Germany: 039. Constructive Dividends - So What?

Last Updated: 17 January 1996
KPMG Germany Webpage
Click on the above link to visit the KPMG Germany webpage on the Mondaq website
For disclaimer and copyright see end of this article.

The avoidance of constructive dividends can be of great importance under the German imputational system of corporation tax. The corporate tax system is often not well understood by foreign managers, and German tax advisers frequently find it difficult to explain even in their own language, much less in a foreign one. Obviously, income will be increased for tax purposes when a payment which has been accounted for as a deductible expense turns out to be a constructive dividend. The increase applies both to the trade tax on earnings and to the corporation tax. It is also clear that, aside from criminal sanctions for intentional or reckless conduct (sec. 370, 378 AO), there are no penalties under German law by reason of the underpayment of taxes which occurs until the constructive dividend is determined and corrected. Interest accrues at 0.5 % per month (6 % p.a.) on underpayment of taxes, but does not start to run until 15 months after the end of the year for which the tax is owing (sec. 233a, 238 AO).

Why, then, can it matter so much if a particular payment later turns out to be a constructive dividend? Besides payment of the tax which would have been owing anyway, together with modest 6 % interest for part of the overdue period, what can happen?

The answer is: A constructive dividend can either be harmless or cost 50 % or more of the amount of the dividend in additional tax.

The tax consequences of all dividends (constructive or declared) by a German corporation to its shareholders depend on the equity category (baskets or equity accounts) out of which the distribution is deemed to come. The following table states the general rules:

Source of distribution    Consequence

Fully taxed earnings      Corporation tax refund 15 % + withholding

Earnings taxed at 30 %    Corporation tax unchanged, but withholding

Tax-free earnings,        Corporation tax increase 30 % + withholding
generally                 tax

Tax-free foreign source   No corporation tax, but withholding tax 
earnings, dist. 
to domestic corp.or to 
foreign person

Capital surplus           Return of capital, no tax consequences

Distribution not covered  Corporation tax 30 % + withholding tax
by available equity

In order to quantify the above general statements, it is necessary to understand how equity is classified for corporation tax purposes and how the source of a distribution is determined. Equity is grouped in a series of accounts or baskets and distributions are deducted from these accounts in the following order to the extent of the positive balance of each account:

Account name      Description

EK 50             Earnings after deduction of 50 % corp. tax
EK 45             Earnings after deduction of 45 % corp. tax
EK 30             Earnings after deduction of 30 % corp. tax
EK 01             Tax-free foreign source earnings
EK 02             Other tax-free earnings
EK 03             Pre-1977 equity (earnings and cap. surplus)
EK 04             Capital surplus

The above are tax accounts, not accounts in the company ledger for commercial accounting purposes. The abbreviation "EK" in the above account names stands for "Eigenkapital" or equity and refers to so-called distributable equity, i.e. all equity except stated capital (which by law may not be distributed unless first converted into capital surplus by reducing the amount of stated capital, a cumbersome process).

The four "EK zero" (EK 0) accounts are so-named because amounts in these baskets have not been reduced by creditable corporation tax. Amounts in EK 03 have probably been reduced by pre-1977 corporation tax, but this "old" corporation tax is not creditable under the new system which went into effect in 1977. The EK 04 account (basket) is a particularly important one. It contains all shareholder contributions not constituting stated capital. It not frequently happens that this basket holds sums which, for commercial accounting purposes, are treated as revenue. Cancellation by a shareholder of a loan to his German corporation generally increases the EK 04 basket and therefore attracts no tax.

EK 50 and EK 45 are baskets for taxable earnings at the old 50 % standard rate and the present 45 % standard rate respectively. If corporate earnings (after trade tax, which is a deductible expense for corporation tax purposes) amount to 100, the amount entered into EK 45 will be 55 (100 - 45 = 55). The EK 30 account contains earnings which have borne 30 % corporation tax. The 30 % rate corresponds to the corporation tax on distributed earnings, just as the 45 % rate corresponds to the current corporation tax on retained earnings. One might suppose that earnings are put into the EK 45 basket or the EK 30 basket depending on whether they are retained or distributed, but this is not so. All "normal" earnings are first put into the EK 45 basket, even if they are "immediately" distributed. The EK 30 basket serves a technical purpose, being used essentially for income with respect to which the German corporation tax is less than the standard rate. Since the non-standard rate is seldom 30 %, amounts in this equity basket generally arise by virtue of dividing earnings between EK 45 and EK 30 (for non-standard rates between 30 % and 45 %) or between EK 30 and an EK 01/EK 02 (for non-standard rates under 30 %).

