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Germany: Related Information

Holding Companies

For a country to be an attractive location in which to set up a holding company 4 criteria must be satisfied:

  • Incoming Dividends: Incoming dividends remitted by the subsidiary to the holding company must either be exempted from or subject to low withholding tax rates in the subsidiary's jurisdiction.
  • Dividend Income Received: Dividend income received by the holding company from the subsidiary must either be exempted from or subject to low corporate income tax rates in the holding company's jurisdiction.
  • Capital Gains Tax on Sale of Shares: Profits realized by the holding company on the sale of shares in the subsidiary must either be exempt from or subject to a low rate of capital gains tax in the holding company's jurisdiction.
  • Outgoing Dividends: Outgoing dividends paid by the holding company to the ultimate parent corporation must either be exempt from or subject to low withholding tax rates in the holding company's jurisdiction.

By these criteria Germany is a relatively attractive jurisdiction in which to set up a holding company although not the most attractive.

 

Withholding Taxes on Incoming Dividends

As a member of the EU Germany is governed by the provisions of the EU's Parent-Subsidiary directive, whose effect is that where a German holding company controls at least 10% (down from 15% since January 1, 2009) of the shares of an EU subsidiary for a minimum period of 12 months any dividends remitted by the EU subsidiary to the German holding company are free of withholding taxes.

Where the provisions of this directive do not apply (or where anti-avoidance provisions are in place) German holding companies can rely on an extensive network of double taxation treaties the effect of which is to obtain a reduction in withholding tax rates on dividends remitted to Germany from the subsidiary jurisdiction.

Germany has more than 90 double taxation treaties in place. The greater a country's network of double taxation treaties the greater its leverage to reduce withholding taxes on incoming dividends. An elaborate network of double taxation treaties is thus a key factor in the ability of a territory to develop as an attractive holding company jurisdiction.

 

Corporate Income Tax on Dividend Income Received

Until 2002, dividend income received by a German holding company from a foreign subsidiary was treated in one of 3 ways:

  • Exemption Method: The dividends could be completely exempted from an assessment to corporate income tax in Germany. Exemption is granted in some (but not all) of the double taxation treaties signed by Germany. (Other double taxation treaties only give a tax credit).
  • Credit Method: German corporate income tax was paid on the dividend income but a credit for the full value of the tax paid in the foreign jurisdiction is granted and set off against the German tax liability. Thus if the gross value of dividends remitted was 1m DEM on which corporate income tax of 300,000 DEM had been deducted in the foreign jurisdiction and on which the liability in Germany would have been 350,000 DEM then the tax liability in Germany was 50,000 DEM. If the tax paid in the foreign jurisdiction was higher than that payable in Germany no further corporate income tax was payable in Germany. The credit method applies to:
    • Double Taxation Treaties: Some countries with whom Germany has signed a double taxation treaty. (Other double taxation treaty countries grant exemption from corporate income tax on dividend income received).
    • Domestic Law: Countries for whom German domestic law makes special provision whereby foreign taxes already paid on foreign dividend income are credited against any German corporate income tax liability that is assessed on the same. Not all countries are covered by this domestic law.
    • International Affiliation Privilege Rules: Even if there is neither a double taxation treaty in place nor a domestic arrangement, the "international affiliate privilege" rules may grant a tax credit in Germany on corporate income tax paid in a foreign jurisdiction on dividend income remitted to and taxable in Germany. In order to fall within the international affiliation privilege rules the German holding company must meet the following 3 criteria:
    • 10% Shareholding: The German corporation must hold a minimum of 10% of the shares in the foreign subsidiary
    • 12 months period: The shareholding must have been held by the German company for a minimum period of 12 months prior to the distribution of dividend.
    • Active Income: The dividends remitted by the foreign subsidiary must relate to active trading activities and not be "passive income" (e.g. profits relating to bank interest on a deposit of funds).

Deduction Method: Where neither the exemption nor credit methods applied the corporate income tax paid on the dividends remitted was deducted from taxable income prior to an assessment to German corporate income tax. Thus if the gross value of dividends remitted was 1m DEM on which corporate income tax of 300,000 DEM has been deducted in the foreign jurisdiction and on which the liability in Germany would have been a corporate income tax rate of 35% then the tax liability was 35% on 650,000 DEM. Clearly exemption was the most favorable fiscal treatment with deduction being the least favorable.

