Participation Exemption (Schachtelprivileg): Requirements, Limits and International Aspects

• The participation exemption (Schachtelprivileg) exempts 95% of dividends and capital gains (Veräußerungsgewinne) between corporations from tax, in order to avoid multiple taxation within chains of shareholdings.
• For corporation tax purposes, a minimum shareholding of 10% applies to dividends, whereas no minimum threshold applies to capital gains – for trade tax purposes the threshold is 15%.
• If the relevant minimum shareholding is not met, the tax exemption is lost in full rather than merely proportionately – the dividend then becomes taxable in its entirety (portfolio dividend, Streubesitzdividende).

What is the participation exemption?

The participation exemption (Schachtelprivileg) is a tax relief under which dividends and capital gains (Veräußerungsgewinne) from shareholdings between corporations are exempt from tax to the extent of 95%. The legal basis is § 8b KStG: where a corporation receives a distribution from another corporation, 95% of that distribution remains tax-exempt, and only 5% is treated as a flat-rate non-deductible business expense and is subject to taxation. Unlike the partial income procedure (Teileinkünfteverfahren), under which only 60% of the actual income-related expenses are deductible, business expenses connected with the shareholding are fully deductible under the participation exemption, because § 3c Abs. 1 EStG does not apply here by virtue of § 8b Abs. 5 Satz 2 KStG.

The purpose of this provision lies in avoiding multiple taxation within corporate structures with several shareholding tiers. Without the participation exemption, the same profit earned would be fully taxed again on each onward distribution along a chain of shareholdings – in a multi-tier holding structure, the tax burden could thus multiply with every tier. The participation exemption breaks this cascade effect and, in the result, places the profit in approximately the same position as if it had been taxed only once.

An example illustrates the effect: a subsidiary GmbH distributes a profit of EUR 500,000 to its parent holding company. Without the participation exemption, this distribution would be fully charged with corporation tax and trade tax at a combined rate of around 30% at the level of the holding company, so that tax of around EUR 150,000 would arise. With the participation exemption, only 5% of the distribution – that is, EUR 25,000 – is taxable at all; at a burden of around 30% on this partial amount, tax of only around EUR 7,500 arises. The effect therefore corresponds to an effective tax burden of only around 1.5% on the distribution as a whole.

In which cases does the participation exemption apply?

For the participation exemption, the decisive question is primarily whether a current profit distribution or a capital gain is involved; within these two categories, the relevant type of tax and the legal form of the shareholder are additionally relevant.

• Profit distributions (dividends): In the case of distributions by one corporation to another corporation, the 95% tax exemption under § 8b Abs. 1 i. V. m. Abs. 4 KStG applies only if the receiving company holds at least 10% in the distributing company at the beginning of the calendar year; an acquisition of at least 10% during the year is deemed, for corporation tax purposes, to have taken place at the beginning of the year. For trade tax purposes, by contrast, a separate, higher minimum shareholding threshold of 15% at the beginning of the levy period applies (§ 9 Nr. 2a GewStG); there is no such retroactive effect for an acquisition during the year here – profit distributions in the year of acquisition are always subject to trade tax in full, irrespective of the size of the shareholding.
• Capital gains: In the case of capital gains from the sale of shares, no minimum shareholding applies either for corporation tax or for trade tax purposes – the exemption under § 8b Abs. 2 KStG applies irrespective of the size of the shareholding, even where it is only 1%, since § 9 Nr. 2a GewStG covers exclusively profit shares from distributions and not capital gains.
• Partnerships and individuals (§ 3 Nr. 40 EStG): Where an individual holds the shareholding as business assets (Betriebsvermögen) of a sole proprietorship or a partnership, it is not the participation exemption of § 8b KStG that applies to both categories – distributions as well as capital gains – but the partial income procedure under § 3 Nr. 40 EStG: here, only 60% of the income is taxable and 40% remains tax-exempt – a noticeably lower exemption than the 95% applying to corporations, since in the case of individuals there is no comparable cascade problem between several corporation tax subjects.

In advisory practice, the separate examination of the corporation tax and trade tax thresholds is decisive precisely in the case of profit distributions, since a distribution that is privileged for corporation tax purposes may nevertheless be fully taxable for trade tax purposes if the 15% threshold is not met.

What tax risks arise if the minimum shareholding is not met?

If the minimum shareholding relevant in the particular case is not met, the tax exemption is lost not proportionately but in full – the dividend is then treated in its entirety as a so-called portfolio dividend (Streubesitzdividende) and is fully subject to corporation tax or trade tax as the case may be.

In practice, this all-or-nothing principle entails several risks that can cause a shareholding to slip unintentionally below the relevant threshold:

• Dilution through capital increases: Where a subsidiary carries out a capital increase in which the parent company does not participate, or does not participate proportionately, the shareholding ratio may fall below the 10% or 15% threshold without any shares having been actively sold.
• The reference-date issue: Since the beginning of the calendar year is decisive for corporation tax purposes and the beginning of the levy period for trade tax purposes, falling below the threshold even for only a few days at the start of the year can cost the tax exemption for the entire year.
• Partial sales within the group: Where shares are given up in the course of a restructuring or a partial sale, it should be examined in advance whether the remaining shareholding still reaches the relevant minimum threshold – otherwise the tax treatment of all future distributions deteriorates considerably.

Anyone holding a shareholding close to the 10% or 15% limit should therefore actively monitor the ratio and examine capital measures of the subsidiary at an early stage as to their effect on their own shareholding ratio.

How does the participation exemption operate in international tax law?

For companies resident in Germany with foreign subsidiaries, the participation exemption may overlap with further international provisions that must additionally be examined.

Within the EU, the Parent-Subsidiary Directive applies in addition; it provides for an exemption from withholding tax on distributions between affiliated EU corporations, provided that a minimum shareholding of 10% is held over a certain period – these requirements largely, but not entirely, coincide with those of the German participation exemption and should therefore be examined separately.

Outside the EU, the relevant double taxation treaties (Doppelbesteuerungsabkommen, DBA) frequently provide for a so-called “international participation exemption” with their own treaty-specific minimum shareholding ratios, which may differ from the 10% or 15% under German law.

In addition, in the case of foreign subsidiaries, account must be taken of the withholding tax deducted abroad on the distribution: this is not automatically avoided by the participation exemption but is governed by the applicable DBA or, within the EU, by the Parent-Subsidiary Directive. If the foreign withholding tax is not fully reduced or refunded, a residual economic burden may remain despite the participation exemption applying, and this should be taken into account from the outset when structuring international chains of shareholdings.

For capital gains from the sale of shares in foreign subsidiaries, a different principle regularly applies internationally than for dividends: under Art. 13 of the OECD Model Convention, which is enshrined in most double taxation treaties, the right of taxation for capital gains generally lies with the state of residence of the seller – that is, Germany – so that, unlike in the case of dividends, no foreign withholding tax regularly arises. An important exception is formed by so-called real estate companies, for which many DBA grant a right of taxation to the state in which the property is situated; this should be examined separately in the case of corresponding shareholding structures.