There are two additional basic rules one needs to remember to understand the system.

Rule No. 1, which is subject to two major exceptions, is that whenever equity is distributed, the corporation tax burden is adjusted (if necessary) to equal 30 % of the gross dividend (sum of net dividend and the 30 % corporation tax thereon). This is known as the "distribution adjustment" (Herstellung der Ausschuttungsbelastung). If the distribution comes out of EK 45, this means that a 15 % tax refund is made to the distributing corporation (nota bene: 15 % of the gross dividend, not 15 % of the net dividend, much less of amount taken out of EK 45). If the distribution comes out of EK 30, no adjustment is necessary. And if the distribution comes out of an EK 0 basket, tax must be increased to equal 30 %. The two exceptions to the rule are as follows:

- Distributions from EK 04 are treated as tax-free returns of capital.
- Distributions from EK 01 (foreign tax-free earnings) result in no increase in corporation tax. The resulting dividend is tax-free if made to domestic corporations or to non-resident persons. Withholding tax does arise and is refundable to resident taxpayers, but generally not to non-resident persons.

Examples 1 and 4 below illustrate the above rule and Examples 2 and 3 its exceptions.

Rule No. 2 is that, if the positive amounts in the various equity baskets are insufficient to cover a distribution, the difference is entered as a negative amount in the EK 02 account. Furthermore, amounts so entered trigger corporation tax at the 30 % distribution rate pursuant to rule no. 1 (see Example 4 below).

It is possible, and frequently happens, that a distribution affects more than one equity account under the above rules (because no single account has a balance big enough to cover the entire distribution). The examples given below are very simple ones and avoid such complexities.

Examples illustrating the above principles

It should now be clear why the tax consequences of a constructive dividend can vary so greatly depending on the structure of the equity accounts at the time of the distribution. We should like to further illustrate this by several examples, all of which assume that a royalty fee paid by a German corporation to its foreign parent in the Netherlands is deemed excessive to the extent of DM 70,000 and hence treated as a constructive dividend in this amount. It is further assumed that the German corporation has net income of minus DM 70,000 in the year in which the constructive dividend is made. Thus, even after add-back of the constructive dividend, corporate income is still zero for the year for purposes of both the trade tax on earnings and corporation tax.

Depending on the structure of the equity accounts, it will be seen that the tax burden triggered by the constructive distribution varies between zero and DM 33,500, i.e. up to almost 50 % of the basic amount of the constructive dividend (Example 4). The examples all ignore the solidarity surcharge (7.5 % of corporation tax). They also assume that the recipient is entitled to a reduced rate of withholding tax. If this were not the case, the tax burden as a percentage of the dividend amount can reach as high as 68 % or even 90 % if the distributing subsidiary assumes the withholding tax liability of the dividend recipient (see Examples 1a and 4).

Example 1

Balance in EK 45 is DM 100,000; all other EK balances = 0.

Net amount of constructive dividend                        70.000

Balance in EK 45                                          100.000
Amount withdrawn from EK 45                    55.000     -55.000
Amount remaining in EK 45                                  45.000
Corporation tax reduction on distribution      15.000
Dividend                                       70.000

Latent corp. tax in amount withdrawn from EK 45            45.000
Corporation tax reduction on distribution                 -15.000
Residual corp. tax on amount distributed (not refundable)  30.000
Above, as percentage of sum of net div. and resid.
corp. tax                                                  30,00%

Withholding tax 25 % of net dividend           17.500
Withholding tax - EU rate 5 %                   3.500
Refundable to foreign parent                   14.000
Owing from foreign parent to German sub.       17.500

