date | theme

24. August 2018 | UK-Limited and Brexit: Cross-border merger helps!

27. May 2020 | Actual tax easing in cross-border conversions in light of the changed understanding of the agreement by the BFH (task of the final extraction theory)

28. October 2020 | Sell partnership abroad tax-free by conversion

15. January 2021 | Cross-border conversion: German law violates fundamental freedoms (this article)

With the National Grid Indus judgment (recital C-371/10), the European Court of Justice (ECJ) issued a basic ruling on the tax treatment of cross-border conversions. This established that in the event of a loss of national taxation rights, the country that loses tax sovereignty can make a final taxation. In the case of a cross-border conversion, however, Germany only loses its tax jurisdiction when it comes to a conversion of an accounting permanent establishment (exempted permanent establishment) in a state without double taxation agreements. In all other cases, tax relief in Germany is based on a fiction. But this can mean a violation of EU fundamental freedom. Even the free movement of capital in relation to third countries can be affected by a transfer. In addition, the currently pending implementation of the EU ATAD Directive by German legislation is in danger of violating fundamental freedoms.

Right of taxation for cross-border conversions

Why is Germany conducting a tax easing?

If you want to transfer an asset from a permanent establishment to a second permanent establishment of the same company by conversion in Germany, this is tax-free. However, if you want to transfer the economic asset from one German company to another, which is abroad, then a tax easing takes place in Germany. Germany thus imposes a final tax on the hidden reserves contained in the asset to be transferred at the time of the transfer. In this way, Germany wishes to ensure that this potential profit, which would result from the discovery of the hidden reserves in the sale of the asset and thus be taxable, is actually subject to taxation in Germany. After all, the profit potential has also arisen in Germany.

2nd Cross-border conversion: previous legal situation

So far, the legal situation in Germany is such that cross-border conversions also lead to final taxation. Regulatory examples serve as the basis for this taxation. They feign a loss of German taxation rights in the event of a cross-border conversion, although, as we want to show in this article, this does not have to exist in all cases. Such regulatory examples are contained in the income tax law in § 4 (1) sentence 4 EStG and in the corporate tax law in § 12 (1) sentence 2 KStG.

The heading of this chapter more than obviously sets the direction of the march. So we want to show here that a cross-border conversion does not necessarily have to be associated with a loss of German tax law.

3.1. Loss of taxation rights in the event of transfer of a foreign permanent establishment

But first we want to go into the opposite case. Because by proving under which circumstances Germany actually loses its tax jurisdiction in a cross-border conversion, it is easier to understand the reverse case.

For this purpose, we imagine a German company that has a permanent establishment in a third country with which our country has not concluded a double taxation agreement. In addition, the German company is also involved in a capital company in this country. Now the entrepreneur wants to transfer this permanent establishment to the foreign corporation. For this purpose, we consider the hidden reserves contained in the site at the time of transfer. Because only a sale of the permanent establishment leads to its discovery, Germany cannot levy a tax on the realised profit, because after the transfer to the foreign capital company only the foreign country has a right to this. Therefore, the German tax law is actually lost in such a case. The legal provisions for final taxation are therefore comprehensible.

3.2. Cross-border conversion without loss of German tax law

If, however, instead of a foreign permanent establishment, one wishes to transfer a German permanent establishment or another economic asset of the working capital or fixed assets to the foreign company by a cross-border conversion, then there also appears to be a loss of German taxation law. After all, foreign countries will then be entitled to tax the profits generated by a subsequent sale which were associated with the transfer of the hidden reserves. So the assumption follows that Germany cannot levy a tax here.

Ultimately, however, there is a taxation of the realised profit in Germany. For example, if both operating sites belong to a German GmbH, then it must tax its world income in Germany within the framework of the corporate tax assessment. However, the German Treasury must also take into account the tax that the company pays abroad on the profit. This consideration is made by applying the foreign tax to the German tax. So you deduct the foreign tax from the German tax. Another procedure that can be applied here is the exemption of foreign tax. For this reason, such establishments are also called accounting establishments or exemption establishments.

15 years without paying taxes – Special design after returning from abroad

4. applicability of the ECJ judgment to cross-border conversions?

The ECJ’s National Grid Indus judgment brought this issue into line with the general treatment of cross-border conversions of German premises. This means, on the one hand, that there is unequal treatment between purely national and cross-border conversions within the EU. On the other hand, the relinquishment of taxation sovereignty justifies a final taxation by the State of departure, if this is appropriate.

What was obviously overlooked here, however, is that in most cases a cross-border conversion does not mean an actual abandonment of taxation law in Germany. Rather, in this country there is only a fiction about this. Therefore, the question of the applicability of the National Grid Indus judgment to the cross-border conversion is raised here from the German point of view. And our clear answer to this is that the National Grid Indus judgment should not apply to the German legal situation (except for an actual abandonment of German taxation law); See 3.1.

5. Impact on the implementation of ATAD requirements

In implementing the EU Anti Tax Avoidance Directive (ATAD); Directive (EU) 2016/1164 of 12.07.2016 has so far been drafted by the legislator, which we now want to examine with regard to the discussed findings.

In fact, the application of the regulatory examples remains in situations of cross-border conversion. So far, there has been no sign of a departure from previous practice, so that a cross-border conversion basically always provides for final taxation, although actual taxation still has to take place at the time of realisation of the transferred hidden reserves. This is basically a double taxation. On the one hand, hidden reserves are taxed at the time of cross-border conversion. On the other hand, the increase in the value of the asset transferred abroad is also subject to German taxation, namely at the time of the actual sale.

6. Cross-border conversion: infringement of the free movement of capital in third countries

Finally, we want to shed light on another consequence if there is no actual loss of Germany’s taxation right, but the legal fiction nevertheless demands it accordingly. If, for example, securities or claims are transferred in the case of cross-border conversion, this leads to a final taxation of this capital asset. As a reminder: if there had been a conversion between two German companies, we could of course have taken a tax-neutral approach. It is therefore appropriate to ask whether such taxation may lead to the managers of an undertaking concerned refraining from a taxable cross-border conversion with capital assets. The answer to this is absolutely yes. Thus, taxation of capital assets in the course of a cross-border conversion constitutes a restriction on the principle of the free movement of capital.

The important difference to the restriction of the freedom of establishment in the case of cross-border conversion with other assets is that the transfer of capital assets affects both the Treaty on the Functioning of the European Union (TFEU) and the free movement of capital in international contexts. Therefore, the application of the existing laws on final taxation in the case of a cross-border conversion of capital assets can also be considered problematic in connection with third countries.