Withholding tax deduction for third-country companies before the ECJ

There has been considerable legal uncertainty for some time now regarding the withholding of capital gains tax on dividends paid to companies in third countries. The German Federal Fiscal Court (BFH) has now taken the opportunity to refer fundamental questions to the Court of Justice of the European Union (CJEU) for review in its decision of June 3, 2025 (case no. VIII R 21/22).

In the ongoing proceedings, a Japanese corporation was the sole shareholder of a German corporation and received dividends from it in the disputed years 2009 to 2011. In accordance with the provisions of the double taxation agreement (Section 10 (2) DTA Japan 1966, DTA), the distributing German company withheld 15% capital gains tax from the dividends and paid this to the tax authorities. This had a definitive effect in Germany; in Japan the company was able to offset the withholding tax retained in Germany against Japanese corporate income tax. However, following a change in Japanese law, such dividends were 95% tax-free from April 1, 2009. The offset, which was possible in principle, was largely ineffective in view of the low Japanese tax rate.

As a result, the Japanese corporation considered itself to be at a disadvantage compared to German parent companies that receive dividends from German subsidiaries, as the latter are entitled to a credit and, if applicable, a refund of capital gains tax when assessing their corporate income tax. Thus, the withholding of capital gains tax constituted a violation of the freedom of capital movement applicable in view of the direct investment in question (participation in a German corporation) pursuant to Article 63 of the Treaty on the Functioning of the European Union, and the withheld capital gains tax should be refunded to it. The tax court took a different view and dismissed the action seeking the issuance of exemption notices.

The BFH considers several legal issues to be doubtful under EU law:

• The central question is first of all whether freedom of establishment overrides freedom of capital movement as a test criterion. This is because the Japanese company, as a company based in a third country, cannot invoke freedom of establishment.
• If the free movement of capital is applicable, however, it is doubtful whether the withholding tax deduction constitutes a violation of this freedom. This is because the DTA still provides for German capital gains tax to be credited against Japanese corporate income tax, which is only ineffective due to changes in Japanese domestic law.
• In the event of a violation or restriction of the free movement of capital, the BFH is of the opinion that the withholding of German capital gains tax is justified by the allocation of taxation rights under the DTA with Japan, but, in view of the ECJ's previous case law on dividend distributions between companies of two Member States, has doubts as to whether this assessment is compatible with EU law. It should also be taken into account that the Japanese parent company would be granted double benefits on the dividend due to the Japanese tax exemption already claimed when the withholding tax is refunded.
• Finally, in the event of an unjustified restriction, the reimbursement modalities must be assessed. Reimbursement would probably only be considered in the amount of the German capital gains tax that is not creditable in Japan. A refund of the withheld capital gains tax would therefore have to be made conditional on the Federal Central Tax Office being able to verify the information provided by the parent company on the basis of an exchange of information with the Japanese tax authorities. However, as this goes beyond the requirements for German parent companies, it could constitute an independent restriction on the free movement of capital.