tax (Kapitalertragsteuer) of 25% on dividends (§ 43a(1) no. 1 EStG), plus a solidarity surcharge of 5.5% on that tax, so that 26.375% of the gross dividend is withheld.

Non-resident shareholders can obtain withholding tax relief in three main ways: an exemption at source or refund under the EU Parent-Subsidiary Directive for qualifying EU parent companies (§ 43b EStG), a reduction under a double tax treaty, or a partial refund of two fifths for foreign corporations (§ 44a(9) EStG). Relief is administered by the Federal Central Tax Office (Bundeszentralamt für Steuern, BZSt) through an exemption certificate or a refund (§ 50c EStG). Each route is subject to the anti-treaty-shopping rule in § 50d(3) EStG.

For foreign investors, private equity funds, holding companies and corporate groups, the difference between full withholding and relief can be a significant part of the return on a German investment. The procedures are formal, electronic and subject to strict deadlines, and the anti-abuse rule requires careful structuring of holding companies.

The routes to relief

The Parent-Subsidiary route is the most valuable. Under § 43b EStG, dividends paid by a German subsidiary to a parent company that meets the requirements of the directive are exempt from withholding tax if the parent has held at least 10% directly in the capital of the subsidiary. The participation must have existed for an uninterrupted period of twelve months; if the period is completed only after the dividend, the tax withheld is refunded, but the exemption certificate procedure is not available.

Treaty relief depends on the specific treaty. Many German treaties reduce dividend withholding to 5% for substantial corporate shareholdings and to 15% for portfolio investors, and some provide for 0% in specific cases. Where the treaty rate is lower than the domestic rate after the partial refund, the treaty is more advantageous. For listed shares held in collective custody, additional requirements on minimum holding periods and economic risk apply under § 50j EStG.

The procedure at the Federal Central Tax Office

German law follows a principle of withholding first: the distributing company must withhold and pay the tax even if the shareholder is entitled to relief (§ 50c(1) EStG). Relief is then granted in one of two ways:

• Exemption certificate (Freistellungsbescheinigung): on application, the BZSt certifies that § 43b, the EU Interest and Royalties Directive provisions or a treaty preclude taxation. The certificate allows the paying company to refrain from withholding. It is valid for a maximum of five years from the date the application is received and is subject to the conditions for its issue remaining fulfilled (§ 50c(2) EStG).
• Refund (Erstattung): where tax has been withheld, the shareholder applies to the BZSt for a refund. The deadline is four years from the end of the calendar year in which the dividend was received, but not earlier than one year after the tax was paid and not before the end of a longer period provided in the treaty (§ 50c(3) EStG).

Applications must be submitted electronically using the official data set via the designated interface (§ 50c(5) EStG). The applicant must provide a certificate of residence from its home tax authority and the tax certificate issued by the paying agent. For dividends from German subsidiaries, applying for an exemption certificate well before the planned distribution avoids the cash-flow cost of withholding and waiting for a refund.

The anti-treaty-shopping rule in § 50d(3) EStG

Under § 50d(3) EStG, a foreign corporation is not entitled to relief from capital gains tax under a treaty, and by reference also under § 43b and § 44a(9), to the extent that two conditions are met. First, persons hold interests in it who would not be entitled to the relief if they received the income directly. Second, the source of income has no substantial connection with an economic activity of the corporation. Earning the income, passing it on to shareholders and activities carried on with a business organisation that is not appropriate for the business purpose do not count as economic activity.

The rule does not apply if the corporation proves that none of the main purposes of its involvement is to obtain a tax advantage, or if its main class of shares is traded substantially and regularly on a recognised stock exchange. The general anti-abuse rule in § 42 of the Fiscal Code remains applicable in addition.

The current version of § 50d(3) was redesigned after the Court of Justice of the European Union found the previous version incompatible with EU law because it applied rigid substance tests. The current rule follows a look-through approach: relief is denied only to the extent that the ultimate shareholders would not themselves be entitled to it. A holding company owned by shareholders who would themselves receive the same relief is therefore not affected, while a holding company interposed for investors from non-treaty jurisdictions is at risk unless it has a substantial connection with an economic activity or passes the main purpose test.