New Rules From 2002

Under the regime introduced in 2002, dividends received by German parent companies from their German and foreign subsidiaries were exempt from tax. For dividends received from German subsidiaries, the exemption applied initially to dividends paid in 2002 if the dividends were based on ordinary shareholder resolutions for prior fiscal years. For dividends received from domestic subsidiaries that have adopted a fiscal year deviating from the calendar year, the exemption applied initially to dividends that were declared in 2002 after the end of fiscal year 2002. For dividends received from foreign companies, the exemption applied initially to dividends received in 2001. However, if the fiscal year deviates from the calendar year, the exemption applied initially to dividends received in the fiscal year ending in 2002. For dividends not based on ordinary shareholder resolutions, such as constructive dividends and interim dividends, the tax exemption applied initially to dividends received in 2001.

However, under the regime introduced in 2002, when a shareholding amounts to less than 10%, dividends paid to the holding company will be charged at the appropriate rate of municipal tax (“Gewerbesteuer”) ranging between 7% to 17% depending on the community where the company is registered. Some advisers consider that this tax is contrary to Federal law.

In March 2005 the then German Finance Minister Hans Eichel said that he was working on a new plan to simplify Germany's complex corporate taxation structure to bring about a single income tax rate for businesses.

At the time, large companies in Germany paid a basic 25% corporate tax. However, this was on top of local company taxes, charged at an average of 13-14%, making a nominal corporate tax rate of about 38% - one of the highest in the world.

Meanwhile, sole proprietorships and partnerships are taxed on a different legal basis, with the profits of these entities attributed to the individual partners who pay tax through the personal taxation system at progressive rates of up to 42% (at the time of writing).

In November 2006, Germany's coalition government arrived at an agreement over key company tax reforms which reduced the overall corporate tax burden to a little under 30% from the previous level of almost 40%.

This has been brought about by a cut in the 25% headline corporate tax rate, paid by large companies, to 15% as of January 2008. Companies will continue to pay corporate tax (trade tax) at the local level, although this is no longer deductible under the new legislation.

 

Capital Gains Tax on the Sale of Shares

If a German corporation or branch holds a 10% or greater interest in a foreign subsidiary, capital gains derived from the sale of shares in the foreign corporation are exempt from corporate income tax and trade income tax. However, to the extent of previous write-offs, normal income taxes are levied on these sales. Losses incurred on sales, liquidations and capital reductions of such subsidiaries are not deductible.

In Germany the capital gains of a corporation are treated and taxed as corporate income. Only German "holding" companies are exempted from corporate income tax in Germany on the profitable sale of shares in a foreign subsidiary and even then the holding company must meet 2 criteria if the exemption is to apply. Those criteria are as follows:

i) International Affiliate Privilege Rules: The German company must be a holding company within the meaning of the "international affiliate privilege rules" in that:

  • The German company holds at least 10% of the foreign subsidiary's shares
  • The German company holds the foreign subsidiary's shares for a minimum period of 12 months preceding the sale of the shares.
  • The foreign subsidiary is an active company in that the income it remits relates to real economic activity as opposed to being passive income (e.g. interest on a bank loan).

ii) Reduced Corporate Income Tax Liability: The German company is exempted from or pays reduced corporate income tax on dividends received from the foreign subsidiary either because:

  • The foreign subsidiary is located in a country with which Germany has a double tax treaty the effect of which is that any dividends remitted from the foreign subsidiary to the German holding company are exempted from (or sometimes credited to) corporate income tax in Germany.
  • The foreign subsidiary is located in a country to which German national law allows a credit against German corporate income tax for foreign taxes paid on any dividends remitted to Germany. Only certain countries are entitled to this credit under German national law.

(N.B. Capital losses on the sale of foreign shareholdings are not tax deductible).

New Rules From 2002

Capital derived from sales of shares of resident and nonresident companies after December 31, 2001 are exempt from tax if, at the date of sale, the shares have been held for at least one year. If the company whose shares are sold has adopted a fiscal year other than the calendar year, the exemption applies initially to sales after the end of the 2002 fiscal year. If the shares were acquired through a tax-free contribution of a business or division of a business in exchange for shares, a seven-year holding period is required for the exemption. For capital gains derived from sales of shares that were acquired in a tax-free share-for-share exchange, the exemption does not apply if the shares were acquired in a tax-free contribution of a business or division of a business and if the seven-year holding period has not expired.

Expenses that have a direct economic connection with an exempt capital gain are not deductible.

 

Withholding Taxes on Outgoing Dividends

Dividend payments made to companies in non-treaty countries are subject to an effective withholding tax rate of 15%. However, this rate may rise to 25% in certain circumstances, for example if the company is acting as a conduit for the payment.

