Germany: 219. Tax Accounting Law: Congruent Dividend Reporting: Abolished For Tax Purposes?

Last Updated: 20 July 2001
Article by Brigitte Romani
KPMG Germany Webpage
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1. Introductory

Germany's highest tax court has rejected the case law of its highest court of general jurisdiction with regard to congruent dividend reporting. Sitting as a combined chamber (Großer Senat) hearing questions referred by its 1st Chamber, the Federal Tax Court dismissed the arguments which persuaded both the Federal Court of Justice (Bundesgerichtshof) and the European Court of Justice (ECJ) to accept congruent dividend reporting. The Federal Tax Court decision is contained in a ruling dated 7 August 2000 (GrS 2/99 - DB 2000, 1993) that commences with the following headnote:

A corporation holding a majority share in another corporation can generally not capitalise a receivable for a dividend arising from an appropriation of profits by the downstream corporation that has not yet been voted as of the balance sheet date.

Previously, taxpayers and tax authorities alike had assumed just the opposite, namely that parent companies could generally record dividends paid by controlled subsidiaries "congruently," that is, in the year for which (not in which) the dividend was paid, as long as parent and subsidiary had the same fiscal year and certain formalities were observed. It made no difference that the dividend resolution was necessarily adopted after preparation and approval of the year-end balance sheet in the fiscal year that followed.

2. Significance Of Congruent Dividend Reporting

Congruent dividend reporting influences the fiscal year in which a parent company records and pays tax on dividends received. Aside from the commercial or tax accounting advantages which the ability to influence the fiscal year in which income is realised may bring in a particular instance, there are structural reasons for accrual basis taxpayers to prefer congruent dividend reporting.

2.1. Commercial accounting

It takes years to pass dividends up through a chain of stock corporations and distribute them to the ultimate shareholders unless congruent dividend reporting is permitted.

Example (adapted from Groh DB 2000, 2558)

S1, S2, and S3 are all stock corporations (AGs). S1 is wholly owned by parent P. S1 holds a 100 % share in S2, and S2 holds a 100 % share in S3. S1, S2, S3, and P all have the same fiscal year. Third tier subsidiary S3 earns a profit of 1000 in Year 1. It distributes this profit to second tier subsidiary S2 in Year 2. Unless S2 can record the dividend in Year 1, it cannot re-distribute the sum received until Year 3. First tier subsidiary S1 receives the dividend in Year 3, but cannot pass it along to the ultimate foreign group parent P until Year 4, which cannot distribute it to its shareholders until Year 5. With congruent dividend reporting, S1, S2, and P can all report the dividend as received in Year 1 and P can re-distribute the sum to its shareholders in Year 2.

The same problems do not arise with respect to a chain of limited liability corporations (GmbHs) because the corporate law governing GmbHs permits the payment of interim dividends out of the profits of the fiscal year in progress. Interim dividends are precluded for stock corporations by § 59 (1) AktG. Were S1, S2, and S3 in the above example all GmbHs, their respective shareholders could vote successive interim dividends out of the profits of the year in progress (Year 1), causing S2, S1, and P to record a dividend receivable in Year 1. If P were a GmbH, its shareholders could vote an interim dividend in Year 1 as well.

Interim dividends involve extra effort compared with normal declared dividends and may be impractical for GmbHs with a large number of shareholders because of the difficulty in arranging a shareholders meeting after certainty exists as to the sum available for distribution and before the close of the fiscal year in progress.

Congruent dividend reporting is permitted for commercial accounting purposes, at least with respect to 100 % subsidiaries (see sec. 4.2 below).

2.2. Withholding Tax

Under § 43a (1) EStG, tax is withheld on dividends at a rate of 20 %. The rate is 25 % for dividends subject to the old corporation tax credit system (Part IV of the old corporation tax law), which is presently being phased out (see article nos. 209 and 215). Under § 44 (2) EStG, withholding tax is payable when the dividend is due for payment under the terms of the authorising shareholder resolution or, if no time is specified, on the day after the resolution. The tax withheld is creditable against the income tax owing for the year in which it is received.

