In a decision issued on 16 November 2011 (case reference: 10 V 2336/11), the local tax court of Cologne suspended the execution of a tax assessment in which the tax authorities had taxed built-in gains in a shareholding that was held by the claimant but allocated to his Belgian permanent establishment (PE) in 1998.
In line with common practice at the time, the taxpayer treated the built-in gains as having been triggered by the transfer to the PE in 1998, but eliminated the resulting gain by setting up a special balance sheet item. This tax treatment followed the general guidelines of the tax authorities on the taxation of PEs. The treatment aimed at postponing capital gains taxation until the actual sale of the assets (but for a maximum period of 10 years). Consequently, in the tax assessment for 2008, the tax authorities increased the taxpayer’s taxable income by the amount of the gain from the transfer of the participation. The taxpayer appealed the assessment and requested a suspension of the execution, arguing that taxing the built-in gains was not in line with recent case law of the Federal Tax Court (BFH) on exit taxation, and further that such taxation infringes the freedom of establishment principle in the Treaty on the Functioning of the EU.
In its decisions of 17 July 2008 (case reference: I R 77/06) and 28 October 2009 (case reference: I R 99/08), the BFH reversed its long-standing view on 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 BFH held that even if the profits of a PE are exempt in Germany under an applicable tax treaty, the treaty does not prevent Germany from taxing the built-in gains in the asset transferred that had built up until the transfer date. Therefore, the transfer of assets to a non-German PE could not be regarded as an event that triggers capital gains taxation.
The BFH decision also had implications for the exit tax rule enacted in 2006. According to this rule, exit taxation is triggered where Germany lost its right to tax the built-in gains in the asset. To ensure the rule still applied to the situations for which it was intended after the BFH decision, Germany amended the rule to provide that a loss of a taxing right is deemed to arise where assets are transferred to a foreign PE and that this rule applies retroactively to all open cases.
The tax court of Cologne has now held (in preliminary proceedings) that even if the new rules are applied to the present case (leaving aside the potential breach of constitutional rights due to the retroactive introduction of the amendments), there are substantial doubts that the rule is in line with EU law because in a comparable domestic situation, the taxation of the built-in gains would take place only upon a realization event (e.g. a sale of the shareholding).
The outcome of the proceeding is in line with the first case dealing with the new exit tax rules, which was decided by the local tax court of Rheinland-Pfalz on 7 January 2011 (case reference: 1 V 1217/10, see Deloitte Tax-News).
It is not yet clear whether the tax authorities will appeal the decision. Taxpayers that have transferred assets abroad and triggered exit taxation under the 2006 rule (or have deferred exit taxation according to the pre-2006 guidance) should keep their tax assessments open and monitor these cases closely.
If you have any questions, please contact the authors of this article at gtln@deloitte.de or your regular Deloitte contact.
