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A decision rendered by the European Court of Justice in March 1999 (Case C-212/97 Centros Ltd. vs. Danish Commercial Register – 9 March 1999) is being interpreted in Germany as the death knell of the so-called "seat-of-management" theory (Sitztheorie) for determining whether an association has separate corporate identity and legal capacity. Abandonment of this choice of law rule in favour of the "place-of-incorporation" theory would have major impact on the legal and tax status of so-called dual incorporated corporations (DRCs) in Germany. Numerous experts consider that, after Centros, the seat-of-management theory is a dead letter at least as far as corporations organised under the law of another EU member state are concerned. Other authors are more cautious and inclined to limit Centros to its facts.
The tax and legal status of DRCs in light of the "seat-of-management" theory has repeatedly been dealt with in prior articles nos. 40, 94, and 158). Under the prevailing German choice of law rule, the separate legal identity and legal capacity of an association depends on the law of the jurisdiction in which the association's "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 (see, however, sec. 6.4 below). If an association's seat of management is in Germany, this means that, from a German perspective, the association can only acquire corporate status if it has been organised in accordance with German law. Incorporation under the laws of another jurisdiction is irrelevant. 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. item 2.3 of 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.
2. Centros: facts and holding
Centros Ltd. was a private limited company duly incorporated and registered in England by a Danish married couple who resided in Denmark and acted as the company's managers. Centros applied for registration of a branch in the Danish Commercial Register. The application was rejected on the grounds that the company had never engaged in business in England and that incorporation there with nominal share capital (£ 100) was merely a means of avoiding the minimal share capital requirement of then approx. £ 20,000 for incorporation as a Danish limited liability company. The purported Danish "branch" was in fact to be the company's principal establishment. These facts were undisputed.
The Danish lower court upheld the Commercial Register. On appeal, the matter was referred to the ECJ for a preliminary ruling.
The ECJ held that failure to register the branch was a violation of the freedom of establishment under then Articles 52 and 58 (now Articles 43 and 48) of the EC Treaty. These articles read in pertinent part as follows:
"[R]estrictions on the freedom of establishment of nationals of a Member State in the territory of another Member State shall be prohibited. Such prohibition shall also apply to restrictions on the setting-up of agencies, branches or subsidiaries by nationals of any Member State established in the territory of any Member State. [....] Companies or firms formed in accordance with the law of a Member State and having their registered office (satzungsmäßiger Sitz), central administration (Hauptverwaltung) or principal place of business (Hauptniederlassung) within the Community shall, for the purposes of this Chapter, be treated in the same way as natural persons who are nationals of Member States."
The ECJ interpreted these provisions literally. "The provisions of the Treaty on freedom of establishment are intended specifically to enable companies formed in accordance with the law of a Member State and having their registered office, central administration or principal place of business within the Community to pursue activities in other Member States through an agency, branch or subsidiary" (Centros at par. 26). Having a registered office in England, Centros was entitled to register a branch in Denmark. No nexus with England over and above the fact of incorporation was required to invoke rights under the EC Treaty. There is discussion whether the structure chosen was "abusive" in the sense of ECJ case law. The court finds that it is not. Finally, the court considers whether considerations of public interest, such as creditor protection, might justify the restriction of freedom of establishment, but concludes that they do not.
3. Centros and the seat-of-management theory
There is no mention of the seat-of-management theory in Centros. Nor does this theory appear to have been discussed in the Opinion of the Advocate General. Nevertheless, it is clear that the outcome of the case is diametrically opposed to the seat-of-management theory as practised in Germany, under which Centros Ltd. is clearly not entitled to registration in Denmark because its seat of management is in Denmark (where its owners and managers were located). Hence, Danish law determines its separate legal existence. Since no incorporation in Denmark has taken place, Centros is not a corporate entity and not entitled to register a branch.
Many, though by no means all commentators in Germany regard Centros as signifying that no discrimination of any sort is permitted against corporations incorporated in other EU member states. This would be tantamount to the end of the seat-of-management theory as regards such companies. Moreover, the principle of non-discrimination against companies incorporated in other EU member states has a wide array of tax implications for the treatment of dual resident corporations.
