In a pivotal ruling, Germany’s Federal Financial Court (Bundesfinanzhof) has recently declared that foreign investment funds are entitled to a refund of dividend withholding tax previously paid. This decision, which addresses a longstanding issue of discriminatory tax practices against foreign investment funds for dividends received prior to 2018, marks a significant milestone in upholding equitable treatment under EU law. With substantial sums at stake, the refunds could lead to an increase in fund basis-points, offering a long-overdue remedy for years of unfair taxation.
Background: The Legal Battle
The landmark ruling was precipitated by a case involving French and Luxembourg investment funds that had received dividends from German corporations. Unlike their domestic German counterparts, these funds were subjected to withholding tax, despite the exemption granted to German investment funds during the same period.
The affected funds sought a refund of the tax withheld between 2008 and 2013, arguing that the denial of this refund was a violation of EU law, specifically the principle of free movement of capital as enshrined in Article 63 of the Treaty on the Functioning of the European Union (TFEU).
The taxpayers’ claims were initially rejected by the lower courts, which determined that foreign investment funds were not in a comparable position to domestic funds and therefore did not qualify for the exemption. However, the Bundesfinanzhof overturned this decision, referencing European Court of Justice (ECJ) case law that mandates non-discriminatory treatment of EU-based entities.
The Court’s Decision
The Bundesfinanzhof’s ruling was unequivocal: foreign investment funds must not be treated less favourably than their domestic counterparts. The court emphasised that such differential treatment is incompatible with the EU’s principle of free movement of capital. As a result, the taxpayers were awarded a refund of the withholding tax, along with 6% annual interest on the amounts withheld.
The Bundesfinanzhof has remanded the case to the Hessian Tax Court to calculate the interest in accordance with its guidelines. Additionally, the lower court is tasked with evaluating whether the claimant was indeed subject to a withholding tax burden in all instances.
This decision aligns with the judgement published in February concerning the corporate taxation of specialised EU real estate investment funds where the court ruled on similar grounds of discrimination.
The Broader Implications
The Bundesfinanzhof’s decision is expected to have a significant financial impact, with potential refunds likely to exceed billions. According to a report by the German business journal WirtschaftsWoche on August 22nd, Germany’s Federal Audit Office estimates refund demands to be at least 4 billion EUR.
For foreign investment funds operating within the EU, this decision is a welcome affirmation of their rights to refunds and interest compensation under European law. It is worth noting that the unequal treatment of foreign investment funds in Germany was addressed and eliminated by the reform of the German Investment Tax Act in 2018. Following this reform, both foreign and domestic investment funds are now taxed at a rate of 15% on German dividends.
Interest on these refunds will continue to accrue until payments are made. However, the Federal Tax Office (BZSt) is anticipated to process these applications only after the lower Hessian Tax Court has concluded the related proceedings.
Conclusion
The Bundesfinanzhof’s ruling represents a crucial victory for foreign investment funds and highlights the importance of harmonising national tax policies with EU principles. As the effects of this decision continue to unfold, it will be essential for investment funds to remain vigilant, particularly in monitoring and responding to any requests from the Federal Tax Office regarding previously filed reclaims for dividends paid before January 1, 2018.
The forthcoming decision in a case currently under review at the Hessian Tax Court involving a U.S. Regulated Investment Company, will be of particular interest to investment funds domiciled outside the EU.
For further insights into the implications of the recent court rulings on your German ECJ reclaims, reach out to WTax’s regional specialists.
