The Federal Tax Court (BFH, case reference: I B 49/10) and two local tax courts (the tax court of Munich (case reference: 1 K 608/07) and the tax court of Hessen (case reference 8 V 938/10)) recently ruled on whether the German minimum tax rules are in compliance with the German Constitution. Both the BFH and the local tax court of Hessen have taken the position that the rule may not be constitutional, while the tax court of Munich has reached the opposite conclusion.
Under the minimum tax rules, loss carryforwards may be set off against current year income up to EUR 1 million without restriction, but amounts exceeding EUR 1 million may be offset only to the extent of 60% of the excess over EUR 1 million. Even though losses can be carried forward indefinitely, loss carryforwards may be forfeited under the change-in-ownership rule and certain rules on reorganizations.
In its decision, the local tax court of Munich concluded that the minimum tax rules are in line with the Constitution where the taxpayer voluntarily took steps that ultimately led to the forfeiture of the loss carryforwards and was unable to show that it was actually forced to make the decision that ultimately led to the forfeiture of the loss carryforwards for business or other reasons. This case is currently pending before the BFH (case reference IV R 36/10).
Shortly after the tax court of Munich issued its ruling, the BFH published a decision in preliminary proceedings, where it upheld a decision of the local tax court of Nuremberg, in which the court suspended the execution of a tax assessment where the tax authorities taxed profits by applying the minimum tax rule (for prior coverage, see Deloitte Tax-News). This case involved a German GmbH (a private limited company) that had a substantial loss carryforward from previous years. The profits earned by the GmbH in 2007 could not be fully offset against the loss carryforwards under the minimum tax rule so some of the profits were subject to tax in 2007. In 2008, the loss carryforwards were forfeited under the change-in-ownership rule and the rules on reorganizations of loss companies.
In its analysis of whether the minimum tax rules were compatible with the Constitution, the BFH concluded that the rules may have to be interpreted restrictively in situations where the use of the losses by way of a loss carryforward was impossible for “factual or legal reasons” (such as a change-in-ownership or in a restructuring, where loss carryforwards are forfeited). According to the BFH, the fact that the losses were forfeited as result of a voluntary action on the part of the taxpayer was not decisive under the facts of the case – it would be decisive only in cases of abuse. The BFH, therefore, had doubts as to whether the application of the minimum tax rule in 2007 was in compliance with the Constitution.
The local tax court of Hessen reached the same conclusion in preliminary proceedings where the taxpayer was unable to fully utilize a tax loss carryforward because the corporation that incurred the loss was liquidated.
The BFH now must decide in the appeal of the Munich court decision whether to uphold the taxpayer’s argument or whether the fact that losses are forfeited because of a voluntary action of the taxpayer is sufficient to eliminate any concerns from a constitutional perspective. In the latter case, the BFH must refer the question to the Federal Constitutional Court, which has the sole authority to determine whether a rule violates the principles in the Constitution.
Taxpayers that have forfeited tax losses under the change-in-ownership or reorganization rules should review tax assessments of previous fiscal years. If the minimum tax rule was applied in the past therefore restricting the utilization of the losses, the taxpayer should consider keeping the assessment open by filing an objection.
If you have any questions, please contact the authors of this article at gtln@deloitte.de or your regular Deloitte contact.
