158. Dual Resident Corporation: Dividends Exempt from German Withholding Tax

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In a case decided under the old version of the German-American tax treaty, the Federal Tax Court has held that dividends paid by a corporation organised in the United States under the law of one of its states are exempt from German withholding tax even if the corporation has its principal place of management in Germany and is, by this fact, subject in principle to tax in Germany on its worldwide income (DB 1998, 1495 - 24 March 1998).

Under a line of cases beginning in 1992, entities organised under foreign law are treated as subject to German corporation tax if they sufficiently resemble typical German corporations with respect to their legal structure and economic role even if, under German choice of law principles, Germany does not recognise their separate legal existence. Sufficient resemblance exists in the case of corporations organised under U.S. law (U.S. corporations), which are therefore subject to German corporation tax. If a U.S. corporation has its principle place of management in Germany, it is subject to German tax on its worldwide income under sec. 1 (1) KStG. For details see articles nos. 40 and 94.

In the case before the court, a U.S. corporation with its principal place of management in Germany paid dividends in the years 1987 and 1989 to its U.S. parent corporation, whose principal place of management was not in Germany. The distributing corporation withheld 25 % tax and remitted this to the German tax authorities. The parent requested a full refund under Art. XIV (2) of the German-American tax treaty in force prior to 1990. The tax authorities allowed only a partial refund (reduction to 15 % withholding). In the ensuing litigation, the tax authorities were upheld by the Cologne Tax Court.

The Federal Tax Court reversed the lower court and held that the dividends were free of German tax because paid by an "American corporation" within the meaning of Art. II (1) (e) of the old tax treaty, which defines "American corporations" as corporations formed or organised under the laws of the United States, its constituent states, or its territories. The distributing corporation met this requirement. It was, at the same time, a "German corporation" under Art. II (1) (f) of the tax treaty.

Art. XIV (2) of the German-American tax treaty in force prior to 1990 prohibits German taxation of dividends paid by "American" corporations unless paid to German persons, which was not here the case. Were it not for Art. XIV (2), the court reasoned, the U.S. corporation receiving the dividend would suffer double taxation because the German withholding tax paid by its subsidiary would not be creditable under U.S. law since the subsidiary was itself a U.S. corporation. The court therefore viewed Art. XIV (2) as avoiding double taxation by providing that Germany would impose no withholding tax.

The court construed the statute literally in spite of the negative impact on the German treasury, noting that the Federal Republic is a nation under the rule of law which must abide by the laws which it has ratified.

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