For cash basis taxpayers, the dividend constitutes income in the year in which it is paid. However, for accrual basis taxpayers, congruent dividend reporting advances the time of credit of withholding tax by one year. While it is possible to file motions to abate tax prepayments based on creditable dividend withholding tax, this is not as effective as claiming the credit in an earlier tax reporting period. Also, there is no way to advance a refund owing by reason of tax withheld.

Inter-corporate dividends remain subject to withholding tax under the new corporate tax system. Since tax is generally not owing on inter-corporate dividends under the new corporation tax system, withholding tax will in principle always be refunded at the parent level. The unavailability of congruent dividend reporting will delay the timing of such refunds, however.

Dividend withholding tax is creditable to resident taxpayers and to non-residents holding their shares in a domestic permanent establishment including a partnership in which they are a partner. Dividend withholding tax is partially refundable to foreign persons entitled to claim the protection of a tax treaty.

2.3. Corporation Tax Credit / New Corporate Tax System

Under the old corporation tax system, dividends paid by German corporations carried a corporation tax credit equal to 3/7 (43 %) of the dividend payment (almost twice the amount of the withholding tax on the dividend). The credit was available to resident taxpayers and to non-residents holding their shares in a domestic permanent establishment including a partnership in which they were a partner. The same considerations discussed with regard to dividend withholding tax apply a fortiori with regard to creditable corporation tax. By reporting a dividend received in the fiscal year just ended, instead of in that just commenced, the timing of the corporation tax credit is advanced considerably.

Without congruent dividend reporting, the problems in claiming the corporation tax credit increase exponentially inside multi-tiered groups. It would take 4 years to move a tax credit from a third tier subsidiary to the group parent, for instance.

The old corporation tax system is presently being phased out, however. Declared dividends paid by calendar year corporations in the year 2001 and by non-calendar year corporations prior to the end of their 2001/02 fiscal year still carry a corporation tax credit.

No corporation tax credit exists under the new corporation tax system. Corporations receive all dividends tax free under the new system. Aside from withholding tax (see sec. 2.2 above), inter-corporate dividends generally have no tax consequences under the new corporation tax system.

Furthermore, during a 15 year transition period after the corporation tax credit system expires, distributions of "old" retained earnings (earnings accumulated by calendar year corporations prior to 2001 and by non-calendar year corporations through the close of their 2000/01 fiscal year) will continue to result in a corporation tax reduction for the distributing corporation. This is accomplished by refunding 1/6 of the dividend to the distributing corporation. The receiving corporation is required to pay a like amount of corporation tax on the dividend and receives a corresponding "credit," to be refunded when it re-distributes the funds. The reduction and increase in corporation tax take place, however, in the year in which the dividend is disbursed and received. It thus makes no difference in this regard whether a dividend is reported congruently or not.

2.4. Loss Utilisation Planning

Under the corporate law in effect through the end of the year 2000, many corporate groups relied on dividend distributions to offset intra-group losses. Such offset was made possible by the corporation tax credit system under which corporation tax paid by a subsidiary on its earnings was credited in full to its parent. A parent with offsetting losses received a refund of the corporation tax (and dividend withholding tax) paid by its subsidiary. While dividend-based loss utilisation strategies were not optimal – because trade tax paid at the subsidiary level was not recovered and because only subsidiary profits, not subsidiary losses could be passed on for offset at a higher level – they were common due in part to their simplicity and in part to the inability of some groups to form a consolidated group for trade tax and corporation tax purposes. Other groups satisfied the consolidation requirements for trade tax purposes, thus avoiding the payment of trade tax where the group was in a loss situation as a whole, but not the more stringent requirements for corporation tax purposes.

Wherever group loss utilisation depended on dividend distributions, congruent dividend reporting was vital to the offset of profit and loss at the group parent level.

Under the new corporation law, the situation changes radically. The elimination of the corporation tax credit precludes any offset of subsidiary-level profits against parent-level losses. The corporation tax of 25 % paid at the subsidiary level is definitive. Only corporation tax consolidation can achieve intra-group loss offsetting in the future.

