Dividends from shares are taxable for shareholders, even if the dividends do not remain with them economically.

This (not entirely new) finding can be gleaned from a recent Federal Fiscal Court (BFH) ruling in which the BFH specified who is considered a shareholder: The person who objectively and in fact is entitled to the essential rights of the share. In contrast, subjective intentions are irrelevant, so it is irrelevant whether the shareholder wishes to exercise their voting rights at general meetings.

Background: Shareholders Pay Tax on Dividends Depending on Their Investor Category

Dividends are taxed by the “shareholder” of shares (Section 20(5) of the German Income Tax Act (EStG)). This is usually the civil law owner, who is also the beneficial owner. However, if the beneficial owner (Section 39(2) No. 1 of the German Fiscal Code (AO)) differs from the civil law owner, the beneficial owner is the shareholder. The beneficial owner is the person who is entitled to the essential administrative and property rights associated with the share (particularly the right to receive dividends and the right to vote) and who can therefore exclude the civil law owner from the economic use of the share.

The taxation of dividends for shareholders depends on their investor category. The following generally applies:

• Private investors pay withholding tax at a rate of 25%.
• Natural persons who hold shares as business assets pay tax on dividends under the partial income procedure. Dividends are 40% tax-free and subject to the individual income tax rate of up to 45%, which in many cases results in a similar tax burden to that of private investors.
• (Domestic) legal entities and other investors subject to a corporate income tax receive 95% of dividends tax-free (Section 8b of the German Corporation Tax Act (KStG)), provided these are not smaller investors (a threshold of 10% for corporate income tax and 15% for trade tax).

The distributing public limited company must withhold a 25% withholding tax in all cases. While this generally has a final effect for private investors, in the other two cases the withholding tax is offset against the income tax or corporate income tax liability.

What Did the BFH Decide?

In its judgment, the BFH considered the civil law owner of shares to be the tax shareholder, as well as the beneficial owner. For a deviating beneficial ownership, it was not sufficient that the civil law owner passed on the dividends received from the shares in full and did not retain any income from the shares.

Circumstances of the Case

In the case in dispute, the plaintiff (a public limited company) transferred fixed-interest securities to its bank by way of a loan. As security, the plaintiff received shares from the bank’s portfolio, which were selected by employees of the plaintiff in such a way that the plaintiff was the owner of the shares on the dividend date. The shares were then exchanged for shares for which the dividend date was still pending. The plaintiff had unrestricted power of disposal over the shares transferred as collateral and could exercise the voting rights attached to them but did not do so and did not intend to do so. Upon termination of the securities loans, had to transfer back shares of the same type and quantity. The plaintiff also had to pass on dividends received to the bank at the same time and in the same amount and pay an “arrangement fee” of 2.2% of the dividends to the bank.

Determining the Tax Shareholder

In the taxation and subsequent court proceedings, there was disagreement as to who was the shareholder of the transferred shares as collateral and what tax consequences would be drawn from the transaction.

The plaintiff wanted 95% of the dividends to be treated as exempt from corporate income and trade tax (in the disputed year 2006 as the above mentioned full tax liability on dividends from shares below 10% and 15% respectively did not yet apply) and the payments to the bank (forwarding dividends and payment of arrangement fees) to be treated as tax-deductible operating expenses. This would result in a tax advantage for the plaintiff.

The tax office did not want to recognise this tax advantage because it considered the transactions as a whole to be an abuse of tax planning schemes (Section 42 of the AO).

The Munich Fiscal Court dismissed the action because it considered the bank to be the economic owner (the tax shareholder) to whom the shares were attributable because the bank received the dividends economically. However, the parties had not intended for the shares to be used or the economic opportunities and risks to be transferred to the plaintiff. The dividends and their transfer were only transitory items. The plaintiff had neither received tax-free dividends nor incurred tax-deductible operating expenses.

BFH: A Shareholder Is Someone Who Can Exercise the Rights associated With the Shares

The BFH considered the plaintiff to be the shareholder. This is because it is irrelevant for the determination of the shareholder whether the civil law owner or economic owner subjectively intends to exercise the rights associated with the shares. Instead, it must be asked whether the civil law owner has the legal powers and whether they can actually exercise them. This was the case with the plaintiff, who, as the civil law owner of the shares, was also entitled to sell them or exercise their voting rights at general meetings, for example.

Whether there was an abuse of tax planning schemes under Section 42 of the AO (as the tax office believes) must now be clarified by the Munich Fiscal Court in the second instance, to which the BFH referred the case back. The Munich Fiscal Court now has to find whether the plaintiff and the bank can prove that the transactions also had a purpose other than achieving the tax advantage described.

Outlook for Practice on the Correct Determination of the Shareholder

The BFH’s ruling will be referred to even more frequently when it comes to determining shareholders, primarily for the following three reasons:

1. A shareholder can also be someone who is obliged to forward any dividend income.
2. A shareholder only must be able to exercise the rights attached to the share. They do not have to actually exercise them or have such intentions. The BFH thus confirms its ruling issued on 29 September 2021 (Ref.: I R 40/17). To correctly determine the shareholder, particular attention must be on which rights the shareholder can objectively exercise, even if they may subjectively have other plans. According to the BFH, the Munich Fiscal Court had wrongly examined what the plaintiff intended to do with the shares and not what rights they actually had.
3. The BFH held that the designation of the share transfer as a security (regardless of the wording of Section 39(2) No. 1 sentence 2 of the AO) does not lead to the shares being attributed to the security provider (the bank) because, unlike in typical cases of security ownership, the plaintiff was entitled to sell the shares even if a default event did not occur.

Whether the specific tax structure constitutes an abuse of tax planning schemes within the meaning of Section 42 of the AO is to be clarified by the Munich Fiscal Court in the second instance. However, under current law, the disputed tax advantage could no longer be achieved through the specific arrangement because dividends from smaller shares are taxable (Section 8b(4) of the KStG) and the transfer of dividends would no longer be a deductible operating expense (Section 8b(10) of the KStG).