Tax risks: constructive dividends at German GmbHs with foreign shareholders

In the case of German subsidiaries of foreign corporate groups, tax audits regularly focus on the service relationships with the parent company. If terms and conditions or contract structures are not in line with arm's length principles, there is a risk for transactions being classified as a constructive dividend – with corresponding consequences for income and withholding tax. 

A constructive dividend exists when a shareholder is granted a pecuniary advantage by a corporation, and this is based on the corporate relationship. 

Pursuant to Art. 8 (3) sentence 2 KStGv (German Corporate Income Tax Act), a constructive dividend must not reduce the corporation’s taxable income. At the same time, a constructive dividend generally leads to an obligation to withhold and pay capital gains tax in accordance with Art. 43 (1) sentence 1 no. 1 EStG (German Income Tax Act) – regardless of whether the benefit was actually paid out. 

In international corporate structures, the Parent-Subsidiary Directive (Directive 2011/96/EU) can generally be applied, which provides for a reduction or complete exemption from capital gains tax. However, this requires the timely submission of an exemption certificate from the German Federal Central Tax Office. However, if a constructive dividend is only discovered during a tax audit, this certificate is usually missing. 

Although the withheld capital gains tax can be reclaimed through a refund procedure, this process is complex, lengthy, and involves considerable administrative effort. In practice, this often leads to temporary liquidity problems and, not infrequently, to permanent disadvantages. 

Typical risk constellations in practice 

In tax audit practice, certain circumstances are regularly classified as constructive dividends if no reliable arm's length documentation is available. These include in particular: 

• Management remuneration paid to the foreign group headquarters without adequate proof of performance or without any link to specific operating results 
• Loan agreements without market interest rates, repayment terms, or contractual backing 
• Free or unreasonably remunerated transfer of use of real estate, vehicles, or trademark rights 
• License payments without functional involvement of the licensor or at prices that are not in line with market conditions 
• Group allocations without economic substance or without a clear exchange of services (see BMF letter dated March 14, 2006, Federal Tax Gazette I 2006, p. 278) 

The distinction is essentially based on the arm's length principle, measured by whether a prudent and conscientious manager would have concluded a transaction with an unrelated third party on the same terms. 

Regardless of compliance with the arm's length principle, formal deficiencies such as the conclusion of an agreement between the companies that has retroactive effect may also lead to the transaction being classified as constructive dividend.  

International interdependence: Link to Art. 1 AStG (German Foreign Transaction Tax Act) and Art. 90(3) AO (German General Fiscal Code) 

If there are performance relationships between a domestic corporation and a foreign group company, Art. 1 AStG must also regularly be observed. In addition to cross-border deliveries of goods, the focus in this respect is particularly on cross-border services, transfers of use, or group allocations between affiliated companies. 

Although the tax assessment is primarily based on the principles of a constructive dividend – for example, in the case of corporate benefits – this does not preclude the additional application of Art. 1 AStG. Rather, Art. 1 AStG can supplement or extend the legal consequences of a constructive dividend, in particular through the additional income adjustment in the case of conditions that are not in line with the arm's length principle. The arm's length principle remains decisive here as well, ensuring that intra-group services are treated as they would have been agreed between independent third parties.  

In the case of cross-border transactions, there is also an obligation to prepare transfer pricing documentation in accordance with Art. 90 (3) AO in order to be able to prove the contractual terms’ appropriateness to the tax authorities. Failure to submit transfer pricing documentation, or submission of unusable documentation, may result in significant penalties, in particular in the form of estimates to the detriment of the taxpayer as well as penal surcharges. 

Since 2025, there has also been a significant tightening of transfer pricing documentation requirements, including the obligation to prepare a transaction matrix. 

The following constellations are particularly critical in practice: 

• Intercompany settlements, both for supply and service relationships without reliable transfer pricing documentation 
• Headquarters charges that are not allocated to the German service recipient in accordance with the arm's length principle and that demonstrate a verifiable benefit for the service recipient 
• Transfer of functions or transfer of tangible or intangible assets without appropriate compensation, whereby the valuation should also be in accordance with VWG VP 2024 (Administrative principles for transfer pricing 2024; December 12, 2023, Chapter I). This also includes the transfer of know-how, trademarks, or customer relationships free of charge or at below-market value. 

In practice, tax audits are usually conducted in three stages: First, the existence of a constructive dividend is examined, then the deductibility of the expenses as operating expenses, and finally – in cross-border cases – the appropriateness of the transfer prices and the correctness of the documentation in accordance with international transfer pricing principles.  

Tax implications at a glance 

The determination of a constructive dividend leads to a number of tax consequences: 

• The constructive dividend increases the GmbH’s taxable income in accordance with Art. 8 (3) sentence 2 KStG. 
• At the same time, the granted benefit is considered a notional payment to the shareholder and is subject to capital gains tax deduction (Art. 43 (1) sentence 1 no. 1 EStG). 
• The tax must be withheld and paid by the GmbH (Art. 44 (1) EStG), even if no payment is made 
• If the tax is not withheld, the management is liable for the unpaid tax (Art. 69 AO) 
• In international structures, there is a risk of double taxation if the constructive dividend is not classified as dividend income in the country of residence. 

Recommendations for action to minimize risk 

Companies with cross-border structures should structure their supply and service relationships with their shareholders in a forward-looking manner. From a tax audit perspective, the following points are particularly relevant: 

• Drafting contracts in writing and in accordance with arm's length principles – with reliable supply and service descriptions and terms and conditions in line with the market 
• Regular review of loan terms, license agreements, and intra-group service agreements, especially in the case of centrally charged services (e.g., headquarters fees) 
• Transfer pricing documentation in accordance with Art. 90 (3) AO even for seemingly minor matters such as IT services or marketing support 
• If necessary, obtaining an advance ruling in complex or potentially contentious matters 
• Exercising caution with regard to additional remuneration, withdrawals, or benefits granted to shareholders, even if these appear to be “customary within the group” 
• Preparing comprehensive transfer pricing documentation (depending on size or value limits, consisting of a transaction matrix, country-by-country reporting, master file, and local file, as well as documentation of exceptional circumstances) 

Assessment and outlook 

Constructive dividends remain a key area of tax audits, even for GmbHs with foreign shareholders. The distinction between these and services at arm’s length is not always clear, and the requirements for documentation and economic substance are increasing. Tighter requirements for transfer pricing documentation and recent experiences from tax audits demonstrate the enormous importance of this issue in practice. Acting with foresight in this area not only reduces tax risks, but also secures the company's ability to distribute dividends in the long term.