ECJ: Exclusion of limited taxpayers from withholding tax refunds violates EU law in the event of losses

As a rule, dividend distributions are taxed at source in the country in which the distributing corporation is domiciled by way of a withholding tax for the account of the dividend recipient. The national tax laws provide for a tax deduction irrespective of whether the dividend creditor is resident for tax purposes in the source state (domestic case) or is a non-resident (limited taxpayer).

Settling effect of withholding taxes for persons with limited tax liability

If the dividend creditor is a corporation that is not resident in the source state and the shareholding in the distributing company does not belong to a permanent establishment of the creditor located in the source state, the tax due on the dividend is covered by the tax deduction. If intergovernmental regulations such as the Parent-Subsidiary Directive or double taxation agreements are applicable, the withholding tax may be reduced. Compared to this, the withholding tax does not necessarily have a discharging effect in purely domestic cases: many national tax laws contain regulations according to which the withholding tax merely represents an advance tax payment and is refunded to the dividend creditor in the event of a loss due to a lack of “other” corporate income tax charges.

Compensatory effect in the event of loss contrary to EU law

The ECJ has now ruled that tax regulations according to which a dividend recipient resident in the source state is reimbursed the tax withheld on the dividend in the event of a loss, but this reimbursement option is denied to a non-resident in the same situation and thus leads to a definitive charge, constitutes a restriction on the free movement of capital (Art. 63 TFEU).

The plaintiff was a British limited company that had made a loss in the UK in 2017. This loss included distributions from a corporation based in Bizkaia (province of the autonomous community of the Basque Country, Spain), which - in accordance with the Spanish-British double taxation agreement - were subject to a withholding tax of 10%. The Parent-Subsidiary Directive, which stipulates a reduction of withholding tax to zero in certain cases, did not apply due to the limited company's small shareholding in the Spanish company. The withholding tax could also not be credited in the UK, as no tax was assessed due to the loss situation.

Unequal treatment is not permitted

The court considers the unequal treatment of resident and non-resident dividend creditors in the event of a loss to be unlawful. In particular, it rejects the justifications put forward for the efficiency of tax collection, the balanced allocation of taxing powers and the coherence of the tax system. Rather, a non-resident dividend creditor must be given the opportunity to prove the loss suffered to the source state in order to obtain a refund of withholding tax. The accuracy of such information could be verified by the existing mechanisms for mutual assistance between the authorities of the Member States (requests for administrative assistance).

Practical tips

The case concerned a constellation between a corporation based in Spain and a corporation based in the UK. Nevertheless, it can be applied both to outbound investments by German taxpayers in Spain and to inbound investments by non-residents in Germany. The inbound case in particular shows parallels to the judgment: If, for example, the domestic dividend recipient is subject to unlimited corporation tax liability, the capital gains tax is credited against the corporation tax in the case of a tax exemption (shareholding ≥ 10%; Section 8b (1) KStG) as well as in the case of free float dividends (shareholding < 10%; Section 8b (4) KStG) or refunded in the event of a loss (Sections 31 and 36 KStG), whereas it has a discharging effect in the case of companies with limited tax liability. 

As the Parent-Subsidiary Directive in EU cases, as implemented in Germany, already provides for a full refund of withholding tax for a shareholding of 10%, the ECJ ruling is particularly relevant in cases in which the foreign dividend creditor receives a free float dividend from Germany and generates a loss in the reference year. In future, it will be crucial to prove the loss situation as well as the lack of chargeability and the resulting effective burden. It remains to be seen how the German tax authorities will position themselves on this decision. In the case of corresponding case constellations and a significant volume of withholding tax, applications for withholding tax refunds should be made in any case, even if a long processing time is currently to be expected.

Source: ECJ of 19.12.2024, C-601/23, Credit Suisse Securities (Europe) Ltd.