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1. Introduction

In its judgement of 14 September 1999 (Frans Gschwind - Case C-391/97), the European Court of Justice (ECJ) upholds the most important changes made in German income tax law following the ECJ's 1995 Schumacker decision (see articles nos. 29 sec. 4.1 and 50).

At issue in Gschwind, as in Schumacker, is the extent to which an EU Member State may permissibly deny foreign non-resident EU nationals working within its borders the personal and family-related tax benefits available to its residents. In Schumacker, the Court held that such denial was precluded by the EC Treaty where the income earned in the state of employment constitutes all or virtually all of an individual's total income and the income earned in the state of residence is inadequate to permit this state to take account of the taxpayer's personal and family circumstances.


2. Schumacker and its aftermath

Before Schumacker, Germany only took account of the personal or family circumstances of resident taxpayers. In order to file a joint return and qualify for the highly advantageous splitting rate, both spouses had to be residents.

After Schumacker, Germany changed its laws to permit residents of EU Member States, Liechtenstein, Iceland, and Norway to receive all personal and family-related tax benefits available to resident taxpayers if one of two conditions is met:

• at least 90 % of the taxpayer's total income for the calendar year is subject to German taxation (percentage threshold)


• the amount not subject to German taxation does not exceed the equivalent of DM 12,000 (absolute threshold).

With regard to the splitting rate, the (minimum) percentage threshold applies to the joint income of both spouses (not just to the spouse working in Germany) and the alternative (maximum) absolute threshold is doubled (DM 24,000).


3. Facts, central issue, and holding of Gschwind

The case involved a Dutch national living in the Netherlands with his wife and child, but working in Germany. Mr. Gschwind's German salary constituted his entire income. However, his wife also worked in the Netherlands and earned approx. 42 % of the joint spousal income. The German tax authorities refused to apply the splitting rate to Mr. Gschwind's taxable income. Since only Mr. Gschwind's income was subject to German taxation, he fell short of the minimum percentage threshold (90 %). Since Mrs. Gschwind's income exceeded the equivalent of DM 24,000, he could not meet the alternative maximum absolute threshold either.

Under the German splitting rate, the standard income tax rate is applied to half of a married couple's joint taxable income and the result is multiplied by two to determine their income tax. Because German income tax rates are sharply progressive, the splitting rate results in tax savings compared with filing two single returns wherever a couple's joint income is not earned half by each spouse. The current maximum tax reduction from the splitting rate is DM 22,886.

Mr. Gschwind appealed the denial of the splitting rate to the Cologne Tax Court, arguing that the requirements established by German law were discriminatory under Art. 48 (now Art. 39) of the EC Treaty since no comparable thresholds applied to German residents. The Cologne Tax Court suspended proceedings and requested a preliminary ruling from the ECJ (see articles nos. 114 and 160).

Following the recommendations of the Advocate General (Case C-391/97 - 11 March 1999), the ECJ upheld the relevant provisions of German law. The ECJ distinguished Gschwind from Schumacker on the grounds that Gschwind did not involve circumstances in which "almost the entire income" of the taxpayer's tax household was earned and taxable in the state of employment (Germany). Noting that nearly 42 % of the Gschwinds' total income was received in the Netherlands, the ECJ considered the tax base in this state to be sufficient to permit it to take account of the Gschwinds' personal and family circumstances (Gschwind at par. 28, 29).

The EJC rejected the taxpayer's argument that he and his wife were unfairly discriminated against because a German resident married couple, one of whom worked in Germany and the other in e.g. the Netherlands such that the latter's income was not subject to German taxation under the relevant tax treaty, would qualify for the splitting rate without regard to the percentage of joint spousal income which remained subject to German taxation. While Germany would take account of the exempt income of the spouse working in the Netherlands in fixing the tax rate applicable to the other spouse's income (progression adjustment), the same progression adjustment would occur if the splitting rate were applied to Mr. Gschwind's income (cf. § 1a (1) no. 2 EStG).

The reasoning of the ECJ on this issue (Gschwind at par. 30) is essentially that the different treatment of non-residents is justified because the state of residence of both spouses is better able to take account of their family circumstances since only this state has the power of taxation over their worldwide incomes. Equal treatment of residents and non-residents is only mandated by the EC Treaty where the income earned in the state of employment is such that the state of residence is no longer able to take account of the family circumstances as a factual matter.

Instead of holding merely that the state of residence is still able to take sufficient account of the family circumstances of a married couple where approx. 40% of the household income remains taxable in this state, the Court went further and explicitly endorsed the 90% German threshold, implying that the state of residence remains able to make a sufficient adjustment if as little as 11% of the household income is earned within its borders.


4. Observations and comments

Gschwind and Schumacker were both decided under Art. 48 (now Art. 39) of the EC Treaty providing for "freedom of movement for workers ... within the Community" and, more specifically, "abolishing any discrimination based on nationality between workers of the Member States as regards employment, remuneration, and other conditions of work and employment".