A number of authors (e.g. Kindler NUW 1999, 1993; Leible NZG 1999, 298; Bungert, DB 1999, 1841) are cautious in their interpretation of Centros. Bungert states (loc. cit. p. 1842/1, 1842/1; thus contradicting Meilicke DB 1999, 627/2) that both England and Denmark apply the place-of-incorporation as their choice-of-law rule, hence that the seat-of-management rule was never even potentially at issue. Bungert regards the reach of Centros as limited and suggests that the seat-of-management rule may continue to apply to pure "mailbox" companies (loc. cit. p. 1843/1). He does not comment on the tax implications of Centros.
4. Civil law implications of Centros
After Centros, German courts may be required to recognise the separate legal identity and legal capacity of foreign corporations duly incorporated under the laws of an EU member state irrespective of the location of the corporation's seat of management. Moreover, since the fundamental freedoms of Articles 39 ff. (ex Art. 48 ff.) of the EC Treaty are extended to Norway, Iceland, and Liechtenstein as members of the European Economic Area (EEA), Centros may require German recognition of corporations organised in these countries as well. Meilicke (DB 1999, 627, 628/1) contends that the nationals of countries such as Poland and Hungary are likewise entitled to claim the protection of the fundamental freedoms of the EC Treaty under association agreements, hence that their corporations would be protected by Centros as well.
The term "foreign EU corporation" as used below includes corporations organised under the laws of the EEA countries or any other country whose nationals enjoy freedom of establishment under an association agreement with the EU.
Recognition of corporate existence protects the officers and shareholders of foreign corporations from personal liability. It moreover simplifies dealings with the German authorities, e.g. when a foreign corporation seeks to enter its German branch in the Commercial Register (analogous to Centros) or to register its title to real property with the land records office (Grundbuchamt). However, at least in certain cases, the German authorities have in the past routinely processed such applications by foreign corporations without investigating their actual place of management (see e.g. the cases reported on in article no. 40). On the other hand, Bungert cites a recent case before the Bavarian Higher Regional Court in which a corporation organised under English law was denied registration in the Commercial Register because it was unable to show that its seat of management was in England (loc. cit. p. 1841/1; DB 1998, p. 2318 - ruling of 26 Aug. 1998).
5. Tax law implications of Centros
Of greater potential importance are the tax law implications of Centros, which are addressed e.g. in articles by Meilicke (DB 1999, 627), Sörgel (DB 1999, 2236), and Eilers/Wienands (IStR 1999, 289). The remarks which follow are indebted to these authors.
It is noted as a caveat that Centros itself is narrowly centred around the issue of registration of a branch for transaction of business in an EU state other than the state of incorporation. The EC Treaty specifically protects the right to do business in another EU state through a branch (see above sec. 2). It is debatable whether Centros should be read as prohibiting all discrimination against duly registered EU corporations (barring indications of fraud or abuse not present in Centros).
5.1 Dividends-received exemption under § 8b (1) KStG
In a 1992 decision dealing with a Liechtenstein corporation with its seat of management in Germany, the Federal Tax Court held that the corporation was resident in Germany and subject to German corporation tax on its worldwide income even though it lacked separate legal identity (article no. 40, sec. 3.3). Even without legal identity, the court found a resemblance between the Liechtenstein corporation and other entities lacking legal existence but subject to corporation tax under § 1 (1) no. 5 KStG and therefore affirmed corporate tax liability under this provision of the corporation tax code.
Under Centros, it may be impossible to deny the legal identity of the Liechtenstein corporation (because Liechtenstein is a member of the European Economic Area and its corporations are entitled to invoke the fundamental freedoms of the EC Treaty). Hence, corporate tax liability for such corporations would have to be affirmed under § 1 (1) no. 1 KStG (similarity of the Liechtenstein corporation to German corporations, i.e. stock corporation or limited liability company.)
§ 8b (1) KStG creates (subject to certain conditions) a tax exemption for dividends received by a resident corporate entity within the meaning of § 1 (1) nos. 1, 2, 3 or 6 KStG from another resident corporation where the dividends are paid out of the distributing corporation's tax free earnings (primarily, dividends received tax free under tax treaties from foreign corporations). Resident corporations within the meaning of § 1 (1) no. 5 KStG are not included in the list of qualifying corporations and the corporation tax guidelines hence explicitly deny them the benefit of § 8b (1) KStG (A. 41 (2) sent. 2 KStR).
Hence, after Centros, a foreign EU corporation with its seat of management in Germany may be entitled to the dividends received exemption of § 8b (1) KStG.
