An organization exists when a company (so-called organization company) transfers all its profits to another company (the organ carrier) on the basis of a profit transfer agreement. The corresponding definition can also be found in § 14 (1) sentence 1 KStG. The institution shall continue to operate cross-border if at least one of its sub-members, be it the organ carrier or the body, is not established in the country.

The rules for a cross-border body were subject to various reforms. The background to the reforms were decisions of the European Court of Justice (ECJ) and the Federal Finance Court (BFH). According to the ECJ, European law requires the relinquishment of the double national reference for the institution. Furthermore, BFH decided on the trade tax organisation that a limited liability company with its registered office in Germany could be the trade tax organisation of a company based in Great Britain. These decisions gave rise to the concern of the national legislature that organ income is attributable to a foreign organ carrier without taxation at home. This could lead to tax deficits in Germany.

1. National rules on the nationality of the institution

1.1. Law currently in force

Germany, like many other countries, knows the group taxation of companies. In Germany, there is the so-called Organschaft. It is regulated in §§ 14 ff. KStG.

§ 14 (1) sentence 1 number 2 sentences 4-7 KStG regulates the requirements for the national reference of the organ carrier. Accordingly, in addition to the economic ownership of the shares intermediating the majority of voting rights, a permanent detention of the shares in a domestic permanent establishment of the organ carrier must be ensured. This regulation serves, among other things, to combat abuse in a cross-border body.

Furthermore, the organ company must be financially integrated into the organ carrier. There must therefore be a subordinate/superior relationship between the relevant companies. Therefore, only an organization between parent company and subsidiary or grandfather company is possible. On the other hand, the organization does not come into consideration between sister companies.

1.2 Historical Development

For the acceptance of a board, according to § 14 (1) no. 2 KStG a.F., both the board owner and the subsidiaries had to have their registered office and management in Germany as board companies. Therefore, a double domestic reference was required. It was therefore not possible to offset losses between the organ carrier and the subsidiaries across the border. There was therefore no cross-border body.

The need for the seat and management of the organ carrier and the organ company in Germany, however, has been increasingly criticized, so that it even came to infringement proceedings against Germany. On the basis of this criticism, § 14 (1) sentence 1 number 2 KStG was recast. Now the legislator waived the double domestic reference. The only prerequisite was that only the body owner had a seat or management in Germany. Whether the organ company had a domestic connection, however, did not matter. This seemed to make it possible to have a cross-border body and to offset losses accordingly.

At the same time, however, the legislature again limited this newly created possibility of a cross-border body. The newly inserted § 14 (1) sentence 1 number 5 KStG regulated a comprehensive prohibition on loss deduction in the event that negative income of the organ carrier in a foreign state is taken into account in the context of a taxation corresponding to German taxation. A comprehensive loss offset was therefore still not possible.

The law amending and simplifying corporate tax law and tax travel expense law limited the domestic reference to the existence of a domestic permanent establishment of the foreign organ carrier. This is the current law.

2. Tax deficits by cross-border bodies

2.1. In principle, attribution of income to the foreign company

The rules on the nationality of the organ were introduced on the basis of judgments of the BFH and the ECJ. They should ensure that taxation substrate remains in Germany. Without the regulations, the German Treasury fears tax deficits.

The fear of tax deficits has several reasons. In the case of cross-border organs, it can happen that the organ carrier is located abroad and the organ company in Germany. As a result of the profit transfer agreement, the profit of the domestic organ company would thus be imputable to the foreign company. Then the domestic organ company no longer has any profit at home. It therefore no longer has a taxation substrate in Germany. The taxation of the profits of the domestic company takes place in principle in the country of the organ carrier. However, we now want to check whether the corresponding profit is not in any way subject to taxation and therefore there are no tax deficits at all.

2.2 Tax liability of the foreign company in the country?

First of all, it would be conceivable that the organ carrier is subject to limited taxation in Germany. Then at least the domestic income is subject to national tax. However, even if the organ bearer is subject to limited taxation in Germany, Germany would actually have to be entitled to taxation for domestic income. If Germany has concluded a double taxation agreement (DTA) with the country of residence of the foreign company, this must be observed. It distributes taxation rights among the contracting parties.

