The Court of Justice of the European Union (CJEU) recently ruled that German withholding tax on dividends from domestic corporations to nonresident pension funds may restrict the free movement of capital (C-641/17, College Pension Plan of British Columbia v Finanzamt München Abteilung III). Foreign pension funds affected should be able to reclaim German taxes on dividends withheld.
Background: Taxation of pension funds in Germany
German resident pension funds
Domestic pension funds are subject to unlimited corporate income tax liability. They do not benefit from the participation exception enshrined in Sec. 8b of the German Corporate Income Tax Act, which in general applies to all corporations. But the recognition of pension provisions as liabilities de facto exempts their dividend income. Typically, investment income arising from the capital stock of a pension fund is directly credited to the relevant beneficiary. This income therefore directly increases the pension fund’s obligation to the beneficiary. Therefore, the dividends increase not only the pension fund’s assets, but also the value of the actuarial pension provisions on the liabilities side of its tax balance sheet. This completely neutralizes the dividend income for tax purposes.
Taxes on dividends are also withheld if the recipient is a domestic pension fund. But a domestic pension fund may claim full reimbursement of the withholding tax via an assessment procedure for corporate income tax.
Nonresident pension funds
Nonresident pension funds are not eligible for this assessment procedure. Since the withholding tax on dividends has a compensatory effect for foreign corporations, the tax burden is final and foreign pension funds may not deduct any expenses which are directly linked to the received dividends.
Recent CJEU decisions
The CJEU has ruled in several cases with regard to withholding tax on dividends where the recipient was a pension fund.
In 2012, the CJEU ruled that the Finnish regulations restricted the free movement of capital (C-342/10, European Commission v Republic of Finland). Finnish pension funds received dividends de facto tax-free as the investment income simultaneously increased the funds’ pension provisions. The increase in the provisions qualified as tax-deductible expenses which neutralized the dividend income in full. By contrast, nonresident pension funds were subject to a withholding tax on dividends at a rate of 19.5% – or a reduced rate under an applicable double tax treaty – which could not be reduced by any deductions.
In 2016, the CJEU took the view that also the Swedish regulations infringed the free movement of capital (C-252/14, Pensioenfonds Metaal en Techniek v Skatteverket). The Swedish regime was quite similar and allowed resident pension funds to deduct expenses directly related to dividends whereas nonresident pension funds were not entitled to do so.
The CJEU already had the German withholding tax regime in its sights. In 2012, the European Commission launched an infringement procedure against Germany (C-600/10, European Commission v Federal Republic of Germany). The Commission addressed the issue of discrimination between nonresident and resident pension funds. It argued that nonresident pension funds were treated less favorably as they were not permitted to deduct expenses which were directly linked to received dividends. However, the Commission had wrongly excluded expenses arising from pension provisions recognized as liabilities. The Commission was subsequently unable to prove that the free movement of capital was restricted by the German rules.
Nevertheless, German tax experts were convinced that the German withholding tax regime was contrary to European law as it had a lot in common with the Finnish and Swedish regulations. In that sense, the current judgment seems to be a long-awaited correction of the 2012 decision.
Current CJEU decision
The German withholding tax regime on dividends came before the CJEU for a second time. The plaintiff in the case was a Canadian trust (College Pension Plan of British Columbia), which had a legal structure comparable to that of a German pension fund. The purpose of the trust was to provide pensions to former officials of British Columbia Province, for which it also recognized pension provisions in its balance sheets, corresponding to its pension guarantee commitments. The trust’s profits were tax-exempt in Canada.
In the years in dispute – 2007 to 2010 – the trust received dividends from German stock corporations (shareholdings were less than 1%), which were subject to withholding tax of 15% under Art. 10 para. 2 (b) of the Double Tax Treaty between Germany and Canada. The trust applied for a refund of the withheld tax, but this was rejected by the competent tax office.
As expected, the CJEU regards the less favorable treatment of nonresident pension funds (see above) as a restriction on the free movement of capital. This is justified only if the difference in treatment covers situations that are not objectively comparable. According to the CJEU, a nonresident pension fund is in a situation comparable to that of a resident pension fund if it allocates dividends received to pension provisions that it will have to pay in the future, intentionally or pursuant to the law in force in its state of residence.
Consequences of the decision for pension funds and other corporations
The chances are good that foreign pension funds will receive a refund of taxes withheld in the past. So pension funds affected should appeal against tax assessments that are not yet time-barred.
German tax literature expects the legislature to introduce an opportunity for foreign pension funds to deduct expenses that are directly linked to dividend income (in particular expenses arising from the recognition of pension provisions). It would not make sense to limit this regulation to foreign pension funds since other foreign corporations also have expenses that are linked to received dividends. But so far, neither the German legislature nor the German tax authorities have reacted to the CJEU decision.