In connection with the abolition of the old corporation tax law, the requirements for corporation tax consolidation were relaxed considerably. Those for trade tax consolidation remained unchanged. See sec. 2.12 of article no. 209.

2.5. Discrepancy Between Commercial And Tax Accounts

The Federal Court of Justice, Germany's highest court of general jurisdiction, recently affirmed the permissibility of congruent dividend reporting for commercial tax purposes at least where the parent holds 100 % of the shares in the distributing subsidiary (see article no. 125 and sec. 4.2 below). The ruling of a combined chamber of the Federal Tax Court here reported on may bar congruent dividend reporting for tax accounting purposes, however. At the very least, the new ruling establishes stiff new requirements for tax recognition of congruent dividend reporting (see sec. 6.3 below).

If congruent dividend accounting is practised by a parent company in its commercial accounts, but not in the tax accounts, this leads to a discrepancy between the income reported by the parent for commercial and tax accounting purposes. A dividend recorded in Year 01 in the commercial accounts will not be reflected by the tax accounts until Year 02.

While discrepancy between the commercial and tax accounts is the norm in many countries, in Germany it is the exception because of the principle of linkage of the tax accounts to the commercial accounts under § 5 (1) EStG. See also sec. 7.2 and 7.3 below.

2.6. Dividend Pitfall And Distribution Obstacle

Hoffmann (DStR 2000, 1997, 1999) points out that the discrepancy between the commercial and tax accounts can cause unwary taxpayers to commit a dividend distribution blunder.

Example

X AG is the sole shareholder of Y AG. Y AG pays a dividend of 1,000 to X AG out of the Y AG's Year 01 profit. The dividend is reported congruently for commercial accounting purposes by X AG, that is, treated as income in Year 01. For tax accounting purposes, the dividend is not recorded until Year 2. The commercial balance sheet of X AG at the close of Year 01 thus likewise reflects a profit of 1,000, which X AG in turn distributes to its sole shareholder (dividend resolution adopted and dividend paid in Year 02 for Year 01). Let us, however, assume that the tax equity accounts of X AG contain no old or new retained earnings as of the close of Year 01. While the dividend, if recorded in Year 01, would have created new retained earnings, it is not recorded until Year 02 for tax purposes. Let us further assume that the equity accounts of X AG show a positive amount in equity basket EK 02. This is an equity category which many corporations will carry with them throughout the 15 year transition period under the new corporation tax law. Distributions are deemed to come out of EK 02 to the extent no old retained earnings (EK 40) and no new retained earnings are present. The distribution of 1,000 by X AG is therefore deemed to come out of EK 02 under the assumed facts. All distributions of EK 02 trigger an increase in corporation tax equal to 3/7ths (just under 43 %) of the sum distributed. Hence, X AG must pay corporation tax of approx. 430 on the dividend.

All other things being equal, the goal of corporations with EK 02 should be to avoid distributions from this equity basket until the transition period has expired and the basket is eliminated. In the above example, X AG has overlooked the fact that, while the dividend received from Y AG enables it to pay a dividend for Year 01 from new earnings for commercial accounting purposes, it generates no new retained earnings for tax purposes until Year 02. Under the facts assumed, X AG should therefore delay the dividend by one year (i.e. pay a dividend in Year 03 for Year 02, instead of in Year 02 for Year 01).

The above example also illustrates how the inability to record dividends congruently can delay dividend re-distribution. In the above example, the shareholders of X AG should have waited an extra year before authorising the dividend. Hence, where congruent dividend reporting is unavailable, corporations in the situation of X AG (presence of EK 02 without sufficient old or new retained earnings to cover the dividend) will have to delay their distributions or pay what Hoffmann (loc. cit.) refers to as a "penalty tax for unskilful dividend distribution planning".

Where dividends are passed up through a whole chain of corporations, the situation described in sec. 2.1 above results: It takes it five years to distribute the earnings of a third tier subsidiary to the ultimate shareholders of the parent company. Once again, consolidation for corporation tax purposes is the way out of this dilemma (cf. sec. 2.4 above).

