Dr. Oliver Heinsen, KPMG Frankfurt
For editorial cut-off date, disclaimer, and notice of copyright see end of this article.
1. ECJ to rule on German seat-of-management rule
Prior articles have described the seat-of-management rule (Sitztheorie) under German choice of law doctrine and the impact of this rule on dual resident corporations (DRCs). The 1999 Centros decision of the European Court of Justice (ECJ) was widely interpreted as signifying that the separate corporate identity and legal capacity of an EU corporation must be determined under the law of the jurisdiction where the corporation was organised (place-of-incorporation rule – see KPMG German News no. 3-4/1999 p. 27 = article no. 190; see also issues nos. 4/1995 p. 2, 3/1997 p. 19, 4/1997 p. 2, and 4/1998 p. 13 = articles nos. 40, 81, 94, and 158).
A case is now pending before the ECJ in which the court is expected to hold that the seat-of-management rule is incompatible with the freedom of establishment clause of the EC Treaty (articles 43 and 48 EC). The new case, Überseering BV v. NCC Nordic Construction Company Baumanagement GmbH (ECJ docket no. C-208/00), was referred to the ECJ by the German Federal Court of Justice (Bundesgerichtshof) in a ruling dated 30 March 2000 (VII ZR 370/98 – IStR 2000, 382).
An opinion issued in the matter on 4 December 2001 by one of the ECJ's eight Advocates General argues that the seat-of-management rule violates the EU freedom of establishment clause.
Under the prevailing German choice of law rule, an association is subject to the company law of the jurisdiction in which its "seat of management" (more literally, "seat of administration" – Verwaltungssitz) is located. The seat of management generally coincides with the entity's principal place of management (Ort der Geschäftsleitung), though exceptions are conceivable. If an association's seat of management is in Germany, this means that, from a German perspective, the association can only acquire (or retain) corporate status if it has been incorporated in accordance with German law. Incorporation under the laws of another jurisdiction is irrelevant. Without corporate status, the entity lacks separate legal identity and legal capacity, including the capacity to sue. The owners and officers of a corporation with a foreign registered office, but a domestic seat of management, can be held personally liable by German courts (see e.g. KPMG German News no. 4/1995 sec. 2.3 = article no. 40).
A major exception to the above principles is created by a 1954 treaty between Germany and the United States by which the parties, among other things, mutually recognise all corporations duly formed under the laws of the other treaty state. A similar agreement exists between Germany and Spain. A draft EU treaty deals with mutual recognition of EU corporations, but has not yet entered into force. Germany has ratified the treaty.
For tax purposes, foreign corporations with German permanent establishments or a German place of management are generally subject to corporation tax even though lacking separate legal identity under the seat-of-management rule. Germany's Federal Tax Court first reached this result in 1992 by likening foreign corporations without separate legal identity to certain domestic entities that are subject to corporation tax under § 1 (1) no. 5 KStG, even though not possessed of separate legal identity.
3. Facts of Überseering
The case grew out of a 1992 construction contract entered into by Überseering BV, a Dutch limited liability company, as purchaser, and NCC GmbH, a German limited liability company, as contractor. The contract involved work on German real property. The BV sued the GmbH for damages by reason of alleged defects in the work performed.
Just prior to the filing of suit in 1995, the BV was purchased by two German-resident individuals, who then managed the BV from Germany. The lawyers of the GmbH alleged, and the lower courts agreed, that this caused the BV's seat of management to shift from the Netherlands to Germany, meaning that henceforth the BV's separate legal existence and legal capacity depended on German corporate law. The BV's shareholders did not attempt to form a GmbH in Germany as the successor to the BV (re-incorporation), nor did they attempt direct conversion of the BV into a GmbH under §§ 362 - 393 of the Business Reorganisation Act. (Whether such reorganisations are possible is controversial.) The German courts therefore held that the BV had ceased to exist as a separate legal entity with capacity to sue when the seat of management was transferred. They dismissed the BV's complaint against the German contractor without reaching the merits of the case.
The BV appealed the case up to the Federal Court of Justice, Germany's highest court of general jurisdiction, which suspended proceedings and certified two questions to the European Court of Justice for preliminary decision:
- In the case of companies duly organised under the laws of another EU member state, do Articles 43 and 48 EC (freedom of establishment) preclude application of the corporate law of the country in which such companies have their seat of management where this means that the companies are no longer able to enforce their contractual rights in court?
