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Taxation of free-float dividends

Dividend income or profit distributions that a corporation receives from its shareholding in another corporation are generally exempt from corporation tax. The aim of this exemption procedure is to ensure that the operating profits that are generated at the lowest shareholding level are not repeatedly subject to tax on all the shareholding layers. However, the prerequisite for an exemption is that, at the beginning of a calendar year in which the dividends are received the share-holding in the share capital has to be at least 10%. If the size of the shareholding falls short of this level then the tax exemption would not apply to the distributions that are received from it but, instead, as so-called free-float dividends they would be subject to regular taxation (Section 8b(4) sentence 1 of the Corporation Tax Act [Körperschaftsteuergesetz, KStG]).

Issue – Late payment of purchase price due to bank errors 

In a case that was recently heard by the Federal Fiscal Court (Bundesfinanzhof, BFH), the GmbH [German limited liability company] making the claim had a shareholding, in 2013, of just under 10% in an AG [German stock corporation]. From 2014, the GmbH wanted to receive the expected dividend income free of tax and, therefore, increased its shareholding in the AG to just over 10% by purchasing the additional shares from another shareholder via an agreement dated 16.12.2013. The AG approved the transfer of the shares on 19.12.2013. The effectiveness of the purchase agreement was however subject to the satisfaction of the condition precedent of payment of the purchase price. The electronic bank transfer of the purchase price was admittedly carried out by the GmbH already on the date when the agreement was concluded, namely, on 16.12.2013. Yet, the vendor’s account was not credited until after 1.1.2014 because of a bank error.

The local tax office did not agree with the way the GmbH had treated the dividend income it had received and did not allow the tax exemption. This was because, in the opinion of the local tax office, the income constituted free-float dividends on account of the fact that at the start of 2014 the GmbH did not have a direct shareholding in the AG of at least 10%.

The crucial factor is beneficial ownership

In consequence of the late payment of the purchase price, at the start of 2014 the GmbH had admittedly not yet attained ownership under civil law of the additional shares that had been purchased. Nevertheless, contrary to the opinion of the local tax office, the BFH decided in its ruling of 7.6.2023 (case reference: I R 50/19) that for the question of the size of the shareholding at the start of the year what matters is not the ownership under civil law, but rather the beneficial ownership. According to this, an asset has to be attributed to the party that effectively controls this asset in such a way that the party is generally able to economically exclude the owner (under civil law) from affecting the asset during the normal period of its useful life. 

In the case in question, the BFH was of the view that this criterion had been satisfied. The legislation (Section 20(5) EStG) already specifies that a shareholder is the one to whom the shares can be attributed according to the principles of beneficial ownership. Moreover, following the conclusion of the purchase agreement the GmbH had expectancy rights and the vendor would not have been able to easily withdraw from the contract. 

Please note: The BFH rejected the argument by the local tax office that attributing the shares on the basis of beneficial ownership was not relevant in the present case because the factual basis for the assumption of free float draws on civil law concepts such as share capital.

Recommendation: To avoid taxable free-float dividends it is also possible to make an additional purchase during the course of the year that, according to Section 8b(4) sentence 6 KStG, would be regarded as having been executed at the start of the calendar year if the additional shareholding that is purchased constitutes at least 10% of the share capital.

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