In a chain of GmbHs, interim dividends can be another alternative (see sec. 2.7 below).

2.7. Interim Dividends

As explained in sec. 2.1 above, German company law allows limited liability companies to pay interim dividends, whereas § 59 (1) AktG precludes such dividends for stock corporations. For GmbHs, interim dividends can generally be used to accomplish the same ends as congruent dividend reporting. The amount of effort involved is greater, however.

2.8. Summary

Congruent dividend reporting has enormous tax significance under the old corporation tax system because of the corporation tax credit, but is not nearly so important under the new corporation tax system. Nevertheless, there can be advantages to congruent dividend reporting even under the new corporation tax law:

  • The denial of congruent dividend reporting retards the refund of dividend withholding tax (see sec. 2.2 above).
  • For corporations with positive sums in their EK 02 equity basket, the unavailability of congruent dividend reporting can provoke costly dividend distribution blunders or delay dividend distributions during the 15 year transition phase of the new corporation tax system. Corporations in this position should consider consolidating for corporation tax purposes. See sec. 2.6 above.

For commercial accounting purposes, congruent dividend reporting is important for efficient distribution of earnings (see sec. 2.1 above). The Federal Tax Court decision reported on in this article does not affect congruent dividend reporting for commercial tax purposes, which remains permissible.

Congruent dividend reporting is irrelevant to loss utilisation under the new corporation tax system. Corporation tax consolidation takes on new significance, however (see sec. 2.4 above).

3. Reaction Of Tax Authorities

Prior to announcement of the August 2000 ruling of the combined chamber of the Federal Tax Court, the Federal Ministry of Finance instructed the tax authorities to continue applying the "previous principles of congruent dividend reporting" until the high court handed down its ruling (directive of 24 August 1999 - BStBl I 1999, 249). Shortly after the August 2000 ruling was announced, the tax authorities issued another directive (1 November 2000 - DStR 2000, 1997) stating that, notwithstanding the ruling, they would continue to apply the "previous principles of congruent dividend reporting" with respect to all dividends subject to the old corporation tax credit system (Part IV of the old corporation tax law).

In effect, the tax authorities are willing (within certain limits) to permit congruent dividend reporting for tax purposes for all dividends which carry a corporation tax credit. As explained above, declared dividends paid in 2001 by calendar year corporations and prior to the end of the 2001/02 fiscal year by non-calendar year corporations still carry a corporation tax credit.

Hoffmann (DStR 2000, 1997, 1998/1) notes that dividends received from foreign corporations do not carry a corporation tax credit under the old corporation tax system and are therefore apparently outside the scope of the November 2000 directive. Since constellations are conceivable in which congruent dividend reporting of foreign dividends can be important, Hoffmann develops arguments why the tax authorities should interpret their directive as covering such dividends.

Hoffmann (loc. cit. p. 1998/2) further notes that no one is precisely sure what is meant by "the principles of constructive dividend reporting." He surmises that the practice accepted in the past for each particular company will be accepted under the November 2000 directive. Hoffmann points out that the Düsseldorf Regional Tax Office has taken the position that a firm's past practices with regard to congruent dividend reporting can bind it for future years as well, hence limiting its discretion (directive of 12 February 1992 - FR 1992, 181).

4. Context Of The Ruling

4.1. Background In German Law

Germany has long permitted congruent dividend reporting for both commercial and tax accounting purposes in certain circumstances. While some scenarios remained unclear, a well established core doctrine held that, where a parent company and its controlled subsidiary had the same fiscal year, the parent could record a dividend receivable from its subsidiary in the year for which the dividend was paid even though the dividend was not voted, much less disbursed, until the following year. The additional requirements for treating the dividend as earned in the fiscal year for which it was paid were easy to fulfil – or to avoid fulfilling – and essentially depended on the order in which the financial statements of the subsidiary and its parent were approved. De facto, parent companies could decide whether to report dividends congruently or not as they wished (within the limits of the accounting principle of consistency).

