Federal Fiscal Court judgement: scope of exemptions from the EU Parent-Subsidiary Directive

Tax burden on distributions in “inbound cases” 

In an “inbound case,” i.e. where a non-resident taxpayer (section 1(4) of the Income Tax Act; section 2 of the Foreign Transactions Tax Act [Außensteuergesetz–AStG]; section 2 no. 1 of the Corporate Income Tax Act [Körperschaftsteuergesetz–KStG]) holds an interest in a domestic corporation, distributions are subject to non-resident tax liability under section 49(1) no. 5 (a) of the Income Tax Act. Under subpoint (aa), the distributing corporation must have either its place of effective management or its registered seat in Germany. In such cases, the tax liability of the non-resident taxpayer is generally paid in advance and settled by withholding tax on capital income (section 43(1) sentence 1 no. 1 of the Income Tax Act; section 50(2) sentence 1 and section 32(1) no. 2 of the Corporate Income Tax Act). The mechanisms for mitigating economic double taxation – the partial income system [Teileinkünfteverfahren] of section 3 no. 40 of the Income Tax Act and the exemption of section 8b of the Corporate Income Tax Act – are irrelevant (section 43(1) sentence 3 of the Income Tax Act), as is the type of income earned by the creditor (section 43(4)).

The withholding tax amounts to 25% (section 43a(1) sentence 1 no. 1 of the Income Tax Act) plus solidarity surcharge (section 3(1) no. 5 of the Solidarity Surcharge Tax Act [Solidaritätszuschlaggesetz–SolZG]). On the “other end,” that is, in the recipient’s country of residence, an exemption for the dividend will often apply if the recipient is a corporation, either under a domestic participation exemption or through the articles on the avoidance of double taxation of the double tax treaty (DTT). This results in all the withholding tax that has been withheld being non-creditable and thus forfeited as a tax cost without compensation. 

Reductions in withholding tax are therefore particularly attractive. In section 44a(9) of the Income Tax Act, the legislature has mitigated the tax burden for non-resident corporations acting as recipients to 15% plus solidarity surcharge. However, this must be applied for from to the Federal Tax Office (section 44a(9) sentence 2 in conjunction with section 50c(3)), which means that a disadvantage in liquidity arises with respect to the two-fifths of the withholding tax and the associated solidarity surcharge to be refunded.

However, section 44a(9) sentence 3 points out that further claims arising from section 43b or a DTT “remain unaffected”. German DTTs, which exist with all EU member states among others, typically reduce the withholding tax burden on dividends to a maximum of 15% (Art. 10(2) of the OECD Model Convention 2025), with the solidarity surcharge already included (section 5 of the Solidarity Surcharge Tax Act). For distributions to corporations, a reduction to 5% withholding tax is typically granted, usually starting at a minimum ownership threshold of 10%.

Withholding tax reductions under section 43b of the Income Tax Act

Under section 43b of the Income Tax Act – the German transposition of the EU Parent-Subsidiary-Directive – an “EU corporation” can even apply for a full refund of the withholding tax on investment income as defined by section 20(1) no. 1 received from its German subsidiary. This, however, requires a “qualifying ownership relationship” (section 43b(2) sentence 1 no. 2). At the time the withholding tax arises (section 44(1) sentence 2), the parent company must demonstrate that it has held at least 10% of the subsidiary’s capital directly and continuously for a period of twelve months (section 43b(2) sentence 4). Alternatively, the date of the resolution to distribute the profit may be taken as the point in time (section 43b(2) sentence 2). As a further “relief,” the minimum holding period may also be completed after the withholding tax has arisen (section 43b(2) sentence 5).

However, section 43b(1) sentence 4 contains an important exception to the general rule that such qualifying distributions are fully exempt from withholding tax: the exemption does not apply to investment income as defined by section 20(1) no. 1 that accrues when a subsidiary is liquidated or reorganised.

A prominent example of such investment income is the “notional dividend” in section 7 of the Reorganisation Tax Act [Umwandlungssteuergesetz–UmwStG]: when a corporation is reorganised as a partnership, this is triggered to “prevent previously untaxed retained earnings from being permanently removed from taxation by the fact that, following… “the reorganisation” … into a partnership, they can be withdrawn by the partner as their equity without incurring income tax liability” (Federal Tax Court judgement of 11 Apr 2019, file ref. IV R 1/17). Since non-resident corporations may also hold interests in the acquiring partnership (Federal Ministry of Finance Circular of 2 Jan 2025, Federal Tax Gazette [Bundessteuerblatt–BStBl.] I 2025, p. 92, para. 07.02), the same question arises as to the application of section 43b of the Income Tax Act to the withholding tax, which is incurred here too (Federal Ministry of Finance Circular of 2 Jan 2025, Federal Tax Gazette I 2025, p. 92, para. 07.08). In this respect, section 43b(1) sentence 4 prevents it from being applied (Federal Ministry of Finance Circular of 2 Jan 2025, Federal Tax Gazette I 2025, p. 92, para. 07.09), with the result that reductions under applicable double taxation treaties mostly remain available.

Does the Parent-Subsidiary Directive under section 43b of the Income Tax Act apply after liquidation has commenced?

According to its wording, the restriction under section 43b(1) sentence 4 applies to investment income “received in connection with the liquidation … of a subsidiary.” In the proceedings VIII R 8/24, the Federal Fiscal Court has now had the opportunity to address the question of how the distribution of profits generated before the start of liquidation proceedings but distributed afterwards should be viewed in this context.

Applying Article 4 of the Parent-Subsidiary Directive, the Federal Fiscal Court concluded that the claimant, a Luxembourg parent company, was entitled to a full exemption from withholding taxes under section 43b, as interpreted in accordance with the Directive. In the Federal Fiscal Court’s view, the ECJ’s broad interpretation of the term “profit distribution” (e.g., ECJ judgement of 12 Dec 2006, file ref. C-446/04) leads to profits “from the active period of the dissolved company” being covered by Article 5 of the Parent-Subsidiary Directive and not being subject to any restrictions.

It should be noted that all forms of relief for the non-resident recipient are only granted under the conditions of the “anti-treaty shopping” rule of section 50d(3) of the Income Tax Act. Furthermore, according to recent Federal Fiscal Court case law, the conditions of the Parent-Subsidiary Directive cannot be met by structuring the distribution so that a controlled company [Organgesellschaft] (section 14(1) sentence 1 and section 17(1) sentence 1 of the Corporate Income Tax Act) receives the distribution as a corporation and the income is then attributed to an individual as the controlling company [Organträger] within the framework of the tax group [Organschaft] (Federal Tax Court judgment of 6 Feb 2025, file ref. IV R 29/22, Federal Tax Gazette. II 2025, p. 360).