A domestic company which holds a stake in foreign partnerships and receives tax-exempt dividends or capital gains from them must nevertheless accept a flat-rate addition of notional business expenses. This applies even if the income in question is exempt from tax in Germany under a double taxation agreement (DTA). This was ruled by the Münster Finance Court in its judgement of 23 June 2026 (Ref. 9 K 552/22 K).
What was the case about?
A domestic company held shareholdings in a large number of private equity firms abroad. Some of these companies carried on business and maintained permanent establishments abroad. The dividends, write-ups and capital gains derived therefrom were exempt from tax in Germany under the relevant double taxation agreements and were therefore not taken into account for German tax purposes.
Nevertheless, during a field audit, the tax office added a flat-rate amount for business expenses. This was based on section 8b(3), first sentence, and section 8b(5), first sentence, of the Corporation Tax Act (KStG). These provisions stipulate that 5 per cent of tax-exempt dividends and capital gains are treated as non-deductible business expenses, and are therefore added to taxable income. The company contested this, arguing that this notional treatment should only apply if the hypothetical expenses, had they actually been incurred, would have been subject to German tax. In the case of permanent establishments exempt under a double taxation agreement, this was not the case.
Court sides with the tax office
The Münster Finance Court dismissed the claim. In the judges’ view, Section 8b of the Corporation Tax Act (KStG) does not depend on whether the notional expenses would, in functional terms, be attributable to a foreign permanent establishment. The provision deliberately applies a flat-rate approach and expressly excludes proof that the actual expenses were lower.
It is also crucial that the so-called ‘domestic connection’ is established not by the DTA, but by the unlimited liability to corporation tax under section 1(2) of the Corporation Tax Act (KStG). The exemption under the DTA does not, in substance, affect this domestic tax status. To put it another way: the DTA determines whether Germany is entitled to tax the company, not whether the company is subject to tax at all. As the company is subject to unlimited tax liability in Germany, the addition rule applies regardless of which state is assigned the right of taxation under the DTA.
What does this mean in practice?
This judgement has significant consequences for companies that hold shares in foreign partnerships or private equity funds. Even if the income generated is fully exempt from German tax under the terms of a tax treaty, a tax liability amounting to 5 per cent of the tax-exempt income remains. This seemingly paradoxical consequence is a deliberate feature of the system, but is often overlooked in practice.
The tax treatment should be carefully examined, particularly in the case of shareholding structures involving several foreign tiers and differing double taxation agreement (DTA) rules. Anyone holding or planning to hold such shareholdings should take the implications of Section 8b of the Corporation Tax Act (KStG) into account at an early stage in their tax planning. The judgement is not yet final; it is not currently known whether an appeal will be lodged.
If you have any questions regarding the corporation tax treatment of foreign shareholdings and the distinction between tax treaty exemptions and domestic tax adjustments, it is advisable to seek individual tax advice.
Source: Haufe: Tax
This post and the accompanying image were created with the help of AI and have been editorially reviewed.
