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1. ECJ ruling in Eurowings
In a decision dated 26 October 1999, the European Tax Court held that central provisions of German trade tax law violate the guarantee of freedom to provide services under Art. 49 of the EEC Treaty. Ruling on a request from the Münster Tax Court for a preliminary ruling (see article no. 102), the ECJ found that the contested provisions of trade tax law (§§ 8 no. 7, 12 (2) no. 2 GewStG) discriminated against foreign lessors of movable goods (Eurowings, case C-294/97).
The cited provisions of the trade tax law require that half of the fees paid by the lessee for lease of personal (moveable) property be added back to the lessee's earnings in determining its trade tax earnings. The full value of such leased property is added back for purposes of the trade tax on capital, which was in force through 1997. The addbacks do not occur, however, if the fees and the leased property are subject to German trade tax in the hands of the lessor. Generally speaking, this is the case when the lessor is a German resident.
As an exception to the exception, the addbacks still take place even though the lease payments are in principle taxable in the hands of the lessor if the leased property constitutes a business or branch of activity and the lease payments exceed DM 250,000. In this case, the lease payments are deducted from trade tax income at the level of the lessor under § 9 no. 4 GewStG.
Eurowings AG, a German lessee of aeroplanes from an Irish lessor, challenged the addbacks under EU law on the grounds that they impermissibly discriminated against the foreign EU lessor. The lessee argued that, since the addbacks as a practical matter only apply when a German enterprise leases from a foreign enterprise, German lessees would be inclined to lease from German lessors to avoid the addback, hence that the addback impermissibly disadvantaged foreign EU lessors.
The ECJ adopted this line of reasoning. While the purpose of exempting lessees from the addback where the lease payments are subject to trade tax in the hands of the lessor is to avoid double trade taxation of such earnings, adding half of lease payments to the taxable earnings of the lessee is likely to result in a greater overall trade tax burden than taxation of 100 % of the lease payments in the hands of the lessor, which pays trade tax only on its net income from leasing operations. Since the addback tends to increase the trade tax burden instead of simply shifting it from the lessor to the lessee, a foreign lessor would have to offer prices significantly below those of a domestic lessor in order to compensate the lessee for the added trade tax lease cost.
2. Response of the tax authorities
In response to the ECJ's ruling, the state tax authorities announced in a series of directives (see e.g. that of Sachsen-Anhalt of 24 January 2000, DB 2000, 398) that, pending action by the German legislature, the addback provided for by § 8 no. 7 GewStG would not be enforced in situations analogous to that in Eurowings (lessor in another EU country, German lessee).
3. Legislative response
The first draft of the Tax Reform 2000 package released in January 2000 would have repealed the exception to the addback under § 8 no. 7 GewStG, not the addback itself. § 9 no. 4 GewStG would also have been deleted. After these changes, half of lease payments would have been added back to the trade tax earnings of the lessee and, in addition, such payments would have been subject to trade tax in the hands of a domestic lessor. In situations such as Eurowings, domestic lessees would have included half of their lease payments in trade taxable earnings, while foreign lessors would have continued to escape trade tax for want of a domestic permanent establishment.
The contemplated changes would thus have transformed the advantage previously enjoyed by domestic lessors over foreign lessors into a whopping disadvantage, in that domestic lessors would have had to absorb an added tax burden in order to offer prices equivalent to those of foreign lessors (all other things being equal).
The resulting outcry from the German leasing industry was, however, heard by the German government, which removed the changes from the second draft of the bill. They are not contained in the draft bill passed by the Federal Parliament in May 2000 (see articles nos. 195 - 199 on Tax Reform 2000).
An addback at the level of the lessee without any relief at the level of the lessor would disadvantage domestic lessors. Since the government is loath to eliminate the addback for lease payments altogether, it seems likely that it will opt for a solution under which the addback will take place at the level of the lessee, but lessors subject to trade tax will be able to deduct lease payments received in computing their income for trade tax purposes.
Besides this solution and that first advanced by the government, there is also another alternative. Scheffler (DB 2000, 735) argues that the best solution would be to add half of the interest component of leasing payments to the income of lessees instead of half of the full lease payment. This would eliminate the tax difference between lease and credit purchase of fixed assets. Half of interest paid on long-term debt, e.g. on borrowings to purchase fixed assets, is added back to trade tax earnings under § 8 no. 1 GewStG.
For further information, please send a fax or an e-mail stating your inquiry to KPMG Frankfurt, attn. Christian Looks: Fax +49-(0)69-9587-2262, e-mail cLooks@kpmg.com. You may also send an e-mail to KPMG Germany by clicking the Contract Contributor button on this screen.
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