Congruent dividend reporting has been elective for commercial accounting purposes since at least 1975. Where the election existed, the tax courts held that it was mandatory for tax purposes. This was in keeping with a 1969 decision by a combined chamber of the Federal Tax Court that capitalisation is mandatory in the tax accounts wherever it is elective in the commercial accounts (ruling of 3 Feb. 1969 - GrS 2/68 BStBl II 1969. 291). Applied to congruent dividend reporting, this meant that the parent company must capitalise a dividend receivable in its tax accounts wherever it had the option of so doing in its commercial accounts.

4.2. Affirmation Of Congruent Dividend Reporting By ECJ And FCJ

The European Court of Justice affirmed the permissibility of congruent dividend reporting in its Tomberger rulings of 27 June 1996 and 10 July 1997 - C-23/94, at least where the distributing subsidiary is wholly owned by the parent company and certain conditions are fulfilled. Strictly speaking, the ECJ ruling applied only for commercial accounting purposes, but it was widely thought to have tax significance as well. In 1998, the German Federal Court of Justice (FCJ) mandated congruent dividend reporting in the commercial accounts under the conditions specified by the ECJ (FCJ decision of 12 January 1998 (DStR 1998, 383)). See articles nos. 106 (ECJ) and 125 (FCJ).

The requirements for congruent dividend reporting established by the ECJ and adopted by the FCJ are as follows:

  • The parent company holds a 100 % share in the distributing subsidiary and controls it;
  • The parent and the subsidiary are part of a consolidated accounting group under national accounting law;
  • Both companies have the same fiscal year;
  • The subsidiary's shareholders approve payment of the dividend by shareholder resolution;
  • The shareholder resolution is adopted prior to completion of the audit of the parent company for the same fiscal year for which the dividend is voted; and
  • The national court is satisfied that the subsidiary's financial statements for the year in question give a true and fair view of its net assets, finances, and earnings.

While neither the ECJ nor the FCJ addressed situations involving subsidiaries that are majority-owned, but not wholly owned, the presumption of practitioners was – and is – that congruent dividend reporting continues to be acceptable for commercial and tax accounting purposes in these cases as well.

Now comes the German Federal Tax court with a ruling that not only rejects the reasoning of the ECJ and FCJ decisions, but reverses previous tax accounting practice as well by overruling a long line of tax cases holding that congruent dividend reporting is permissible in principle when certain conditions are fulfilled.

5. Facts Of The Case

Given that there was a general consensus in Germany in favour of congruent dividend reporting, one may wonder how a case challenging the practice ever made it to a combined chamber of the Federal Tax Court. A combined chamber is a special panel of the court to which individual chambers refer or certify questions when they wish to decide a case before them in a manner inconsistent with the prior holding of another chamber of the same court.

The case involved a German corporation (a GmbH) with a large loss carryforward that, under the law then in effect, would have expired on 31 December 1985. To avoid forfeiting this loss carryforward, the German corporation purchased an 84% share in a German AG on 23 December 1985. The German AG was in a position to pay a dividend for its 1985 fiscal year, which was the calendar year. The GmbH was likewise a calendar year corporation. The 84 % stake in the AG was purchased by the GmbH from its 100 % parent corporation. Only by reporting the dividend congruently, that is, in its 1985 fiscal year, could the GmbH offset it against its loss carryforward, which would otherwise expire unused at year's end.

Only the extreme facts of the case (acquisition of the shareholding eight days before the end of the fiscal year from a related party) prompted the tax authorities to oppose congruent dividend reporting. This ultimately brought the case before the 1st Chamber of the Federal Tax Court, which had theoretical reservations about congruent dividend reporting to begin with. Since other chambers of the Federal Tax Court had approved the practice, the 1st Chamber referred its questions to a combined chamber.

