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German Tax and Legal News

BFH rules treaty participation exemption supersedes add-back for trade tax

The Federal Tax Court (BFH) ruled on 23 June 2010 that a dividend is not subject to trade tax where a tax treaty provides for a participation exemption (and these requirements are met), even if the requirements for the participation exemption under the domestic trade tax rules are not met (case reference: I R 71/09).

In the case, a German corporation received a dividend from its Polish subsidiary. The dividend was 95% tax exempt for German corporate income tax purposes, with 5% treated as nondeductible business expense. Although this is also the general rule for trade tax purposes, the German tax authorities treated the dividend as fully taxable because they concluded that the specific requirements for the participation exemption under the trade tax rules were not met; these requirements include holding the shares in the nonresident subsidiary for a full calendar year which was at issue in the case decided and the meeting of an activity requirement for non-EU entities.

The BFH decided that the broader scope of the participation exemption in the Germany-Poland tax treaty applies so that (i) the dividend is tax exempt for trade tax purposes, and (ii) the requirements for qualifying for the trade tax participation exemption were not relevant in the case. The BFH primarily based its decision on the fact that the trade tax rule denying the domestic participation exemption could not be considered a tax treaty override and that the treaty with Poland specifically applies to the German trade tax.

The BFH did not discuss whether a participation exemption under a treaty could also prevent the 5% add-back of deemed nondeductible business expenses so that dividends should be 100% tax exempt (rather than 95% exempt). Discussion of this issue is likely to continue in the professional literature.

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