In Example 1 the constructive dividend results in a net tax saving of DM 11,500. The only tax paid is withholding tax in a net amount of DM 3,500. This is more than offset by the corporation tax refund of DM 15,000 which follows from Rule No. 1 (distribution adjustment, here reduction, of corporate tax on distribution to 30 % of the gross dividend). Please note that, in order to create the amount of DM 55,000 withdrawn from EK 45, the corporation had to earn income of DM 100,000 on which it paid corporation tax of DM 45,000. This corporation tax paid with respect to the amount withdrawn from EK 45 is referred to above as "latent" corporation tax.

Note that the constructive dividend has reduced the balance in the EK 45 account by more than half and hence that insufficient EK 45 is now available to cover a dividend in the same amount next year.

The example is constructed so that the sum of the (net) constructive dividend (DM 70,000) and the corporation tax finally paid (DM 30,000) with respect to the corporate earnings from which the dividend is funded equals DM 100,000. Another way of stating this is that the gross dividend, consisting of the sum of residual corporation tax and the net dividend, equals DM 100,000. The distribution rate of corporation tax (30 %, here DM 30,000) and the corporation tax refund of 15 % (here DM 15,000) relate to the gross dividend, not the net dividend. Note that only DM 55,000 is withdrawn from EK 45 to account for the dividend, the rest coming from DM 15,000 which is refunded to the German corporation as a result of the constructive dividend (reduction from standard to distribution rate of tax).

Withholding tax is, however, calculated on the net dividend. The German corporation owes DM 17,500 in withholding tax, but has a claim for reimbursement in the same amount against its foreign parent. The foreign parent can obtain refund of all but DM 3,500 of this sum. Should, however, the German subsidiary choose to forego its claim for reimbursement of withholding tax paid on behalf of its foreign parent, the amount of the constructive dividend would increase accordingly. This frequently happens in practice and results (based on the equity accounts assumed in the example) in an increase in withholding tax to DM 4,667 as shown in Example 1a. Please note that withholding tax on dividends to 25 % EU parent corporations will be eliminated as of 1 July 1996.

Upon request, the withholding tax rate on distributions to parent companies within the European Union will be reduced to 5 % or, for dividends after 30 June 1996, eliminated entirely if the parent holds a 25 % share in the distributing company. In some cases, a 10 % share is sufficient. This would mean that withholding would be at the 5 % rate or eliminated entirely from the start and no refund procedure would be necessary (sec. 44d EStG).

Example 1a

Same as Example 1, except distributing corporation assumes withholding tax liability of parent.

Net amount of constructive dividend                         70.000
Additional const. div. from withholding tax                 23.333
Total constructive dividend (net)                           93.333

Balance in EK 45                                           100.000
Amount withdrawn from EK 45                     73.333     -73.333
Amount remaining in EK 45                                   26.667
Corporation tax reduction on distribution       20.000
Dividend                                        93.333

Latent corp. tax in amount withdrawn from EK 45             60.000
Corporation tax reduction on distribution                  -20.000
Residual corp. tax on amount distributed (not refundable)   40.000
Above, as percentage of sum of net div. and resid.
corp. tax                                                   30,00%

Withholding tax 25 % of net div.                23.333
Withholding tax - EU rate 5 %                    4.667
Refundable to foreign parent                    18.667
Owing from foreign parent to German sub.             0

Assumption of the withholding tax has two consequences. Firstly, the amount of the non-refundable withholding tax increases by DM 1,667. More importantly, the amount of the net dividend increases to include the entire withholding tax. The withdrawal from EK 45 increases as a consequence. In the above example, the balance of EK 45 is still large enough to cover the increased dividend. If this were not the case, the excess amount would have to be taken from the next equity account in line with a positive balance or, if all have zero or negative balances, from EK 02 (see Example 4 below).

Inside the European Union, the filing of the request under sec. 44d EStG as explained at the end of Example 1 would greatly alleviate (and from June 1996 on eliminate) the above problem.

Example 2

Balance in EK 01 = DM 100,000; all other EK balances = 0. Distribution to foreign parent.