  • Where the parent corporation to which the dividends are remitted by the German holding company is resident in another EU territory and holds at least 10% of the German holding company's shares for a minimum period of 12 months prior to the dividend distribution. (N.B. Germany has anti-avoidance provisions aimed at non- EU parties attempting to benefit from the terms of the directive).
  • Where the ultimate parent corporation is located in a jurisdiction with whom Germany has a double taxation treaty then the rate is generally reduced from the standard rate to a reduced rate of between 5-15%. Germany has over 90 double taxation treaties.

One feature of the German tax system is that taxes are deducted first and re-claimed subsequently after the issue of an exemption notice which the taxpayer must apply for.

In March 2009, the European Commission announced its decision to refer Germany to the European Court of Justice for its tax provisions concerning outbound dividend payments to companies.

The Commission notes that Germany taxes dividends paid to foreign companies more heavily than dividends paid to domestic companies. The Commission considers the higher taxation of outbound dividends to be contrary to EU law as it restricts the free movement of capital and the freedom of establishment, as provided for in Article 56 of the European Treaty and Article 40 of the European Economic Area (EEA) Agreement.

Outbound dividends are those paid by a German company to a foreign shareholder, while domestic dividends are those paid by a German company to a German shareholder. The German tax rules may lead to outbound dividends being taxed at a higher rate than domestic dividends. While there is a tax exemption for domestic dividends, outbound dividends are subject to withholding taxes of up to 25% (plus solidarity surcharge).

The discrimination concerns outbound dividends paid to EU member states and to those EEA and European Free Trade Association countries (which includes the 27 EU member states plus Iceland, Liechtenstein, Norway and Switzerland) which provide exchange of information.

In the Denkavit ruling of December 14, 2006 the Court of Justice confirmed the principle that outbound dividends may not be subject to higher taxation in the source state than domestic dividends.

"Given that the German tax rules were not amended to comply with the reasoned opinion sent to Germany in June 2007 the Commission has decided to refer the case to the Court of Justice," the Commission announced on March 19.

 

German v Danish Holding Companies

Since Denmark is currently the benchmark holding company jurisdiction which other holding company jurisdictions seek to emulate a comparative assessment of the two jurisdictions is a useful exercise. As members of the EU, and with approximately equal numbers of double tax treaties, the two countries are equivalent in terms of the imposition of withholding taxes by the jurisdiction from which a dividend emanates.

(N.B. The Danish parliament has approved changes to the participation exemption rules from 2010 that will make it easier for companies to claim an exemption from tax or reduced withholding tax).

Corporate Income Tax on Incoming Dividends: In Denmark dividend income received by a Danish holding company is exempted from corporate income tax provided that the Danish holding company meets the "participation exemption criteria" in that for a minimum period of 12 months prior to the dividend distribution it holds at least 10% of the shares of the foreign subsidiary (which subsidiary must not be deemed a "financial company"). If the subsidary is resident outside of the EU and in a state with which Denmark does not have a tax treaty, dividends are only tax-free if the Danish parent company holds more than 50% control. A withholding tax rate of of 15% applies to outgoing dividend payments to shareholders owning less than 10% of the share capital of the Danish paying company, but only if they are resident in countries with which Denmark has exchange of information agreements. After the German 2002 reforms, the German regime is not noticeably inferior to the Danish regime.

(N.B. New Danish legislation effective from 2010 will remove the requirement that shares must be held for a minimum of 12 months in order for an exemption from dividend tax to be claimed).

Capital Gains on the Sale of Shares: A Danish holding company is exempt from any capital gains on the profitable sale of shares in a foreign subsidiary provided that it has held at least 10% of the foreign subsidiary shares for a minimum period of 3 years prior to the disposal and the foreign subsidiary is not a financial company. There is no requirement that the foreign subsidiary jurisdiction have a double taxation treaty with Germany or that it be subject to a favorable arrangement under German domestic law.

After the German 2002 reforms, the German regime is not noticeably inferior to the Danish regime.

(N.B. New Danish legislation effective from 2010 will remove the 3-year rule on share holdings).

Withholding Taxes on Outgoing Dividends: In Denmark no withholding taxes are deducted from outgoing dividends provided the ultimate foreign parent corporation holds at least 10% of the shares in the Danish holding company for a minimum period of 12 months and the foreign parent is located in the EU. Dividends paid to a foreign parent located outside the EU are also exempt if they own at least 10% of the Danish company, provided there is a tax treaty between the Denmark and the parent company's country. This makes the Danish holding company a considerably more flexible entity than its German counterpart.

(N.B. New Danish legislation effective from 2010 will remove the requirement that shares must be held for a minimum of 12 months in order for an exemption from dividend tax to be claimed).

 

 

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