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In four rulings dated 10 November 1998, the German Federal Constitutional Court has once again declared central aspects of the German tax system to be unconstitutional. The decisions deal with two related issue complexes:
- How much tax relief must be accorded to account for parents' expenditures for their children's material needs?
- What tax relief must be accorded to account for the demands made on parents by their children's need for care, attention, and education?
1. Zero taxation of income to support children's minimum standard of living
Building on earlier decisions, the court has now firmly established the constitutional prohibition of taxation of that part of a parent's income which is necessary to support his or her children at the children's minimum material standard of living (Kinderexistenzminimum). This confirms the principle of taxation of so-called subjective net income, that is, of the net income remaining after deductions to take account of certain basic personal needs.
Under the subjective net income principle, previous decisions of the Federal Constitutional Court had held that the state may not impose income tax on that part of an individual's income which the taxpayer reasonably requires to maintain a minimum standard of living for himself or herself. The court determined such minimal need with respect to the minimum welfare support accorded to indigents. The court also made clear in these decisions that the principle of zero taxation of income needed to support a minimum standard of living applied no matter how large an individual's total income. The consequence of these decisions was a sharp increase in the zero bracket amount in the German income tax system.
The same principle has now been extended to that part of a taxpayer's income which is reasonably required to pay for a minimum standard of living for his or her children. The principle of zero taxation of the minimum child support amount also applies no matter how great the parent's total income.
2. Measure of minimum children's standard of living
Again, the court has determined the minimum amounts based on the welfare support accorded to parents who are themselves unable to support their children. The court took account of welfare support both in cash and in kind. Based on its calculations, the court declared the taxation of parents with one child or two children to be unconstitutional in the years 1985, 1987, and 1988.
Up until 1996, the German income tax system allowed parents a standard deduction for children and, in addition, parents also received direct child support payments. In 1996, partly as a response to previous constitutional rulings, the system was changed to provide for either direct child support payments or a standard deduction, whereby both the child support payments and the standard deduction were increased considerably.
The court held that the sum of the standard deduction for children and the deduction amount represented by child support payments paid must be equal to the minimum child support amount. In converting direct child support payments into an additional deemed deduction amount for purposes of this calculation, the court held that the individual taxpayer's marginal tax rate was to be used, causing the deemed additional deduction amount to be smaller the higher the taxpayer's marginal tax rate.
3. Retroactive application
The court specified that its ruling with regard to zero taxation of the minimum child support amount was to be applied retroactively. The cases before the Federal Constitutional Court were remanded to the Federal Tax Court. It is conceivable that the required additional relief can be granted under provisions of the tax code allowing for abatement of tax on equitable grounds. Otherwise, the legislature must enact a law implementing the ruling of the Federal Constitutional Court.
The ruling will only benefit taxpayers whose tax assessment notices are still open. This group of taxpayers is large, however, as doubt as to the constitutionality of the tax system with regard to child support has existed for some time.
4. Cost of child care, attention, and education
In this area, the court declared the deduction of child care costs allowed by sec. 33c EStG to be unconstitutional to the extent it denied the deduction to married couples living in a single household and granted it only to single parents. Furthermore, a standard deduction allowed single parents was also declared unconstitutional on the same grounds (sec. 32 (7) EStG).
Unlike the rulings discussed in sec. 1-3 above, the court here granted the legislature transition periods to remedy the constitutional problems. In the case of the child care deductions, the deadline for rectification is 1 January 2000; for the standard deduction, the deadline is 1 January 2002.
The decisions in this area would appear to have no retroactive effect. The court stated that the parties who brought suit would, however, have to be granted relief.
The decisions of the court in this area move in the direction of zero taxation of the sums expended by parents to satisfy their children's reasonable needs for care, attention, and education irrespective of the parents' marital status and whether both have jobs or not.
5. Implications of the rulings
The principle of zero taxation of the amount needed to provide for a child's minimum standard of living applies retroactively as well as prospectively. Conceivably, the German income tax provisions in this area are unconstitutional in all past years right up to the present. Presently, calculations are being carried out of for the various years using the system specified by the Federal Tax Court. The tax authorities have generally begun issuing all assessment notices on a provisional basis pursuant to sec. 165 AO (cf. directive of the Ministry of Finance of North-Rhine/Westphalia of 26 Jan. 1999, DB 1999, 257). Assessments issued on this basis can be corrected at a later time after the legal situation is clarified.
It would appear prudent to insist upon provisional assessment in all open cases posing the issues discussed in sec. 1-3 above.
It is not clear that the rulings discussed in sec. 4 will have any retroactive effect. It may nevertheless be prudent to seek provisional assessment in these cases as well until this question is completely clarified.
6. Effect on pending legislation
The rulings by the Federal Constitutional Court prompted the government to remove a provision from its recently enacted tax legislation which would have increased direct child support payments for the first and second child by DM 10 per month from the year 2002 onwards. The government has announced plans to enact a new comprehensive bill bringing the taxation of families into line with the requirements defined by the Federal Constitutional Court. An increase in child support payments in the year 2002 in an amount at least equal to that originally planned will be part of this bill.
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