5.2 Capital gains exemption under § 8b (2) KStG
§ 8b (2) KStG creates (subject to certain conditions) a tax exemption for capital gain derived by a resident corporate entity within the meaning of § 1 (1) nos. 1, 2, 3 or 6 KStG on liquidation of or sale of shares in a foreign corporation where dividends received from the foreign corporation would have been exempt under a tax treaty (possibly in conjunction with German domestic law) or would have qualified for certain other tax relief. Here again, Centros may have removed the primary obstacle to application of this provision to foreign EU corporations having their place of management in Germany, namely exclusion of corporate entities within the meaning of § 1 (1) no. 5 KStG from the list of qualifying entities.
Whether a foreign EU corporation with place of management in Germany meets the other requirements of § 8b (2) KStG will depend on the terms of the specific tax treaty in question and the location of the corporation whose shares are being sold (or which is being liquidated). The exemption will often be available, though not always (see examples of Eilers/Wienands IStR 1999, 289, 296/1).
5.3 Foreign EU corporation as lead company in a tax consolidated group
Under § 14 no. 3 KStG and the 1999 version of § 2 (2) GewStG, a corporation must have both its registered office and its principal place of management in Germany in order to function as the lead company in a tax consolidated group for corporation and trade tax purposes. On the other hand, under § 18 KStG, the domestic registered branch of a foreign corporation may function as lead company in a consolidated group.
Hard pressed for a rationale as to why consolidation should be possible under a mere permanent establishment, but prohibited under a permanent establishment which was also the principal place of business, the court stated that this was the result desired by the German legislature because of the seat-of-management theory so as to discriminate against corporations not having their principal place of management in the jurisdiction in which they are incorporated.
As regards EU corporations, this rationale may fall flat after Centros, which can be read as prohibiting discrimination against duly organised foreign EU corporations no matter where their place of management is located.
5.4 Foreign EU corporation as member company in a tax consolidated group
§§ 14, 17 KStG likewise require that members of a domestic consolidated tax group have both their registered office and their principal place of management in Germany.
After Centros, this requirement also appears invalid as regards foreign EU corporations for the reasons set forth in the preceding section.
5.5 Establishment or abandonment of residence as a tax realisation event
§ 12 (1) KStG provides for realisation of gain or loss when an entity subject to German corporation tax on its worldwide income (resident corporation) transfers either its registered office or its principal place of management to another country and thereby ceases to be subject to German taxation on its worldwide income. Hence, a deemed liquidation occurs when a corporation with registered office in another country establishes its principal place of management in Germany and then transfers this place of management to another country. Centros has no affect on such situations (abandonment of residence).
On the other hand, Centros does appear to affect the initial establishment of residence by a foreign corporation through transfer of its principal place of management to Germany. There is controversy in Germany whether this act will trigger realisation of gain with respect to an existing German permanent establishment. Under the seat-of-management theory, the transfer would destroy the legal identity of the foreign corporation. However, even applying this theory, the prevailing view is that no gain or loss results because the assets of the permanent establishment remain in the German tax sphere. Since Centros may require the continued recognition of legal identity with regard to a foreign EU corporation, this would end all question of tax realisation in such circumstances (cf. Sörgel DB 1999, 2236, 2237/1, 2238/1).
Eilers/Wienands discuss the consequences of transfer of both the principal place of management and the registered office from a foreign country to Germany. Independent of Centros, they conclude that such transfer is not a tax realisation event with respect to an existing German permanent establishment.
6. Centros and dual resident corporations (DRCs)
6.1 DRCs and international business combinations
The article authored by Eilers/Wienands (loc. cit.) is concerned with the uses of dual resident corporations to effect an international business combination of a German corporation with a foreign corporation. National law presently does not permit tax-neutral cross-border mergers. Eilers/Wienands therefore outline a model whereby the shareholders of the two companies being merged contribute their shares to a new joint holding company resident both in Germany and in the home jurisdiction of the foreign corporation (DRC). German law permits tax-neutral contribution of shares in a corporation in exchange for new shares in a resident receiving corporation provided the receiving corporation holds a majority of the shares in the first corporation after the contribution is complete (§ 20 (1) sent. 2 UmwStG). The receiving corporation may also be located in another EU country provided shares in an EU corporation are being contributed (§ 23 (4) UmwStG).
