In past years the Austrian Supreme Administrative Court has decided that under tax treaties which provide for the exemption method to avoid double taxation both positive as well as negative foreign income has to be exempt in the state of residence. Thus especially losses attributable to a foreign permanent establishment of a tax payer (so-called foreign PE losses) could not be set off against domestic income. Moreover there was also no provision which would have allowed the deduction of foreign PE losses on the basis of domestic legislation.
In a groundbreaking recent decision the Austrian Supreme Administrative Court now revises its former rulings. The court concluded that the exemption which needs to be granted by the state of residence under tax treaties applies only to positive income whereas losses sustained in the state of source should be taken in consideration when calculating the domestic tax base in Austria (as the state of residence). Accordingly the tax base of the Austrian complainant was reduced to the amount of losses sustained in a PE in Germany.
The court justified his decision by referring to the objective of the tax treaty between Austria and Germany which is primarily to avoid double taxation. Since a situation in which a taxpayer sustains a foreign loss is not a situation in which double taxation would arise the state of residence (Austria) is not allowed to exempt such foreign losses when calculating the domestic tax base of the Austrian resident tax payer.
Having therefore concluded that a tax treaty which provides for the exemption method would not exclude the possibility to offset foreign PE losses from the Austrian tax base of the Austrian resident the court addressed the question whether and on which legal basis a double deduction of losses in the state of residence and in the state of source could be avoided. The court stated that the double tax treaty between Austria and Germany has also the purpose to avoid double non taxation of certain items of income and concluded that article 4 of the treaty between Austria and Germany (which corresponds to article 7 OECD-MC) needs to be interpreted in a way to avoid double non taxation. Furthermore the court argued that under the purpose and objectives of the treaty the definition of the term "business profit" in the meaning of article 4 (or article 7 of OECD-MC) needs to be attributed a meaning according to which the amount of business profits of a German PE which needs to be exempt in Austria would be reduced by the PE losses sustained in previous years. Accordingly the foreign PE profits realised in the following years must be exempt from Austrian tax only to the extent that they exceed the amount of losses carried forward in the state of source.
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