Luxembourg, 11/04/2007 (Agence Europe) - The Court of Justice, in a judgment delivered on 29 March, held that the German tax system is not in compatibility with Community law, in that it does not allow companies to write off against tax any losses made by subsidiaries established in another member state. Since losses incurred by subsidiaries based in Germany are deductible, this situation discourages German companies from setting up subsidiaries in other EU countries, and this is a restriction on freedom of establishment.
The German law on income tax (Einkommensteuergesetz) of 1990 provides that a parent company established in Germany may deduct from its taxable profits the losses it has incurred in relation to write-downs to the book value of shareholdings in its subsidiaries established in Germany. Conversely, losses of the same kind stemming from shareholdings in subsidiaries established in another member state are deductible only where those subsidiaries subsequently generate positive income of the same kind or if they carry on an activity of a commercial nature.
ITS Reisen, a German company in the tourism sector, owns a subsidiary in the Netherlands. In its annual accounts for 1993 and 1994, ITS Reisen made write-downs to the book value of its shareholding in its Netherlands subsidiary, which it wished to take into account as losses in the calculation of its taxable profits in Germany.
Since the Finanzamt Köln-Mitte (Cologne tax authority) refused to allow it to take into account the losses stemming from those write-downs, Rewe Zentralfinanz eG, as successor to ITS Reisen, brought an action before the Finanzgericht Köln. That court asked the Court of Justice of the European Communities whether the German rules in force at the relevant time were compatible with Community law.
In its judgment of 29 March, the Court held, first of all, that the German legislation constitutes a restriction on freedom of establishment. That legislation applies a different tax treatment to parent companies according to whether their losses stem from write-downs to the value of shareholdings in a resident subsidiary or in a non-resident subsidiary. It therefore discourages them from creating subsidiaries in other member states.
It is possible for such restrictions to be justified, but the Court, after consideration of the arguments put forward by the German authorities, held that they were not proportionate in this case, and therefore inadmissible. The arguments rejected were that the state of residence cannot exercise its taxing powers on the subsidiary in another member state; that the system being challenged is necessary to avoid the risk of double taxation through artificial arrangements; that this system is necessary to ensure consistency with the system governing the movement of dividends received from foreign subsidiaries.
With none of these arguments being accepted, the Court held that the German restriction on freedom of establishment was not justified. The Finance Ministry told EUROPE that it was planning to consult the Länder (regions) to decide whether this judgment would require a review of the legislation itself, or simply some changes in the way it is implemented. In the first case, action at national government level would be necessary; in the second, it would be up to the Länder to act, since the application of laws is a devolved matter. (cd)