Planned Abolition of Participation Exemption for Participations below 10%

In the course of the legislative procedure for the annual tax bill 2013 (Jahressteuergesetz 2013), the Bundesrat (the upper house of the German federal parliament) suggested to abolish the current (domestic) participation exemption for corporate income tax purposes for dividends and capital gains derived from participations below a shareholding of 10%. This shall be set forth in a new Section 8b para. 4 of the German Corporate Income Tax Act (KStG). It remains to be seen whether these changes will be adopted in the further legislative process.

According to current German tax law and, in particular, Section 8b KStG, dividends of a corporation distributed to another corporation are, in general and irrespective of minimum shareholdings or holding periods, exempt from German corporate income tax (Körperschaftsteuer). Such (domestic) participation exemption also applies to capital gains derived from the sale of shares in another corporation. However, 5% of the aforementioned dividends and capital gains are treated as non-deductible business expenses. Therefore, the actual participation exemption is at 95%.

Now, in the course of the legislative procedure regarding the annual tax bill 2013 (Jahressteuergesetz 2013), the Bundesrat as upper house of the German federal parliament suggested to limit the application of said (domestic) participation exemptions to shareholdings of 10% or more. As a consequence, dividends and capital gains from the sale of shares in other corporations would be fully subject to German corporate income tax in cases where the participation of the shareholder is below 10%. It is also suggested to implement these changes with retroactive effect for the fiscal year 2012.

Background for this suggested amendment of the current participation exemption is a decision of the European Court of Justice (ECJ) in a treaty violation proceeding against Germany (Case C-284/09, Commission vs. Germany). The ECJ decided that the German withholding tax on outbound dividends to EU/EEA corporations violates the free movement of capital principle as in such constellations, the withholding tax levied in Germany (to the extent it is not reduced by the parent-subsidiary directive or an applicable double tax treaty) is definite.

However, the suggested implementation of a minimum shareholding for the participation exemption for corporate income tax purposes and the draft provision are widely criticized by tax practitioners. In addition, the proposed retroactive effect of such amendment may not meet constitutional requirements.

It is currently rumored that the said amendment of the participation exemption may not be included in the annual tax bill (Jahressteuergesetz 2013), but be the subject of a separate bill. However, it remains to be seen and closely monitored whether these proposed changes will be adopted in further legislative proceedings.