Global Tax Alert (News from the EU Competency Group) | 30 January 2014
New CJEU decision does not fully provide clarity on exit taxation
On 23 January 2014, the Court of Justice of the European Union (CJEU) issued its decision in the case DMC Beteiligungsgesellschaft mbH1 holding that (i) an immediate taxation of built-in gains upon exit of a Member State’s tax jurisdiction is an infringement of the free movement of capital-principle but can be justified if the tax is collected in installments over five years, and (ii) the requirement to provide a bank guarantee is proportionate with respect to the objective of the preservation of the balanced allocation of the power to impose taxes between Member States if a taxpayer elects for deferred payment and the respective bank guarantee refers to the actual risk of non-recovery of the tax.
Two limited partners of a German partnership contributed in 2005 their interests to a German limited company (GmbH) against new shares in the receiving entity. As a result, the partnership collapsed into its single partner, the GmbH. The GmbH maintained the book values of the transferred assets, which was allowed under the Reorganization Tax Act 1995 (RTA) only if the new shares issued as consideration were subject to tax in Germany. As the former partners were Austrian residents, Austria was entitled to tax future gains from the alienation of the shares. Under the RTA, the built-in gains in the transferred assets were to be taxed and the tax thus due was to be distributed over a period of five years.
Other than in previous exit tax cases the first chamber of the CJEU regards the free movement of capital pursuant to Art. 63 TFEU (Treaty on the Functioning of the European Union) applicable and held that the German provision at issue infringes this fundamental freedom since it could deter investors from having holdings in German limited partnerships. In respect of a justification on the grounds of the principle of the preservation of the balanced allocation of the powers to impose taxes between Member States the CJEU refers to former decisions2 by acknowledging that a Member State is generally entitled to tax unrealized built-in gains and thus, make this kind of taxation subject to a chargeable event other than the actual realization. The amount of tax payable on not-yet realized built-in gains may be established at the time of the reorganization. This applies even more so if reorganization is performed under the respective domestic reorganization tax provisions and entails the removal of income from the tax jurisdiction of a Member State. In the case at hand the Court considered that Germany had lost its taxing right in the built-in gains of the partnership interest but made a reservation if these built-in gains could actually be taxed at level of the receiving GmbH (which was to be determined by the referring court).
Further, the CJEU reiterated, relying on established case law,3 that the taxpayer has to be given the choice of immediate payment or deferred payment4 in an exit tax event. Nevertheless, the German option to spread payment over a five years period was also qualified as a satisfactory and proportionate measure for the attainment of the objective of preserving the balanced allocation of the power to impose taxes between Member States. Drawing into consideration that no interest is levied by the option at issue the CJEU concludes that this provision does not go beyond what is necessary to attain the objective of the preservation of the balanced allocation of the power to impose taxes between Member States. Eventually, the court holds that the Member States may request the taxpayer to provide a bank guarantee in cases where no immediate single-event tax payment is opted for by the taxpayer. The CJEU held that the Member States need to have the right to take account of the risk of non-recovery of the tax in case of deferred payment options. As the court recognizes the restrictive effect of such guarantees which have to be provided by the taxpayer the court demands the Member States to assess the risk of non-recovery prior to requesting the taxpayer to provide a guarantee.
Considering the relevant German provisions it comes rather as a surprise that the CJEU ruled on the German provisions dealing with a deferred taxation of the gain resulting from the reorganization. That is because pursuant to the relevant German provisions the built-in gains in the assets of the limited partnership were shifted to the receiving German company. Such a transfer is realized by way of an assessment of the relevant assets by the limited company in the take-over balance sheet at their book value. Thus, upon a future disposal of such assets the built-in gains would have been realized anyway under German jurisdiction. Thus it is highly questionable whether the contribution should give rise to the assessment of an exit tax at all. It should as a side remark not go unnoticed that the CJEU in 2008 already decided on a German case where a similar technique was challenged against the Merger Directive.5
Also, it should not go unnoticed that the CJEU held that a transfer of assets which are allotted to a partnership’s holding to another company while receiving capital share in this other company as a consideration is regarded to be covered by the free movement of capital but not by the freedom of establishment. It seems that in this respect the CJEU broadens the understanding of the freedom of free movement of capital.
The decision seems novel with respect to established case law. So far, deferred payments subject to ultimate realization and, as an option for the taxpayer, immediate payments of the exit tax were regarded as being consistent with the fundamental freedoms. This decision marks the first time the CJEU decided on a domestic law’s deferred payment scheme conferring mandatory tax payments irrespective when the ultimate realization of the built-in gains occurs. The CJEU mentions that the distribution of the payments in installments over a period of five years would be proportionate. However, from the context of the decision it does not derive whether this conclusion results from the peculiarities of the German tax provision at issue which did not require interest payments or whether the CJEU considers a deferred payment option generally only proportionate if no interest payment is required.
The decision partially clarifies the conditions under which a deferred payment may be granted subject to the provision of a bank guarantee. Member States must assess the risk of non-recovery prior to requesting the taxpayer to provide a guarantee in the case that a taxpayer opts for a deferred tax payment. However, in yet another aspect this decision is not quite distinct since it refers to guarantees as bank guarantees. It seems not clear whether the requirement to assess the risk of non-recovery prior to requesting the taxpayer to provide a guarantee only refers to bank guarantees or if it comprises any other means of guarantee, too.
The present decision clearly evidences some ambiguities. However, the next exit tax case is awaiting the judgment of the CJEU. In a request for a preliminary ruling
the tax court of Dusseldorf raised questions on German exit taxation rules in a case of cross-border transferred intangibles.6 Ultimately, it remains to be seen whether the current decision deviates from the other decisions7 in the area of exit taxation because of its underlying peculiar facts or whether this decision marks the beginning of a turn of case law in the field of exit taxation. The request by the Dusseldorf tax court might prompt clarification by the CJEU.
1. CJEU, C-164/12.
2. CJEU, C-371/10, National Grid Indus; CJEU, C-261/11, Com/Denmark.
3 CJEU, C-371/10, National Grid Indus; CJEU, C-38/10, Com/Portugal.
4. According to established case law Member States could be entitled to levy interest in turn for granting a deferred payment.
5. CJEU, C-285/07, AT.
6. C-657/13, Verder LabTec.
7. CJEU, C-261/11, Com/Denmark; CJEU, C-64/11, Com/Spain; CJEU, C-301/11, Com/Netherlands; CJEU, C-38/10, Com/Portugal; CJEU, C-371/10, National Grid Indus.
For additional information with respect to this Alert, please contact the following:
Ernst & Young GmbH Wirtschaftsprüfungsgesellschaft, Munich
- • Dr. Klaus von Brocke
+49 89 14331 12287
EYG no. CM4144