6. FTC's Reasoning And Holding

6.1. General Rejection Of Congruent Dividend Reporting

The combined chamber of the Federal Tax Court analyses the concept of an asset in commercial and tax accounting law. Citing a long line of prior cases, the court states that the concept of an asset is the same for both commercial and tax accounting purposes. Only if the parent company has acquired an asset in the form of an account receivable by reason of a dividend claim against its subsidiary as of the parent's balance sheet date is it permitted to report the dividend "congruently." While the court concedes that an economic approach, as opposed to a formalistic or legalistic approach, should be followed in determining whether an asset exists, the court notes that factual circumstances and concrete opportunities must possess objective, independently appraisable and independently transferable value in order to rise to the level of assets. Only that which a prudent businessman would pay a price to acquire constitutes an asset.

Applying these principles to the issues before it, the court holds that "the possibility of capitalising a dividend receivable prior to the adoption of the profit appropriation resolution is to be denied in principle." Not until adoption of a dividend resolution do the shareholders of a German corporation have an enforceable claim to corporate profits. Prior thereto, the court finds it "difficult to imagine" circumstances in which a third party would pay a price to acquire the shareholders' inchoate dividend rights.

The Federal Tax Court therefore rejects congruent dividend reporting in the circumstances in which the ECJ and Federal Court of Justice allowed or mandated it respectively (see sec. 4.2 above). The fact that a parent company is able to cause its subsidiary to vote a dividend if the parent so wishes is not sufficient, in the view of the Federal Tax Court. The factual control of an entity over the missing factors necessary to give rise to a claim is only relevant, the court states, when the missing factors have no "intrinsic economic importance." The shareholders' resolution is, however, "an essential component of the economic existence of a dividend claim." The shareholder resolution is not a subsequent "value-elucidating" event (wertaufhellendes Ereignis) that facilitates evaluation of circumstances in essence completely present at the balance sheet date. Rather, the shareholder resolution must be generally be regarded as "value-creating" (wertbegründend, wertbildend). Hence, no dividend claim arises until the respective dividend resolution has been adopted.

The European Court of Justice and the Federal Court of Justice had decided this issue exactly the other way around, in part with regard to the requirement that financial statements convey a "true and fair view" of a company's financial position. The Federal Tax Court notes here that the "true and fair view" concept complements, but does not override the principle of prudence (conservative accounting) and the principle of realisation (imparity principle: assets not capitalised until realised).

The Federal Tax Court also noted that the positions taken by ECJ and FCJ were tantamount to permitting a parent company to elect to pay tax on dividends received from their controlled subsidiaries either in the year of the dividend resolution or in the preceding fiscal year, at its discretion. For instance, under the FCJ decision described in sec. 4.2 above, the taxpayer can (within the limits of the accounting principle of consistency) control the year in which the dividend is reported by changing the relative timing of the conclusion of the parent's audit and the adoption of the shareholder dividend resolution. The Federal Tax Court stated that the creation of such an election without legislative authority was incompatible with principles of objective taxation.

6.2. Possible Exceptions?

The Federal Tax Court states repeatedly in its ruling that situations are conceivable in which congruent dividend reporting is permissible by way of exception. It establishes the following requirements for such exceptions.

  • The subsidiary must have profits available for distribution (Bilanzgewinn) of not less than a specific minimum amount as of the balance sheet date;
  • The subsidiary's shareholders must be aware of the minimum amount of profits available for distribution;
  • The shareholders must be irrevocably resolved to vote a certain appropriation of profits (a dividend) after the balance sheet date; and
  • It must be possible to establish all of the above conclusively by means of objective, verifiable evidence which is within the range of perception of third parties (outsiders).

The requirement that the shareholders be irrevocably resolved to vote a certain dividend apparently includes as a tacit additional requirement that the shareholders in question must be in a position to enact the dividend resolution as a practical matter. This would generally be the case for any majority shareholder.

The court goes on to state that the subjective intent of the shareholders to adopt a particular dividend resolution is "practically impossible to prove." It is also impermissible to assume or presume the existence of such intent based on extraneous circumstances. Nothing but direct evidence will suffice. The court gives no examples of the form which such evidence might take, but states that exceptions will be "extremely rare."

