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As expected, the European Court of Justice (ECJ) has ruled in the taxpayer's favour in litigation between the French Compagnie de Saint-Gobain SA and the German tax authorities (judgement of 21 September 1999, Case C-307/97 – see article no. 101). The ECJ held that Articles 52 and 58 of the European Community Treaty (now Articles 43 and 48 respectively) were violated by denying tax preferences available to German domestic corporations to the domestic permanent establishment of an EU corporation. At issue were the following preferences:

• tax treaty exemption for dividends received from foreign corporations (participation exemption)

• foreign tax credit on dividends received for corporation tax paid by the foreign distributing corporation (indirect FTC)

• exemption of a qualified shareholding in a foreign corporation for purposes of net worth tax (international net worth tax participation exemption).

The permanent establishment held shares in two domestic corporations and one foreign corporation. Dividends were paid to it directly by the foreign corporation. Other foreign dividends were received by the two domestic corporations. These were allocable to the permanent establishment as the lead entity in a tax consolidated group which included the domestic corporations. A German corporation in the position of the permanent establishment would have enjoyed the preferences at issue.

Paying scant attention to the niceties of German tax law relating to tax consolidated groups, the ECJ held that the denial of the above preferences to the domestic permanent establishment of an EU parent corporation was invalid under EU law. The discrimination against foreign EU corporations doing business in Germany in branch form violated the principle of freedom of establishment and was not justified by any adequate objective considerations. The inability of Germany to tax the dividends paid by foreign EU corporations was rejected as grounds for the discrimination.

The discrimination involved in Saint-Gobain is probably relevant only to past years because of changes which have taken place in German tax law. The net worth tax was de facto repealed from 1997 onwards. In 1994, the corporation tax law was amended to permit the domestic permanent establishment of a foreign corporation to qualify for the participation exemption and the indirect tax credit. Remaining issues with respect to structures involving consolidated tax groups are disposed of by changes made to § 15 nos. 2 and 3 KStG by the 1999 Tax Adjustment Act (see sec. 3.1 of article no. 183)

Of the various other types of discriminatory treatment which persist, the most significant is the denial to domestic permanent establishments of the reduction in corporation tax which domestic corporations receive upon distribution of their earnings. In combination with the Parent Subsidiary Directive, this reduction, currently from 40 % to 30 %, puts foreign EU corporations doing business in Germany in branch form at a significant disadvantage compared with those doing business through subsidiaries.

The higher tax rate for corporate permanent establishments is calculated so as to subject them to a total German tax burden roughly equal to that on dividends paid by subsidiaries to foreign shareholders where the dividend is subject to withholding tax. The present unequal treatment of EU subsidiaries and permanent establishments is largely the result of elimination of withholding tax inside the EU by the Parent-Subsidiary directive.

This tax rate differential was not at issue in Saint-Gobain. In another recent decision, the ECJ voided a provision under Greek tax law granting a reduced corporation tax rate to Greek domestic corporations but denying the reduction to the Greek permanent establishments of foreign corporations which met the same conditions (Royal Bank of Scotland, judgement of 29 April 1999 – see article no. 179). The specifics of the case have little to do with the German corporation tax system, however.

It is not possible to say based either on Saint-Gobain or on Royal Bank of Scotland how the ECJ will decide the issue of the German split rate corporation tax system. It is clear, however, that most forms of discrimination against the domestic permanent establishments of foreign EU corporations will not stand up under EU law.

The government's planned Tax Reform 2000 (see article no. 184) would eliminate the different corporate tax rates and end any future objection to the German corporation tax on rate discrimination grounds.

For further information, please send a fax or an e-mail stating your inquiry to KPMG Frankfurt, attn. Christian Looks: Fax (0)69-9587-2262, e-mail You may also send an e-mail to KPMG Germany by clicking the Contact Contributor button on this screen.

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