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In one of its rare decisions on commercial accounting law, the German Federal Court of Justice (Bundesgerichtshof) held more than 20 years ago that a parent company was under certain circumstances entitled to show a dividend receivable from its controlled subsidiary even though no shareholder resolution had yet been adopted by the subsidiary authorising the dividend. The general idea behind the concept was that, provided certain definite indications were present, the subsidiary intended to declare a dividend for the fiscal year just elapsed, that the parent should show the dividend as received in the same fiscal year for which it was paid.
The specific requirements of this practice, which became known as congruent dividend reporting (phasengleiche Vereinnahmung) are as follows:
- The parent must hold a majority interest in the subsidiary and so be able to vote the dividend as a practical matter.
- The management of the subsidiary must have presented a formal dividend recommendation before completion of the audit of the parent's year-end accounts.
- Both companies must have the same fiscal year.
For commercial accounting purposes, congruent dividend reporting by the parent has been regarded as an option, not a requirement, whereas for tax purposes it became mandatory. Absent the doctrine of congruent dividend reporting, a dividend is treated as income in the fiscal year in which the corresponding distribution resolution is passed. Since, however, such resolutions must be based on the year-end accounts as prepared by management and approved by shareholders (and audited, where this is required), the distribution resolution cannot occur until after the end of the fiscal year. Congruent dividend reporting is thus a virtual necessity if a dividend paid in Year 02 with respect to the results of Year 01 is to be reported as revenue in Year 01 by a parent company having the same fiscal year.
It now seems possible that congruent dividend reporting conflicts with EU law, specifically the relevant provisions of the 4th EEC Directive. The second civil chamber of the Federal Court of Justice has referred the question to the European Court of Justice for its decision. In late February of this year, the final motions to the European Court of Justice by the Counsel General became public. The Counsel General argued strongly and cogently against congruent dividend reporting on classical accounting grounds stating that, until actual approval of the dividend by shareholder resolution, no legal right to the dividend exists on the part of the parent company and that therefore the basic accounting principle of conservatism precludes recognition of income.
The arguments of the General Counsel have been widely reported on in Germany and the apprehension that the European Court of Justice will follow these arguments is considerable. The uncertainty surrounding the issue has led, for instance, to doubt whether accounting firms can give an unqualified certification of accuracy to financial statements prepared assuming the validity of congruent dividend reporting.
An end to congruent dividend reporting would cause tax problems of at least two sorts. The first relates to the taxes payable and the credits available with respect to dividends. The distributing company must remit withholding tax on a dividend at a rate of 25 % when the dividend is due for payment according to the terms of the authorising resolution or, if the resolution fixes no date, at the time of the resolution itself (sec. 44 par. 2 EStG). Withholding tax is creditable for resident recipients (and for non-residents holding the shares in a domestic permanent establishment including that of a partnership in which they are a partner). However, if a dividend paid early in the year is reportable as income of that year, then the credit will not be received until the return for the current year is filed. The same is true of the corporation tax credit carried by the dividend. To some extent these timing problems can be minimised by planning and by filing requests to abate tax prepayments, if any are owing. It is, however, much simpler to report the dividend received, e.g. in January of Year 02 as income of Year 01 under the principles of congruent dividend reporting.
The second problem relates to corporate groups which have planned to net losses in a parent company against dividends received from profitable subsidiaries. Absent congruent dividend reporting, the dividend expected to be received in Year 01 will not "arrive" until Year 02, which creates great potential for mismatching of profits and losses, hence for additional taxes. Here a possible solution is to effect tax consolidation of the companies involved, but this is subject to requirements which may be difficult to meet. Another solution might be to have the subsidiary's fiscal year end before that of the parent. Finally, it is possible for German limited liability companies (GmbH) to distribute advance dividends (Vorabdividenden) before the end of their fiscal year. For stock corporations (AG), the possibilities here are very restrictive.
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