German withholding tax relief & Anti-Treaty Shopping rule

If you’re doing business in Germany, you might be familiar with the German withholding tax system, which requires non-resident taxpayers to pay tax on certain types of income earned in Germany. For example, profit distributions from German subsidiaries to foreign parent companies are subject to German withholding tax.

However, if you’re eligible, you can benefit from the German withholding tax relief system and reduce your tax liability. In the cases of dividends, taxpayers usually enjoy reduced withholding rates on the basis of the Parent-Subsidiary Directive or an applicable double taxation treaties. However, the withholding tax relief is subject to the infamous German Anti-Treaty Shopping rule (Section 50d Paragraph 3 EStG). In this article, we’ll explain the German withholding tax relief and the Anti-Treaty Shopping rule.

Overview of German withholding tax rates

German income Usual WHT rate
Certain investment income (e.g. dividends) ~ 26% (25% WHT + solidarity surcharge)
Artistic, sporting, artistic, entertaining or similar performances 15%
Use of rights 15%
Income received by members of a German Board of Directors 30%

Withholding tax relief in Germany

The German withholding tax relief is a system that allows taxpayers to reduce the amount of tax withheld from their income. This system applies to non-residents who earn income in Germany but are resident in a country that has a tax treaty with Germany or in a EU member stare (e. g. on the basis of the Parent-subsidiary directive). The purpose of these treaties and directives is to avoid double taxation and promote international trade.

For example, if you’re a non-resident who earns income from dividends in Germany, you’ll be subject to a withholding tax of approx. 25%. However, if your country of residence has a tax treaty with Germany, you can apply for withholding tax relief and pay a reduced rate of tax. This rate can vary between 0% and 15%, depending on the treaty. Under the Parent-subsidiary directive, no withholding tax must be applied on dividends within the EU.

To apply for withholding tax relief, you need to submit a certificate of residence from your country of residence to the German tax authorities. This certificate confirms that you’re a resident of that country for tax purposes and eligible for the benefits of the tax treaty. Once the certificate is approved, you can receive the reduced rate of tax on your income.

Alternatively, taxpayers can apply for a tax exemption certificate (Freistellungsbescheinigung). In this way, withholding tax must not be withheld in the first place which improves the cash flow.

What is the Anti-Treaty Shopping Rule in Germany?

However, withholding tax relief is subject to the German anti-treaty shopping rule. This is a provision in the German tax law that prevents taxpayers from exploiting tax treaties or directives by creating artificial structures to reduce their tax liability. This rule aims to prevent treaty or directive shopping, which is the practice of using a tax treaty or deirective between two countries to reduce tax liability, even if the taxpayer has no real connection to the treaty country.

Under the anti-treaty shopping rule, a taxpayer can only benefit from a tax treaty or a directive if they have a genuine economic interest in the treaty country and are not using the treaty or dieretive solely to reduce their tax liability. To determine whether a taxpayer has a genuine economic interest, the tax authorities will consider various factors, such as the taxpayer’s business activities, the substance of their operations, and the level of control they have over their operations.

If the tax authorities determine that a taxpayer is engaging in treaty shopping, they can deny the taxpayer the benefits of the tax treaty or a directive. This means that the taxpayer will not be eligible for withholding tax relief and will be subject to the full rate of tax. This significantly reduces returns for companies.

German Anti-Treaty Shopping Rule (section 50d pragraph 3 EStG)

The German Anti-Treaty Shopping rules have recently been amended several times. This is due in particular to the fact that the provision has been judged to be not in line with European law twice. The current German provision has also been criticised and it is questionable whether the provision is now in line with EU law. At the very least, it should be noted that the current provision is very restrictive and probably goes beyond what’s necessary.

Under the current German Anti-Treaty Shopping rule, a taxpayer maintains a claim under the withholding tax relief system, if (fulfilment of one criterion is sufficient, it is not necessary to fulfil all four criteria):

  1. Shareholders of the receiving company have a hypothetically identical claim (i.e. on the basis of the identical claim standard) if they were to receive the dividends directly (personal entitlement to relief) and for whom at the same time one of the following relief criteria (criteria 2-4) is applicable.
    A claim that merely leads to a comparable tax relief effect is not sufficient for a personal entitlement to relief.
  2. The receiving company carries on an economic activity (substance test) and the shareholding in the distributing company has a substantial connection (function test) with this economic activity (substantive relief entitlement). The mere receipt and forwarding of dividends does not constitute an economic activity.
  3. Tax opmtimization is not a main reason for the structure (principal purpose test).
  4. There is substantial and regular trading in the principal class of shares in the Receiving Company on a recognised stock exchange (stock exchange test).

Risk of permanent withholding tax in Germany

The German withholding tax relief system and the anti-treaty shopping rule are important considerations for non-residents doing business in Germany. If taxpayers are eligible, withholding tax relief can significantly reduce their tax liability. However, taxpayers need to ensure that you comply with the anti-treaty shopping rule and have a genuine economic interest in the treaty country. If you have any doubts or questions, it’s best to seek advice from a tax professional.