In a landmark decision issued in 2011 (I R 54, 55/10), the Federal Tax Court (BFH) held that the inability to form a German tax group with a nonresident parent company violates the nondiscrimination principle in the applicable tax treaty (see Deloitte Tax-News).
Under German group taxation rules (Organschaft), the income of the subsidiary in a group is attributed to the parent company and taxed at the level of the parent. Because of the interaction between the German tax group rules (under which income is attributed to the parent) and tax treaty rules (under which Germany is not allowed to tax the foreign parent), the BFH went one step further and indicated that Germany may not even be allowed to tax the income of the subsidiary at all. It should be noted that the BFH decision only addressed the pre-2002 trade tax rules, under which a profit and loss pooling agreement (PLPA) was not necessary to enter into a (trade tax) Organschaft. In cases where such a PLPA was concluded between a foreign parent and its German subsidiary (and the PLPA was effectively carried out under the German tax group principles), the reasoning of the BFH may have to be extended to current rules on both trade tax and corporate income tax.
On 27 December 2011, the Ministry of Finance (BMF) issued official guidance stating that the tax authorities will not apply the BFH decision in similar cases. The Ministry has taken the position that the BFH decision is in conflict with the Commentary to the OECD model treaty on articles 24 and 7, which should have been authoritative in the application of the (old) German-U.K. treaty. According to the Ministry of Finance, the nondiscrimination principle does not oblige Germany to extend the group taxation principles to foreign parent companies and, even if this was the case, Germany would be entitled to tax the income generated by the German subsidiary by presuming the existence of a German permanent establishment of the foreign parent.
Since the tax authorities will not apply the BFH decision on a general basis, taxpayers will have to take their cases to court if they wish to rely on the principles of the decision. Given that, as from FY 2002, a PLPA is required to enter into a tax group, both for corporate income tax and trade tax purposes, only cases involving FY 2001 and prior years can be taken to court without such a PLPA in place between the foreign parent and the German subsidiary. For FY 2002 and subsequent years, it remains unclear whether a PLPA between the foreign parent and the German subsidiary, or at least a factual transfer of profits and losses, is necessary to make the situation comparable to a German tax group, so that a taxpayer can rely on the nondiscrimination article in a specific tax treaty. Given the possibility of a law change, it is not recommended that taxpayers actively plan into such a situation and conclude a PLPA only to rely on the BFH decision (see previous coverage of the case).
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