According to the abstract regulation of Article 7 (1), second sentence, OECD-MA, Germany is entitled to taxation only if the foreign company has a permanent establishment in Germany. The domestic organ company could be a permanent establishment of the foreign organ carrier. However, under agreement law, the domestic permanent establishment of the domestic organ company is imputable.

Nationally there is a so-called factory fiction in § 2 paragraph 2 sentence 2 GewStG. However, this applies only for business tax purposes and therefore does not enforce Article 7 (1), half-sentence, OECD-MA. On the contrary, the so-called anti-organic clause of Article 5(7) of the OECD-MA expressly prohibits a controlled subsidiary from becoming the permanent establishment of the controlling parent solely on the basis of control under agreement law. The civil autonomy of the two companies is therefore also respected under agreement law.

In summary, the domestic organ company has a permanent establishment in Germany. However, this establishment has no income. Rather, the income is attributed to the foreign organ carrier. However, he has no permanent establishment in Germany and thus no taxation right in Germany. This is the reason for the threat of tax deficits.

These tax deficits do not occur only if the foreign organ carrier has its own, actual permanent establishment in Germany. Then Germany is basically entitled to the taxation right under the DTA. For this reason, the necessary domestic reference of the organization – as described above – also requires the existence of a domestic permanent establishment.

Criticism of the required domestic reference

3.1. Problem of cross-border bodies

The domestic arrest of the shares or the required allocation of the holding is to be viewed critically under EU law. It is central to the case that the subsidiary is located in Germany and the parent company abroad. In a purely domestic case in which both organ carriers and organ company are resident in the country, the establishment of an organ membership would not be in dispute. The parent company in the legal form of a limited liability company always has a recognised domestic management establishment. However, if the parent company is resident abroad but is not arrested in Germany, a loss offset fails. This applies despite the existence of domestic operating sites of the sister company.

3.2. Bundesfinanzhof on cross-border bodies

According to the case law of the Bundesfinanzhof (BFH), EU law does not require income transfer between domestic sister companies and a foreign parent company without a domestic permanent establishment.

The most recent case decided by the BFH in its judgment of 09.08.2023 (reference I R 26/19) concerned the question of when a domestic parent company could assume the losses of its foreign subsidiaries. The BFH rejected a body within the EU and denied the conditions for a loss assumption. The reason for this, however, was that there was no profit transfer agreement between the parent company and the subsidiary. There was therefore no actual body.

At most, a de facto body based on the actual assumption of losses can be considered. This was rejected by BFH, as the recognition of the losses would lead to a quasi-unconditional deductibility of final losses across the border. It is ruled out that an undertaking of a cross-border group may, by relying on the fundamental freedoms of EU law, avail itself of certain elements of corporate taxation which are advantageous to it if, during the relevant period, it has not expressed the will to form a corporate group and has not endeavoured to create these conditions.

The BFH does not say, however, that an actual organization between the parent company and the subsidiary is not considered. It might have decided otherwise if the annual losses had been assumed on the basis of a contractual agreement.

3.3 ECJ on cross-border bodies

The ECJ ruled in the SCA Group case on Dutch group taxation. Dutch law – as in Germany – did not provide for a tax unit between sister companies. The ECJ considered discriminatory that a tax entity could be established by a domestic parent, while this was not possible for a shareholder resident abroad.

Further doubts about the German regulation arose from the case law of the ECJ on Luxembourg group taxation. If a Member State permits fiscal integration between a resident parent or a permanent establishment in its own country, it must also permit vertical fiscal integration and not make this conditional on the requirement of permanent establishment. This judgment was intended to shatter the BFH’s view that EU law does not require cross-console in the context of the German organising regime.

In addition, one can also raise the wider question and the demand that an offset of income of a domestic sister company could also be possible with income of such sister companies that are resident abroad but have a permanent establishment in Germany. However, all this will still be clarified in jurisprudence.