Assuming the other tax jurisdiction involved has similar rules (and ignoring the problem of shareholders resident in third countries), a single corporation can be established which holds all shares in the two companies being combined (and which can assume management responsibility for both companies – managing holding).
Assume, for instance, the combination of an English company with a German company. A new holding could be formed in England and have its registered office there. In a second step, its principle place of management could be established in Germany, causing it to be resident in Germany as well. The described contribution of shares and issuance of new shares could then take place as described (assuming English law on point analogous to German law).
6.2 Treatment of the DRC in Germany
The dilemma of the described holding is that it is, by definition, resident in two jurisdictions at the same time. Is the taxation of its current earnings (dividends received) manageable? This depends in large part on the answers to further questions:
• Will the holding be entitled to tax treaty protection from a German perspective? Specifically, can it receive dividends tax free from its English subsidiary under the German-English tax treaty?
• Can the holding receive dividends tax free under § 8b (1) KStG from its German subsidiary?
• Can the holding distribute dividends to its German corporate shareholders which are tax-exempt in their hands under § 8b (1) KStG?
• Can the holding sell shares in its foreign subsidiaries tax free under § 8b (2) KStG?
• Can the holding participate in German consolidated tax groups as lead or member company where this is expedient?
If the answer to the above questions is affirmative, as it well may be, then the tax disadvantages attaching to German residence may be nil. With respect to the tax treaty status of a dual resident company, Eilers/Wienands (their footnote 16) cite an unpublished decision of the Munich Tax Court (7K 4389/90 - 14 April 1994).
Eilers/Wienands point out (pp. 290/2 - 291/1) that, by giving the holding German residence, as opposed purely English residence, potential problems of look-through taxation under Germany's international taxation act (AStG) are avoided. Under the international taxation act, passive earnings of interposed foreign corporations are taxed directly to the shareholders irrespective of distribution when not subject to taxation of 30 % or more at the level of the interposed corporation.
Furthermore, if the example were modified to involve combination of a Swiss and a German corporation, the holding's residence in Germany (or another EU country) would be a condition of the tax-free contribution as far as the German shareholders are concerned because tax-free contribution to a non-EU corporation is not permitted.
6.3 Impact of Centros on international reorganisations
Centros favours the above model to the extent the registered office of the dual resident holding corporation is in an EU country (including the EEA and possibly other associated countries):
• Under Centros, Germany would appear compelled to recognise the separate legal existence of the dual resident holding, thus avoiding personal liability on the part of its shareholders and officers (see sec. 1 above).
• Under Centros, the holding may enjoy the benefit of § 8b KStG (see sec. 5.1, 5.2 above).
• Under Centros, the holding would appear eligible to function as either lead or member company in a tax consolidated group (see sec. 5.3, 5.4 above).
6.4 Separate location of "place" and "seat" of management?
Even if the registered office of the dual resident holding corporation is not in another EU country, Eilers/Wienands suggest that the model can still succeed by choosing a structure in which the principal place of management (Ort der Geschäftsleitung – controlling for tax purposes) is located in Germany, but the seat of management (Verwaltungssitz – controlling for choice-of-law purposes) remains at the location of the registered office (loc. cit. pp. 292 ff.). They contend that, at least for a holding company exercising management responsibility, situations are realistically imaginable in which the principal place of management and the seat of management need not coincide, although in practice this is generally the case (see article no. 40, sec. 3.1).
The principal place of management is determined with respect to the place from which the person or persons charged with overall management responsibility exercise their functions. The seat of management is commonly defined as the place at which fundamental management decisions are effectively translated into externally recognisable actions, generally the place at which the management body and its members are located. Eilers/Wienands propose a structure which divides the decision-makers from the decision-implementers.
7. Concluding remarks
The ECJ's Centros decision may put an end to the seat-of-management theory as regards foreign EU corporations and hence have fundamental civil and tax law impact on Germany's treatment of dual resident EU corporations. While the possibilities opened up by Centros are far-reaching, it would be rash not to consider carefully the more cautious voices in the literature.
Within the EU and EEA, Centros permits avoidance of provisions of national company law with regard to minimum share capital and in general seems to allow shareholders to choose the European company law they find most conducive irrespective of the country in which their corporation actually conducts business. This may initiate a "race for the bottom" à la américaine as regards European company law, or it may create new pressure for harmonisation of European company laws.
Centros also appears important with regard to the imaginative uses of dual resident companies, such as in international business combinations.
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