The court expressly refuses to decide whether a subsidiary must be consolidated under the dividend receiving parent for commercial accounting purposes (§ 290 ff. HGB) as a condition of congruent dividend accounting.

The other requirements often cited in connection with congruent dividend reporting (such as the timing of the dividend resolution and completion of the parent company's audit, or the timing of formal adoption of the subsidiary's financial statements compared with adoption of those of the parent) are apparently irrelevant under the August 2000 ruling.

6.3. Exceptions As The New Rule?

Groh (DB 2000, 2444 and 2557, 2558) has argued that the ruling by the combined chamber of the Federal Tax Court will have little impact on congruent dividend accounting because it will be simple to structure dividends to meet the new requirements described in sec. 6.2 above. While the new requirements are more stringent than those which previously applied, Groh believes that they can be met with appropriate planning.

Other authors (see e.g. Hoffmann DB 2000, 2557) take issue with this and argue that the requirements laid down by the court are almost impossible to fulfil, just as the court said they were. In this view, the new ruling puts an end to congruent dividend reporting for tax purposes (aside from the dispensation granted by the tax authorities – see sec. 3 above).

7. Weak Points Of The Ruling

7.1. No Conflict With ECJ?

The court refused to suspend its proceedings and refer the issues before it to the European Court of Justice on the grounds that the case related to the year 1985, which was prior to the 1987 entry into force of Germany's implementation of the 4th EU Accounting Directive. Hence, the European Court of Justice lacked jurisdiction over the specific case.

Notwithstanding this refusal, the court stated, in what should probably be regarded as obiter dictum, that it "assumed" that the decision it was handing down would apply equally to accounting periods after 1985.

7.2. No Conflict With FCJ?

The court likewise refused to suspend proceedings and refer the questions before it to a joint chamber (Gemeinsamer Senat) of the five German high courts (Federal Court of Justice, Federal Labour Court, Federal Administrative Court, Federal Tax Court, Federal Social Court). The German court system is composed of several distinct sub-systems with differing subject matter jurisdiction, each of which is headed by a different high court. Where a high court wishes to decide a case before it at variance with a decision by another high court, it is required under Art. 95 of the German Basic Law and the legislation thereunder to refer the issues to a joint chamber of the German high courts for binding decision.

Arguably, the combined chamber of the Federal Tax Court should have convened a joint chamber of the Federal high courts because the decision it reached is at variance with the decision of the Federal Court of Justice of 12 January 1998 (see sec. 4.2 above). The Federal Tax Court contended, however, that its decision did not conflict with that of the Federal Court of Justice because it, the Federal Tax Court, was deciding an issue of tax accounting law, whereas the Federal Court of Justice decided an issue of commercial accounting law.

Since § 5 (1) EStG states that capitalisation of assets for tax purposes is determined by German commercial accounting principles (German GAAP), the theoretical basis of this part of the court's decision is either dubious or revolutionary, depending on one's perspective. Hoffmann speaks of a "shift of paradigms" (DStR 2000, 1813/1) and criticises the court for having invented previously non-existent German tax accounting GAAP as the counterpart to German commercial accounting GAAP.

The court's failure to certify the questions before it to a joint chamber of the German high courts has attracted much criticism (Hoffmann: GmbHR 2000, 1113, 1114/1 and DStR 2000, 1809, 1813/1; cf. Wassermeyer: GmbHR 2000, 1111, 1112/1 and 1113/1). From a practical point of view, the Federal Tax Court wished to avoid placing a complex accounting issue before a panel of judges from disparate backgrounds.

7.3. No Conflict With Prior FTC Decisions?

The Federal Tax Court further states that the decision of the Federal Court of Justice rests on the capitalisation of a non-existent asset as a matter of "accounting convenience." "Accounting conveniences" or "accounting aids" (Bilanzierungshilfen) are disregarded for tax purposes. There are few examples of such "accounting aids" in German law, and most of them are statutory. Arguably, the Federal Court of Justice has in fact created an election to capitalise an asset. By characterising the holding of the FCJ as affirmation of an accounting convenience instead of an accounting election, the Federal Tax Court avoids contradicting its own long-standing doctrine that elective capitalisation for commercial accounting purposes translates into mandatory capitalisation for tax accounting purposes. The Federal Tax Court hence sees no conflict between the instant decision and its own prior holdings on point.

