We recommend reviewing your German structure to determine whether it falls within the scope of the revised practice.
Background – German dividend WHT on distributions to a US Shareholder:
Under the U.S.-Germany Double Tax Treaty, dividend WHT may be reduced to 15%, 5%, or 0%, subject to applicable requirements (including the Limitation on Benefits clause).
However, under domestic law the distributing German entity is generally obliged to withhold, report and remit WHT at the full statutory rate of 26.375% upon distribution unless the (US) shareholder holds at the time of the distribution a valid dividend WHT exemption certificate (Freistellungsbescheinigung) issued by the FCTO, permitting the distributing German entity to partially or fully abstain from its withholding obligation in accordance with the U.S.-Germany Double Tax Treaty.
In absence of a dividend WHT exemption certificate, the US shareholder may apply for a refund in accordance with the applicable rate under the U.S.-Germany Double Tax Treaty of any German WHT remitted by the distributing entity.
New administrative practice denying dividend WHT relief on distributions by disregarded German corporations to U.S. shareholders:
Historically, the U.S. tax classification of the German distributing corporation was irrelevant for German WHT purposes. The FCTO now argues that treaty relief may need to be denied as a matter of principle where the German distributing entity (that is directly held by a U.S. shareholder) is disregarded for U.S. federal tax purposes. The revised approach applies both in the exemption and refund procedures.
The reasoning brought forward by the FCTO is based on an expansive (mis-)interpretation of certain rules both of German domestic law and of the U.S.-Germany Double Tax Treaty.
The FCTO takes the position that these provisions may be triggered as a result of the hybrid mismatch stemming from the divergent qualification of the German disregarded entity. In the present constellation, the distributing corporation is treated as tax-opaque for German direct tax purposes, while for U.S. federal income tax purposes it qualifies as a mere branch of its U.S. shareholder. Consequently, Germany characterizes the payment as a dividend distribution, whereas from a U.S. tax perspective the transaction constitutes merely an intra-entity transfer of funds.
There have been no relevant legislative changes, and this reflects a mere shift in administrative interpretation. In our view, there are substantial technical arguments against the FCTO’s position based on the wording of the law and the treaty (supported by German tax academic literature), which could be brought forward in appeal proceedings against an eventual denial of WHT relief.
While currently observed this issue being raised in dividend cases only, it cannot be excluded that the FCTO might also deny relief from German WHT on royalties paid by a disregarded German corporation to a US entity (in certain constellations) based on the same new interpretation of the aforementioned provisions.
The FCTO has encountered substantial push-back from taxpayers and advisors to this new approach. In response, the FCTO indicated that the revised interpretation is currently still being analyzed and that no final position has yet been adopted.
Recommended actions:
We recommend:
- Reviewing your German structure to determine whether it falls within the scope of the revised practice.
- Monitoring further developments regarding the FCTO’s position where your structure is potentially impacted.
- Where an existing exemption certificate remains valid, consider making (advanced) distributions before the certificate’s expiration.
- If relief is denied, evaluate appeal options based on the specific facts.
- Assessing potential restructuring measures to no longer fall within the scope of this change in administrative practice.
