By Dieter Endres and Angelika Thies, PricewaterhouseCoopers, Frankfurt/Germany

Prof. Dr. Dieter Endres is the head of the tax and legal services practice in Germany, Dr. Angelika Thies is an international tax partner in Frankfurt

As usual in the closing weeks of the year the German legislators have again come up with an omnibus tax bill. The Corporate Tax Development Act adds a, by German legal standards, short sentence to the Organschaft provisions of the Corporation Tax Act stating that, "A loss of an Organschaft parent is not to be taken into account for domestic taxation insofar as it is taken into account in a foreign state when levying a tax comparable to the German taxation on the Organschaft parent." The government's official explanation of this proposed change to the law attached to the bill laid before parliament says, almost equally succinctly, that, "The additional new sentence is to prevent losses of dual resident companies from being offset twice over, at home and abroad, or the offset always being to the detriment of the Federal Republic of Germany as a result of the national rules of foreign countries (e.g. in the USA)."

This new provision and its official explanation seem, at first sight, logical, reasonable and, above all, relatively innocuous for most multinational companies or other cases of cross-border investment to or from Germany. Closer examination reveals, however, that none of this is so. The explanation does not explain the bill as drafted, the wording of the statute is vague, and there seems to be no consensus at any level of society as to which abuses are to be curbed and why. Almost certainly, the provision will require repair very soon, be it by changing the statute, or be it by issuing a long, explanatory implementation decree purporting to explain the statutory provision with examples, but, in fact, changing it into something at least workable.

The immediate prompt for the change was an amendment to the Organschaft definition changing the demand that an Organschaft parent have both its seat and place of management within Germany to one requiring only one of the two criteria. Thus, a German Organschaft parent can now, for the first time, be resident in two countries.

The German provision is modelled on the US dual consolidated loss rules of Sec. 1503 (d) of the Internal Revenue Code (IRC). Sec. 1503 (d) is designed to prevent double dipping of losses, although it only became workable once extensive regulations on its application were promulgated some six years after it attained statutory force. These US regulations cover matters such as how losses are to be calculated when accounting rules differ between the two countries, recapture provisions in the face of future profits, application of the rules to permanent establishments and to comparable vehicles such as partnerships and check-the-box entities, interaction with other US legislation and intermeshing with mirror legislation abroad. There is no indication that the German counterpart to this legislation will prove any simpler in practice. Unfortunately, there is also no reason to believe that those responsible for the German statute have even thought about the implications beyond those on the (unrevealed) specific abuse they had in mind. To cap all, the new provision entered into force on December 25, 2001 with application to the 2001 year of assessment. Effectively, application is therefore retroactive for almost the entire year - or, indeed, for a full business year already over for most companies with non-calendar year ends - and this is bound to raise questions as to its conformity with the constitutional prohibition on retroactive taxation. For some, the position is exacerbated by the consideration that the original Bill carried a different wording of different import when laid before Parliament, so that the ministry civil servants cannot claim realistically that taxpayers could (should?) have known of the coming changes in time to react (abroad?).

There are many other open questions which must be answered, if the new rule is to be accepted by the taxpaying public as fair, reasonable and in accordance with the constitution. Perhaps the most important of these is the fundamental question as to why the provision applies to Organschaft parents only and not to other companies. After all, any German company can have a second residence in any country basing tax residence on the place of management as a, or the, sole criterion. The answer to this question may well reveal a breach of the constitutional requirement of equality of taxation varying only according to the ability to pay.

From the functional point of view, the question must be asked as to whether dual residence is really the target at all. The official explanation to the Bill says that it is, but the statute itself does not mention dual residence as a concept one way or the other. The USA allows a German subsidiary, which can easily be an Organschaft parent, to opt for the status of a disregarded entity under the check-the-box rules, which would mean that its German results, profits or losses, would automatically flow into the tax return of its US parent. Within Europe, at least France and Denmark allow tax groups to include foreign subsidiaries under certain circumstances. In all three cases, the absence of any form of recapture provision in the German statute will lead to serious questions of double taxation. If, for example, the German Organschaft parent's loss is taken into account in France by its own French shareholder under the bénéfice consolidé rules, that loss will not be deductible in Germany against future profits under the new provision. Once the future profits are earned they will be taxable in Germany and in France without relief for the previous loss (though, in France, this will already have been offset against other income). The German tax now payable will be credited against the French tax, although it is hard to see why the French government should be prepared to give a credit for German tax that has only been paid because of Germany's refusal to allow offset of a German loss, and it seems equally unrealistic to expect the French shareholder to accept the resulting double taxation without seeking relief through the courts or under the EU Arbitration Directive. A request for arbitration proceedings under that Directive could, of course, quite easily lead to the German statute being held to be an illegitimate barrier against freedom of movement within the EU.

Seen at a more local level, questions remain as to what exactly is meant by some of the terms used in the statute. This starts with the reference to the loss of the Organschaft parent. Common sense suggests that the entire net loss of the Organschaft - after all profit surrenders and loss subventions from or to the subsidiaries have been taken into account - must be meant, although the wording of the Act is not necessarily so clear.

The reference to a "comparable tax" abroad might be taken to mean that the Organschaft parent must be taxable abroad in its own name, or it might also include those cases where the results of the German company are included in the taxable income of another company abroad, whether as the consequence of a US check-the-box election, or of membership of a French or Danish tax group.

In the same vein, it is not entirely clear what is meant by "taking a loss into account". Is the actual offset abroad against non-German income meant, or will the German right to carry forward the loss be forfeit as soon as the loss is carried forward abroad for later offset against as yet unearned future profits?

As a final remark, it would seem fair to suggest that the amending statute was drafted under the assumption that the German Organschaft parent must necessarily be a corporation with its own legal identity and tax personality. If so, the assumption was false. A German Organschaft parent, though not the subsidiary, can be any business entity operating in Germany, that is in particular, it can easily be a partnership or the German branch of a foreign company or other business. If a partnership is involved, it is, by German definition, the partners and not the partnership that are subject to tax. If these are foreign corporations (or individuals), it would seem impossible to deny them the right to carry forward their German losses in Germany without regard as to what happens in their home countries, without reaching the non-discrimination clauses of the relevant double tax treaty.

In the view of the authors, the German tax legislator has not only failed to hit the target, he has not even clearly said what he is aiming at. There is no doubt of the need for clarification, whether as a further amendment to the statute or as an interpretative decree.

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