- If so, does the freedom of establishment principle mandate use of the place-of-incorporation rule as a choice of law principle?
The Federal Court of Justice stated that it would uphold the lower court decisions dismissing the suit unless the ECJ answered the first question in the affirmative. The German high court explained that the seat-of-management rule prevented avoidance of German company law provisions that were intended to protect creditors, minority shareholders, controlled subsidiaries, and employees. The court expressed concerns about a corporate law "race to the bottom" amongst the member states of the European Union if the protective provisions of domestic law could be circumvented by organising a company in a foreign jurisdiction.
4. Opinion of the Advocate General
After lengthy remarks discussing the applicable provisions of the EC Treaty, particularly Article 293 EC, and the ECJ's Daily Mail and Centros decisions, the Advocate General concludes that the German choice of law rule restrains the freedom of establishment and can only be justified by overriding public interests. While the Advocate General affirms the legitimacy of the goals cited by the German Federal Court of Justice in support of the seat-of-management rule, he argues that the means employed to reach the goals are ill suited to the ostensible ends and unduly burdensome (Opinion sec. 50 ff.). Specifically, the loss of the ability to sue and thus to enforce rights in court was considered "a tremendous obstacle to freedom of establishment" (Opinion sec. 56). The Advocate General bases his Opinion on the assumption that the contractual rights in question are forfeited under the German choice of law rule. Argument from representatives of the German government to the effect that the rights were not lost, but merely could no longer be exercised by the BV as such were disregarded as vague (Opinion sec. 55).
The Advocate General's investigation of the policy behind the seat-of-management rule is cursory. Certain points are brushed aside on the grounds that they "do not deserve to be considered" because they were not adequately explained by the German government or the referring court (Opinion sec. 54). Another surprising aspect of the Opinion is the assumption that the policy goals behind the seat-of-management rule (such as enforcement of the employee co-determination regime for companies with more than 2,000 employees or provisions protecting minority shareholders) have no weight to the extent not implicated by the specific case before the court (Opinion sec. 53, 54).
The Advocate General declined to address to the second question posed by the Federal Court of Justice on the grounds that it concerned a matter of national legislation within the discretion of the governments of the EU member states (Opinion sec. 64 ff.).
The civil law and tax implications of the abandonment of the German seat-of-management rule were discussed in the 1999 article on Centros (KPMG German News no. 3-4/1999 p. 27 = article no. 190).
A number of the tax points discussed in the prior article are now moot as a result of the changes made to German corporation tax law by the 2000 Tax Reduction Act. For instance, the dividend-received exemption and capital gains exemption under § 8b (1) and (2) KStG are now available to all entities subject to corporation tax, not just to corporate entities as defined in § 1 (1) nos. 1, 2, 3, and 6 KStG. Hence, it no longer matters whether a foreign corporation is subject to corporation tax under § 1 (1) no. 5 KStG (consequence of seat-of-management rule) or under § 1 (1) no. 1 KStG (consequence of place-of-incorporation rule).
The Business Tax Development Act (discussed in KPMG German News no. 1/2002 p. 31 = article no. 248) likewise puts an end to the double nexus (place of management and legal seat » registered office) required in order to be a lead entity in a tax consolidated group (new § 14 (1) no. 2 KStG). However, the law continues to require a double nexus in order to be a member company in a tax consolidated group (§ 14 (1) sent. 1 KStG). Since the seat-of-management rule is the only justification for requiring a double nexus, a clear rejection of this rule by the ECJ in Überseering would cast doubt on the validity of this requirement. See article no. 190 for more detail.
On the other hand, if the ECJ upholds the seat-of-management rule, its civil law consequences may prevent a foreign corporation with its seat of management, but not its legal seat, in Germany from taking advantage of the liberalisation of the German tax laws.
Clear rejection of the seat-of-management rule would furthermore facilitate reliance on dual resident corporations as planning instruments in international reorganisations, as is also explained in more detail in article no. 190.
6. Concluding remarks
Unlike Centros, Überseering clearly frames the issue of the validity of Germany's seat-of-management rule as a choice of law principle. In light of Centros and the strongly worded Opinion from the court's Advocate General, the ECJ is expected to reject the seat-of-management rule and thus – implicitly or explicitly – endorse the place-of-incorporation rule as the norm within the EU.
Editorial cut-off date: 20 March 2002
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