Annual Tax Act 2010 may amend exit tax rule for cross-border asset transfers

The German Upper House of Parliament has introduced an amendment to the exit taxation rule into the current draft of the Annual Tax Act 2010. Under the draft law, a transfer of assets held by a German corporation or partnership to a foreign permanent establishment (PE), a transfer of a business abroad and cross-border migrations of corporations would trigger exit taxation on the full built-in gains. The proposed amendment has been sent to the Lower House for further debate with the law becoming effective after both Houses approve the draft and the German president signs the law.

The amended draft law is a legislative response to the decisions of the Federal Tax Court (BFH) of 17 July 2008 (case reference I R 77/06) and 28 October 2009 (case reference I R 99/08), in which the BFH reversed its long-standing approach (“final withdrawal theory”) to the exit tax consequences of cross-border asset transfers and business relocations for fiscal years before 2006, the year the current exit taxation rule was introduced. The German tax authorities issued a non-application decree with respect to the 2008 decision, indicating that it would not apply the BFH decision in other cases.

According to the BFH’s new approach, Germany will retain the right to tax (at the time the asset is sold) built-in gains that accrued before the asset was transferred abroad, even if an applicable tax treaty provides for an exemption for income from PEs. The BFH concluded in both cases that no exit tax would be due because Germany has not lost its taxation rights. Both cases related to pre-2006 years where exit taxation was triggered when Germany lost the right to tax built-in gains. Since Germany could only lose the right to tax built-in gains that might accrue in the future but could never claim a right to tax these gains before the transfer, the application of the new rule has been controversial.

The new provision in the draft tax law, which would apply retroactively to all open cases, would allow exit taxation if assets are transferred abroad to a foreign PE or if such a transfer is deemed for tax purposes (e.g. where the German tax authorities use a functional approach to allocate assets to a headquarter or to a PE). It should be noted that the legislative process is not yet finalized so further changes are possible. There may be arguments that the retroactive application could violate the German constitution and it is unclear whether the provision is in line with ECJ case law (Hughes de Lasteyrie du Saillant, case reference C-9/02).

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