BDO Corporate Tax News

The German Federal Fiscal Court (BFH) has upheld a lower court ruling that significant benefits US shareholders of S corporations with German subsidiaries. Under the Germany-US tax treaty, these shareholders may be entitled to a full refund of German withholding tax on dividends—confirming access to the 5% or 0% treaty rate, rather than the 15% rate applicable to individuals.

Background

U.S. small and medium-sized businesses frequently operate through S corporations, where income is taxed transparently at the shareholder level. From a German perspective, however, an S corporation is treated as a corporation, not a transparent entity—thus creating a hybrid entity. This mismatch has long complicated the withholding tax treatment of dividends paid by German subsidiaries (e.g., GmbHs) to US S corporations.

Withholding Tax Rates Under the Treaty

The Germany-US tax treaty provides for the following withholding tax rates on dividend distributions:

• 15% on dividends paid to individuals; and
• 5% or 0% on dividends paid to corporations.

In 2013, the BFH ruled in a similar case that Germany’s classification of the receiving entity is decisive: an S corporation is a corporation so the corporate rate applies. Germany subsequently introduced Section 50d (1), sentence 11 of the Income Tax Act (EStG) (now Section 50d (11a) EStG). This provision stipulates that, in the case of hybrid entities, “the right to … a refund … is available only to the person to whom the investment income … is attributed as income or profits of a resident under the tax laws of the other contracting state.” Thus, the question arises whether this provision is procedural (i.e., who files the claim) or substantive (i.e., who is entitled to the reduced withholding tax rate). If the former, the right to the reduced rate to which an S corporation, as a corporation, is entitled is attributed to another person but if the effect is substantive, as the German tax authorities maintain, only the shareholder (individual) is entitled to the less favourable tax relief.

Decision

In a 2022 decision, the Cologne Fiscal Court held that Section 50d (1), sentence 11 EStG, as previously in force, only had procedural effect, and this was confirmed by the BFH in its decision dated 11 March 2026 (published on 28 May). The BFH held that although an S corporation is a hybrid entity, it is eligible for treaty benefits. Section 50d (1), sentence 11 EStG, as previously in force, does not shift the attribution of income under domestic or treaty law. The legal consequence of the provision is thus limited to determining which person was actually able to assert the treaty-based claim. As a result, in the case of S corporations, the corporate tax rate (5% or 0%) applies, but the individual shareholder must file the refund request.

BDO Perspective

The BFH’s decision resolves long-standing uncertainty and curtails the German tax authorities’ restrictive interpretation. Because the decision is not yet published in the Federal Tax Gazette, it is not automatically applied by the tax authorities. Until publication, it is important to keep relevant cases open, assert the tax rate applicable to corporations (5% or 0%) and ensure refund claims are filed by the individual shareholder.

Claudia Kachur
Mechthild Pietrek
BDO in Germany