Structuring holding companies

For investors who use holding companies in Luxembourg, the Netherlands, Ireland or other EU states, § 50d(3) EStG shapes the structure. Key points include:

1. Look-through analysis: map the ultimate investors and determine whether each would be entitled to equivalent relief if it held the German shares directly.
2. Economic activity: where look-through does not help, consider whether the holding company carries on genuine business activities connected with the German investment, with appropriate premises, staff and decision-making.
3. Main purpose test: document the non-tax reasons for using the holding company, such as regulatory requirements, investor pooling, financing or management functions.
4. Treaty provisions: check the principal purpose test and limitation on benefits clauses in the relevant treaty and the multilateral instrument, which apply in addition to German domestic law.
5. Documentation: keep evidence of substance, board meetings and decision-making in the holding company's jurisdiction, because the BZSt can request it in the relief procedure.

Illustration: a US private equity fund holds a German GmbH through a Luxembourg company. The Luxembourg company applies for an exemption under the Parent-Subsidiary Directive. The BZSt examines whether the fund's investors would be entitled to equivalent relief if they held the shares directly. US investors may be entitled to treaty relief under the Germany-US treaty, but generally not to the full exemption under the directive. To the extent the look-through test fails, relief depends on whether the Luxembourg company carries on an economic activity or shows that obtaining a tax advantage was not one of the main purposes of its involvement.

Interest, royalties and other income

Similar relief procedures apply to other income subject to German withholding. Royalties and certain other payments to non-residents are subject to withholding under § 50a EStG, and relief under the EU Interest and Royalties Directive (§ 50g EStG) or a treaty is again granted by the BZSt through exemption certificates or refunds, with the same anti-treaty-shopping rule. Interest on ordinary loans to German borrowers is generally not subject to German withholding tax, but certain profit-participating instruments are. Licensing structures and hybrid financing should therefore be reviewed for withholding as well as for income tax deductibility.

Common problems in withholding tax relief procedures

Many claims for withholding tax relief are delayed or rejected for avoidable reasons. Residence certificates must be issued by the competent foreign tax authority for the relevant year and refer to the correct entity; certificates issued for a parent rather than the shareholder, or for the wrong year, are a frequent cause of queries. The tax certificate from the German paying agent must match the amounts claimed. For fund structures, the BZSt often asks for detailed information on the investor base to apply the look-through test, which can be difficult to obtain for widely held funds.

Processing times can be long, particularly for refunds involving holding structures, so investors should not assume that refunds will arrive within the same financial year. Partial refunds under § 44a(9) EStG and treaty refunds can be combined only within the limits of the law; the investor should choose the most favourable route for each payment. Where the BZSt refuses withholding tax relief, the shareholder can lodge an objection and, if unsuccessful, bring an action before the competent finance court. Our page on tax disputes describes these procedures, and early engagement with the BZSt on the facts often avoids litigation altogether.

Practical points for groups and investors

Withholding tax relief should be embedded in the investment process, not left to the treasury department after the first dividend. Acquisition structures for German targets should be assessed for relief before signing, especially where buyers use intermediate holding companies. Changes in the investor base, for example in fund-level secondary transactions, can affect the look-through analysis and should be monitored. The interaction with permanent establishment rules and controlled foreign company rules should also be considered; see our articles on permanent establishment risk and on the corporate tax rate cut, which changes the relative weight of withholding tax in the overall burden on German profits. Our international tax page outlines our cross-border work.

How TRW & Co helps with withholding tax relief

We advise foreign investors, funds and corporate groups on withholding tax relief for German dividends, interest and royalties: structuring acquisition and holding chains with § 50d(3) EStG in mind, preparing exemption and refund applications to the BZSt, documenting substance and non-tax purposes, and resolving disputes with the BZSt, including actions before the Finance Court of Cologne, which has jurisdiction over BZSt decisions. To discuss your structure, contact us. This article provides general information and is not tax or legal advice.