The Supreme Tax Court has confirmed the provisions of the Corporation and Income Tax Acts subjecting corporation tax refunds to foreign shareholders to treaty rate dividend withholding tax.

Under the old, "imputation" system of corporation tax in force up to 2001, foreign shareholders were, under certain circumstances, entitled on receipt of a dividend to a refund of corporation tax previously paid by the company. The statutory provisions regulating the exact entitlement and the procedures for claiming it equate the refund to a dividend and therefore subject it to withholding tax at the tax treaty rate for dividends. The taxpayer claimed, however, that the tax refund was fell under the treaty definition of "other income" as opposed to "dividends". Since other income is only taxable in the state of residence, Germany would be unable to levy any withholding tax. The taxpayer's main argument was that the refund was paid directly to the shareholder by the tax office and was not therefore a distribution by the company.

The Court rejected the taxpayer's argument. Quoting the published work of the chairman of the senate trying the case, it made the point that all income from shares ranks as a dividend under the tax treaties in line with the OECD model (as was the case here). Decisive was the economic connection between the income (the tax refund) and the shareholding. There was always this connection wherever the shareholder received income in that capacity. The fact that the refund was paid neither by the company, nor on any basis in company law was not relevant. Rather, the important point was that the refund was only due to the shareholder in direct consequence of the dividend, and that it was in effect a repayment of additional corporation tax paid by the company in consequence of the same dividend. These principles also apply to hidden distributions - the subject of this case.

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