Withholding Tax Relief at Source in Hybrid Structures: Unannounced Shift in Administrative Practice

Background

In recent months, taxpayers and advisers have observed a more restrictive approach by the BZSt when processing applications for withholding tax relief (both exemption certificates and refunds) in Germany/US structures where:

• the German distributing entity is a corporation under German law, but
• is treated as fiscally transparent or disregarded for US federal income tax purposes (e.g., under US check-the-box rules), and
• treaty relief under the Germany-US tax treaty is claimed by the US parent.

Under prior administrative practice, such structures were commonly regarded as eligible for treaty relief, provided the applicable treaty requirements (including limitation-on-benefits and anti-treaty-shopping rules) were satisfied.

No official announcement or published guidance

A particularly critical aspect of the current development is that the apparent change in practice has not been accompanied by any official communication from the BZSt. To date, there has been no circular letter, no administrative decree or other kind of formal announcement indicating a revised position on treaty relief in the context of German entities treated as transparent for US tax purposes. Instead, the change has become visible only through individual case handling, most notably through the denial of exemption certificate applications and refund claims that, based on previous experience, taxpayers would have expected to be approved.

Technical rationale underlying the denials

Based on current case experience, the BZSt appears to focus in particular on the treaty requirements applicable to hybrid entities, taking the view that treaty relief is available only if the relevant income is treated as income at the level of the US recipient for US tax purposes.

Where a German entity is treated as transparent or disregarded for US purposes, the BZSt may consider this condition not to be satisfied, even though the German entity is regarded as the relevant taxpayer under German law. This interpretation is applied in addition to - not instead of - the existing requirements under:

• the Germany-US tax treaty (including limitation-on-benefits provisions), and
• German anti-treaty-shopping rules.

Structures most affected

The practical risk appears to be highest in cases involving:

• dividend distributions by German subsidiaries,
• direct ownership by a US corporation, and
• a classification mismatch, where the German entity is a corporation for German tax purposes but fiscally transparent or disregarded for US tax purposes.

While the issue has been most prominently observed in the context of dividends, there is also discussion as to whether similar considerations could arise in relation to other cross-border payment types, depending on the specific facts.

Practical implications

The unannounced shift in administrative practice has several immediate consequences:

• Pending and new exemption certificate applications face an increased risk of denial, even if comparable applications were approved in the past.
• Existing exemption certificates may not automatically be revoked, but renewals and future applications may be scrutinised more closely.
• Where relief at source is denied, taxpayers may need to revert to withholding followed by a refund claim, resulting in cash-flow disadvantages and timing uncertainty.
• The absence of formal guidance makes it difficult to assess whether the BZSt views this approach as a permanent reinterpretation or an interim position.

Recommended actions

In light of the current uncertainty, affected groups should consider the following steps:

• Identify potentially impacted structures

Review German payor entities with US parents where the German entity is treated as fiscally transparent or disregarded for US tax purposes.

• Reassess treaty entitlement

Analyse whether the treaty requirements relating to hybrid entities can be robustly supported on the specific facts, including the treatment of income at the level of the US recipient.

• Strengthen documentation

Prepare comprehensive application files addressing ownership, income characterisation, US tax treatment, limitation-on-benefits compliance and German anti-treaty-shopping considerations.

• Consider structural alternatives

Where commercially feasible, evaluate whether adjustments to the holding structure (e.g., interposing a regarded entity) could mitigate denial risk. Any such steps require careful coordination with US tax, accounting and legal considerations.

• Plan for cash-flow impact

Model the effect of potential withholding and delayed refunds and factor this into dividend planning and treasury management.

We are happy to support you in connection with any questions or challenges arising in ongoing exemption or refund procedures. In the case of imminent profit repatriations, it may also be advisable to evaluate alternative structuring options to a dividend distribution and the related exemption process.