Germany: 245. European Law: Discrimination Against Permanent Establishments of EU Corporations

Dr. Oliver Heinsen, KPMG Frankfurt

A case is presently pending before the German Federal Tax Court (FTC) posing the issue of the compatibility of Germany's pre-2001 taxation of permanent establishments with EU law (possible violation of the freedom of establishment clause of the EC Treaty, former Article 52 (1), present article 43 (1)).

The FTC's docket number is I R 31/01. The case results from an appeal from the Cologne Tax Court judgement of 8 February 2001 (IStR 2001, 224 – 13 K 9771/97). In an article discussing the decision of the Cologne Tax Court (IStR 2001, 212), Lausterer is sharply critical of the lower court's refusal to refer the case directly to the European Court of Justice.

For years from 1977 through 2000, German corporation tax law imposed a flat rate tax on the German permanent establishments of foreign corporations, while taxing domestic corporations at split rates depending on whether earnings were retained or distributed. The rates in effect for 2000 were 40 % for the German permanent establishments of foreign corporations (flat rate) and 45 % / 30 % (split rates) for the earnings of German-resident corporations (retained and distributed earnings respectively). The alleged discrimination consists in the denial of the reduced 30 % rate to the domestic permanent establishments of EU corporations. From 2001 onwards, the potential discrimination inherent in this rate system was terminated by implementation of a flat rate of 25 % for foreign and domestic corporations pursuant to the October 2000 Tax Reduction Act.

Lausterer (loc. cit. p. 214, 215) notes that a treaty infringement proceeding was pending against Germany until December 2000, when the European Commission suspended the proceeding because of passage of the Tax Reduction Act. Lausterer explains that the purpose of treaty infringement proceedings under EU law is to compel future compliance with EU law, not to sanction or redress past non-compliance, hence that one may not infer from suspension of the treaty infringement proceeding that the European Commission regards Germany's old corporate tax rates as compatible with EU law. Indeed, Lausterer notes that the Commission took the opposite stance in a position paper addressed to the German government in September 1999.

Past articles in German News have reported on the Royal Bank of Scotland and Saint-Gobain decisions of the European Court of Justice (KPMG German News nos. 4/1997 p. 15, 2/1999 p. 22, and 3-4/1999 p. 31 – articles nos. 101, 179, and 191 respectively). In both cases, the European Court of Justice held the domestic tax law of the EU member state to violate the freedom of establishment article of the EC Treaty (former Article 52, new Article 43).

Royal Bank of Scotland involved provisions of Greek tax law that permitted resident corporations to qualify for a reduced rate of corporation tax under certain circumstances, but denied the same privilege to the Greek permanent establishments of EU corporations (decision of 29 April 1999, C-311/97 – DB 1999, 1197). Saint-Gobain was a more complex case involving provisions of German tax law denying certain tax preferences (tax treaty participation exemption for dividends received from foreign corporations, indirect foreign tax credit on dividends received, exemptions of qualified shareholdings for net worth tax purposes) to the domestic permanent establishments of EU corporations that were available to resident corporations.

Of the two cases, the facts of Royal Bank of Scotland most closely resemble those of the new case now pending.

Since the tax court refused to refer the case reported on in this article to the ECJ, it is now before the German Federal Tax Court, which is not expected to issue a swift decision.

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