GERMANY - Germany will be forced to abolish a withholding tax on overseas shareholders after the European Court of Justice (ECJ) ruled that existing tax restrictions block the free movement of capital.

The ruling will result in the abolition of restrictions on dividends paid to non-resident parent companies - currently a significant barrier for Luxembourg-based real estate funds with operations in the German market.

Initially introduced to deter "treaty shopping", the current rules have added complexity and risk to funds structuring German investments.

The ECJ rejected the German government's argument that the fact overseas companies were exempt from German business tax resulted in a "balanced allocation" on the grounds that the rule did not apply to domestic dividend recipients.

The court also dismissed the claim that double taxation treaties effectively provided a full refund of withholding tax.

John Forbes, real estate funds partner at PwC, said the ECJ's decision would make it "less painful" for Luxembourg-based fund managers to operate in the German market.

"The decision to invest in Germany will always be based on economic fundamentals, but the new ruling will make it less costly," he said. "It won't create investment, but it will make investing easier."

He added: "Holding companies with operations in other countries will be watching for the new German rules.

"If you operate in Germany, France and Italy, the German market has always been the most demanding. If you met the standards for Germany, you met the market standards for other markets, so it was effectively a benchmark."