The issue before the Court was therefore whether the denial of the splitting rate to Mr. Gschwind constituted discrimination based on nationality. The relevant German law makes no mention of nationality, but rather defines different regimes based on residence. A couple resident in Germany is entitled to the splitting rate no matter how little of their joint income is subject to German taxation, whereas a couple resident in an EU Member State (or one of the European Economic Area countries) is only so entitled if it meets one of two thresholds (percentage threshold or absolute threshold). It is, however, clear that rules depending on residence may constitute discrimination based on nationality because non-residents are generally also foreign nationals (Schumacker, at par. 27, 28).

The ECJ defines discrimination as the application of different rules to comparable situations or the same rule to different situations (Gschwind, at par. 21). Since Gschwind involved the application of different rules, the issue was whether there was a justifying difference in the situations to which the different rules were applied.

Here the Court states that, "as far as direct taxes are concerned, the situations of residents and of non-residents in a given state are generally not comparable" because a state taxes the worldwide income only of its residents (Gschwind at par. 22). Its taxation of non-residents is limited to income having its source within its borders. The Court notes that this principle, found in the domestic tax law of most if not all developed nations, is also a cornerstone of the OECD model tax treaty, on which the developed world's network of tax treaties is based (cf. Gschwind at par. 24).

These comments by the Court signal strong deference to the principle of residence, from which derives the corollary principle that it is up to the state of residence to take account of a taxpayer's personal and family circumstances. Failure of the state of employment to take account of the personal and family circumstances of a non-resident is justified, hence not discriminatory in the sense of the EC Treaty, because of the inability of the state of employment to tax the worldwide income of its non-residents. Schumacker, however, stands for the principle that an exception applies when the income earned in the state of employment represents all or virtually all of the taxpayer's income, hence coincides with his worldwide income. In such cases, the limitations on the scope of taxation by the state of employment lose all practical significance and this state exercises de facto taxation over the taxpayer's worldwide income. Hence, in these circumstances, the state of employment must take account of the taxpayer's personal and family circumstances.

In Gschwind, the Court may be thought of as applying the same principles to an issue affecting the taxation of a married couple. Since the couple's joint income was not concentrated in Germany, the Court refused to recognise any obligation on Germany to accord a benefit designed for the couple as an economic unit to the spouse who worked in Germany, even though the income of this spouse, viewed in isolation, was entirely from German sources (subject to German taxation – cf. Gschwind, at par. 31).


5. Impact of the decision

Gschwind may make pragmatic sense because of the unharmonised state of European tax law, particularly as regards the account to be given to a taxpayer's personal and family situation. By approving the high German 90 % percentage threshold to qualify for the splitting rate, the Court has by implication approved the same threshold with respect to other relief related to family and personal circumstances as well.

While the diversity of EU tax law in the area makes it difficult to generalise, the bottom line would appear to be that non-resident individuals who do not earn substantially all of their income in a single EU land will continue to be at a disadvantage as compared with non-residents who meet a high percentage threshold and compared with residents.

The German tax authorities argued in Gschwind that unjustified cumulative benefits would result were Mr. Gschwind to enjoy the splitting rate in Germany while his wife claimed other family benefits in the Netherlands (Opinion of the Advocate General, at par. 14). While it is not clear that this contention was correct, windfall double benefits are conceivable as a theoretical matter as long as income tax law is not harmonised in this area.

In a harmonised tax system, Mr. Gschwind would clearly be entitled to the splitting rate he sought. This is shown by the following example, which assumes the German tax laws to be in force both in Germany and the Netherlands (tax calculations at 1999 rates).



Taxable income, Mr. Gschwind (Germany)


Taxable income, Mrs. Gschwind (Neth.)


Joint household taxable income


Tax on DM 100,000, splitting rate


Tax on DM 52,000, splitting rate: Germany
(with progression adjustment)


Tax on DM 48,000, splitting rate: Neth.
(with progression adjustment)


Total tax, Germany + Netherlands


By applying the splitting rate in both countries, total family taxation on two incomes, one earned in Germany and the other in the Netherlands, is the same as if the entire income had been earned in either of the two countries. This result is unaffected by changes in the distribution of income between the two spouses.

However, failure to apply the splitting rate in Germany in the above example would increase Mr. Gschwind's tax and therefore the total tax for the household by DM 235.

Were one to assume taxable income of Mr. Gschwind of DM 75,000 (75 %) and taxable income for Mrs. Gschwind of DM 25,000 (25 %), the additional tax paid by Mr. Gschwind, and therefore total tax for the household, would increase by DM 3,563 if he were denied the splitting rate. Assuming taxable income to be proportionate to gross income, Mr. Gschwind would meet neither the percentage threshold nor the absolute threshold on these facts and hence be denied the splitting rate under current German law.

In an unharmonised tax world, there is no reason to assume that the penalty resulting from denial of personal and family benefits in analogous cases will be less than in the harmonised system hypothesised above. Gschwind thus appears to stand for the principle that substantial tax penalties on EU nationals who take work outside their country of residence are not incompatible with the principle of free movement of workers.

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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