Amount of constructive dividend                            70.000

Balance in EK 01                                          100.000
Amount of net dividend                          70.000
Amount withdrawn from EK 01                     70.000    -70.000
Amount remaining in EK 01                                  30.000

Corporation tax increase/decrease                    0
Residual corporation tax                             0

Withholding tax 25 % of net div.                17.500
Withholding tax - EU rate 5 %                    3.500
Refundable to foreign parent                    14.000
Owing from foreign parent to German sub.        17.500

The distribution out of EK 01 represents foreign tax-free earnings. German law allows the distributing corporation to pass along the tax exemption to its foreign parent, subject to withholding tax in the same amount as in Example 1.

Example 3

Balance in EK 04 = DM 100,000; all other EK balances = 0.

Net amount of constructive dividend                         70.000

Balance in EK 04                                           100.000
Amout of net dividend                           70.000
Amount withdrawn from EK 04                     70.000     -70.000
Amount remaining in EK 04                                   30.000

Corporation tax increase/decrease                    0
Residual corporation tax                             0
Withholding tax                                      0

This transaction is a mere return of capital without any tax consequence except the reduction of the amount in EK 04.

Example 4

All equity accounts have zero opening balances. This is a situation in which many corporations in the start-up phase can find themselves. It is also the situation in which a constructive dividend inevitably leads to considerable tax expense.

Net amount of constructive dividend                        70.000

Balance in all equity accounts                                  0
Amount of net dividend                          70.000
Corporation tax increase 30 %                   30.000

Amount withdrawn from EK 02                    100.000   -100.000
Amount remaining in EK 02                                -100.000

Residual corporation tax (not refundable)                  30.000
Above, as % of sum of net div. + resid. corp. tax          30,00%

Withholding tax 25 % of net div.                17.500
Withholding tax - EU rate 5 %                    3.500
Refundable to foreign parent                    14.000
Owing from foreign parent to German sub.        17.500

In Example 4 the constructive dividend results in imposition of German corporation tax even though the company had no net income for the year. The German tax cost of the dividend is DM 33,500 (sum of corporation tax increase and non-refundable withholding tax) or 48 % of the net dividend paid of DM 70,000. Please note that the constructive dividend of only DM 70,000 reduces the balance in EK 02 by DM 100,000. This is because the tax increase is also deducted from EK 02, the closing balance of which is DM -100,000. The residual corporation tax burden after the distribution is the same as in Example 1 (DM 30,000).

For the reasons explained under Example 1a, the tax owing would climb to roughly 64 % of the net dividend if the subsidiary assumed the withholding tax associated with the dividend. Assumption of the withholding tax on a dividend as to which no reduction in the withholding tax rate was available would send the tax soaring to over 90 % of the net dividend.

Please remember that our calculations ignore the solidarity surcharge and are based on facts in which the constructive dividend does not trigger trade tax. They are thus closer to a "best case" than to a "worst case" scenario.

We hope that foreign managers find the above explanations useful the next time their German tax advisers try to explain to them the consequences of a dividend, whether constructive or declared.

Disclaimer and Copyright
This article treats the subjects covered in condensed form. It is intended to provide a general guide to the subject matter and should not be relied on as a basis for business decisions. Specialist advice must be sought with respect to your individual circumstances. We in particular insist that the tax law and other sources on which the article is based be consulted in the original, whether or not such sources are named in the article. Please note as well that later versions of this article or other articles on related topics may have since appeared on this database or elsewhere and should also be searched for and consulted. While our articles are carefully reviewed, we can accept no responsibility in the event of any inaccuracy or omission. Please note the date of each article and that subsequent related developments are not necessarily reported on in later articles. Any claims nevertheless raised on the basis of this article are subject to German substantive law and, to the extent permissible thereunder, to the exclusive jurisdiction of the courts in Frankfurt am Main, Germany. This article is the intellectual property of KPMG Deutsche Treuhand-Gesellschaft AG (KPMG Germany). Distribution to third persons is prohibited without our express written consent in advance.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
Related Articles
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions