Germany’s Ministry of Finance tries to restrict the applicability of the court decision by postponing the tax deductibility to the time of termination.

Summary: Germany’s Ministry of Finance (MoF) has qualified the European Court of Justice (ECJ) ruling on the tax deductibility of currency losses incurred in repatriating capital from foreign parent establishments.

Ruling on tax deductibility of currency losses

On 28 February 2008, the European Court of Justice (ECJ) decided that currency losses incurred in repatriating allotted capital from foreign permanent establishments are tax deductible in the country of residence of the head office, regardless of whether and to what extent the profits of such permanent establishments are tax exempt.

In November 2009 German Ministry of Finance (MoF) issued a public ruling on the applicability of this judgment to other cases. In the ruling, the MoF takes the view that currency losses from the repatriation of capital are fully tax deductible in Germany only in cases and at the time when a foreign permanent establishment is effectively terminated.

The MoF tries to restrict the applicability of the court decision in three ways:

1. Restricting its applicability to cases where the foreign permanent establishment ceases to exist
2. Postponing the tax deductibility to the time of termination
3. Shifting the burden of proof to the taxpayer

Even in times of budget constraints, such a restrictive approach is unwarranted and unacceptable because a currency loss becomes definitive at the time when a portion of the branch capital is repaid to the head office, not only when the branch is closed down.

Figure 1: Situations to which the new public ruling might apply

Figure 1: Depicts all the situations to which the new public ruling potentially applies, namely to companies with a head office situated in Germany while a foreign permanent establishment exists in a non-euro country within the European Union or the European Economic Area.

 Figure 2: Development of exchange rates 2005–2010

Figure 2: Outlines the development of exchange rates of selected currencies in the EU/EEA against the euro in the period 2005–2010, the volatility of the exchange rates has significantly risen since 2008, and with it, the risk of currency losses upon repatriating branch capital during the financial crisis if foreign business was scaled down.

Is Germany’s Ministry of Finance position weak?

There is no reason why the ECJ ruling should not apply to all cases of currency losses that occur in connection with the repatriation of allotted capital. The ECJ judgment is not restricted to termination cases.

On the contrary, the ECJ based its judgment on the fundamental insight that such currency losses “by their nature” can never be suffered by a permanent establishment because accounting records drawn up in the national currency could not show the currency depreciation in the start-up capital and hence, must be deductible somewhere.

A currency loss occurs only in the balance sheet of the head office. Therefore, it has to be tax deductible in the country of residence of the head office in order to assure the freedom of establishment within the EU/EEA. The ECJ’s clear-cut reasoning applies to all cases in which the head office repatriates allotted capital, regardless of whether the permanent establishment has been closed down.

What should taxpayers do?

Taxpayers should keep cases with currency losses incurred in repatriating branch capital open and appeal them to the national tax courts or the ECJ with appropriate documentation for the violation of the EU contract of freedom of establishment.