8. Subsequent Court Judgements

Since release of the August 2000 ruling of the combined chamber of the Federal Tax Court, various chambers of the court have applied the ruling in deciding pending cases.

8.1. Judgement Of 31 October 2000 (I R 48/94)

In this decision (DStR 2001, 294), the 8th Chamber of the Federal Tax Court held as follows:

  • The ruling of the combined chamber of the FTC of 7 August 2000 applies where shares in a distributing corporation are held by a partnership, instead of by another corporation.
  • The ruling also applies when the relation of the partnership to the distributing corporation meets the specific German requirements for division of a business into an asset-holding entity and an operating entity (Betriebsaufspaltung).
  • The ruling also applies to years subsequent to 1985 (cf. sec. 7.1 above).

In the case decided, the tax authorities sought to compel the partners of a partnership to report dividends received congruently, i.e. one year earlier than the partners wished. The court decided for the taxpayers in holding that the stringent requirements of congruent dividend reporting established by the ruling of 7 August 2000 were not met.

The court stated that it was not clear that the partners were irrevocably committed to make a particular distribution as of the balance sheet date. Only where an obligation to this effect existed as of the balance sheet date (e.g. under statutory law, under the partnership's articles of association, pursuant to an interim dividend resolution, or under a contractual agreement) could the requirements of the August 2000 ruling be met.

The court rejected the long-standing position of the tax authorities that congruent dividend reporting should apply automatically where a business was divided into an asset-holding entity and an operating entity.

8.2. Judgement Of 20 December 2000 (I R 50/95)

This decision (DB 2001, 734) disposes of the case which prompted the 1st Chamber make the referral to the combined chamber of the Federal Tax Court (see facts in sec. 5 above).

The court held that the requirements for congruent dividend reporting as established by the August 2000 ruling were not met. The fact that the shares in the distributing company had been acquired for the express purpose of paying a congruently reported dividend to avoid forfeiture of loss carryforwards was not considered sufficient evidence of the irrevocable intention of the shareholders to vote a specific dividend for the year in question. The court also noted that the amount of the dividend was open at all times. The mere fact that monthly financial statements were prepared for the distributing corporation was not considered sufficient to concretise the amount of the intended distribution.

8.3. Judgement Of 28 February 2001 (I R 48/94)

Here as well, the court held that the requirements for congruent dividend reporting were not met (DB 2001, 1066). The taxpayer sought to advance the time of realisation of a dividend by one year to utilise a loss carryforward. The tax authorities opposed the use of congruent dividend reporting for this purpose. The court had an easy time deciding for the tax authorities. The shareholders of the distributing corporation, a GmbH, had voted an interim dividend in the last days of 1986. Then, in addition, they congruently reported a regular dividend for 1986. The court pointed out that the adoption of the interim dividend showed that the shareholders were unable to decide on distribution of a larger amount from 1986 profits as of the balance sheet date. They were furthermore uncertain whether there would be any such additional profits. Hence, they were not irrevocably resolved to pay the dividend in question as of the balance sheet date.

9. Concluding Remarks

The August 2000 ruling by the combined chamber of the Federal Tax Court may spell the end of congruent dividend reporting for tax purposes. At the very least, the tax requirements for this accounting practice have been made far more stringent.

Congruent dividend reporting remains of great importance for dividends subject to the old corporation law, the last of which have yet to be paid. In recognition of this fact, a directive issued by the tax authorities in November 2000 permits congruent dividend reporting for such dividends. There are also situations in which congruent dividend reporting remains significant under the new corporation tax law or during the 15 year transition period.

Aside from its practical impact, the August 2000 ruling is interesting from a variety of theoretical perspectives, not the least of which is the greater divergence of tax accounting from commercial accounting which it seems to legitimise.

Editorial cut-off date: 30 May 2001

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