On January 25, 2012, the German Federal Ministry of Finance has published a circular regarding the withholding tax relief of foreign companies. It replaces the previous circulars of 2007 and 2010.

I. Overview

§ 50d para. 3 ITA has been amended as of January 1, 2012 due to the previous potential violation against EU law. According to § 50d para. 3 ITA, a foreign company shall only be entitled to (full or partial) relief from withholding tax under a EU Directive / Double Tax Treaty, to the extent

  • the company is owned by shareholders that would be entitled to a corresponding benefit if they earned the income directly (individual relief entitlement), or
  • the substance requirements under § 50d para. 3 sent. 1 ITA (factual relief entitlement) are met (non-harmful income).

Income is "not harmful", if

  • it consists of gross receipts generated by own business activities or
  • with respect to income generated by non-business activities, there are non-tax related reasons for interposing the foreign company and the company has adequately equipped business substance.

According to the circular and as before, the lack of an individual relief entitlement excludes indirect relief of higher-tier shareholders. Moreover, indirect domestic shareholders are not entitled to relief.

According to the circular, the tax administration will apply the new rules to all open cases retroactively, if the new rules lead to a favorable relief entitlement compared to the previous rules.

II. New Pro Rata Test

§ 50d para. 3 ITA has new legal consequences. If a foreign company earns income on which withholding tax is imposed, this withholding will be reduced – unless there is an individual relief entitlement applicable – only to the extent there are non-harmful gross receipts compared to the overall gross receipts earned (Pro Rata Test). Contrary to the previous rules, an "all-or-nothing" principle does not exist and only pro rata relief will be granted insofar as there is harmful income.


A foreign company with shareholders that are not entitled to withholding tax relief receives dividends of 1,000 from a German subsidiary (which is actively managed). In addition, the company earns passive income of 100. According to tax administration's view only 91% of the German dividend withholding taxes are to be refunded (or there is a 91% withholding tax exemption to be granted). For the remaining 9%, relief depends on the individual and factual relief entitlement of the shareholders.

According to the circular, earnings that are economically functionally linked to the own business activities (e.g., interest income generated by income which was subject to relief) shall qualify as gross receipts generated by own business activities.

For purposes of the new Pro Rata Test, the gross receipts of the year in which the income is earned shall generally be decisive (withholding tax refund) or the gross receipts of the application year (withholding tax exemption). The tax administration must be notified about a (partial) loss of the requirements for withholding tax relief, whereby a de-minimis rule is provided.

III. Recommended Actions

Foreign companies should verify whether the new rules lead to a partial withholding tax relief in the future only. Consequently, the income structure may need to be optimized by intra-group initiatives.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.