In the case-law DMC (ECJ judgment of 23.01.2014 – Az. C-164/12) two Austrian limited companies held a limited partnership in the German DMC KG. As part of a transfer, both (Austrian) limited partners contributed their limited partnership interest to the German DMC GmbH against the granting of new shares. In the case referred, the UmwStG 1995 (old version) still applies. Due to the DTA Austria/Germany, a transfer had to take place at a partial value, which resulted in a transfer profit (immediate taxation). Immediate taxation constitutes a liquidity disadvantage and thereby restricts the freedom of establishment and the free movement of capital. In his critical analysis, Kanzlei Meyers & Partner AG addresses the grounds for the judgment and describes the substantive errors committed by the ECJ in its judgment.

In the Rs. DMC, two Austrian-based corporations (S-GmbH and K-GmbH) have their limited partnerships in the German DMC KG against

Granting of new shares to DMC GmbH, which is also German.

Under the conversion tax law at that time, the transfer at book value was only possible ‘if the right of taxation of the Federal Republic of Germany with regard to the profit from the sale of the shares granted to the transferor is not excluded at the time of the contribution in kind’ (§ 20(3) of the UmwStG 1995). Since the taxation right in the granted shares in the specific situation according to art. 7 par. 1 DBA Austria[749] was located in the State of residence of the two transferring corporations (Austria), the tax administration – in accordance with the applicable application of national law – carried out the transfer at a partial value and taxed a transfer profit accordingly at the level of the transferring corporations.[750]

Since the above-mentioned tax consequences have occurred irrespective of the size of the shareholdings, in the present case both the scope of application of the freedom of establishment (Article 49 TFEU) and the freedom of movement of capital (Article 63 TFEU) have been opened. Since in the main proceedings there is less influence on the establishment of undertakings than on the transfer of a limited partnership to a limited liability company, the ECJ examined a breach of the freedom of movement of capital in the main proceedings.[752]

2nd Decision

The liquidity disadvantage associated with immediate taxation can deter investors from participating in a limited partnership under German law and thus restrict the free movement of capital.[753] With reference to the judgments in Cases National Grid Indus[754] and Commission v Portugal[755], the ECJ also recognised in the present proceedings the objective of safeguarding the division of taxation powers between Member States as a justification for the restriction of fundamental freedom.[756]

With regard to the immediate collection of the tax, the ECJ has ruled in the Rs. National Grid Indus that the deferral of the tax for an indefinite period is the milder means of achieving the objective pursued by the de-integrating tax.[757] The ECJ also noted at that time that the risk of non-collection of the tax, which increases with time, entitles the departure state to make the deferral of the tax for an indefinite period dependent on the provision of bank security.[758] In the present case, however, the ECJ further restricted fundamental freedoms. He was of the opinion that the collection in five annual instalments (§ 21 para 2 p. 3 UmwStG 1995) was still proportionate in the light of the increasing risk of non-transfer over time and that the departure state could additionally demand the provision of bank collateral if the assessment of the risk of non-transfer leads to a jeopardy of the tax liability.[759]

First of all, it should be noted that the ECJ correctly confirmed the applicability of the free movement of capital in cases of legal unencumberment.[760] This makes it clear that, in principle, it must also be possible to carry out tax-neutral transfers involving third countries.

However, the question arises as to how the transfer taxation can be justified by the objective of a balanced distribution of the tax bases if for the Federal Republic of Germany no taxation right at all is lost on the transferred assets. Both before and after the transfer, the Federal Republic of Germany has the full right to tax the operating assets of the transferred German DMC KG. Finally, the two Austrian shareholders (two capital companies) were subject to limited corporate tax before the transfer with the domestic permanent establishment income from DMC KG; and this taxation substrate is transferred to the German DMC GmbH as part of the transfer, where it is then even included in the context of the unlimited corporate tax liability.

The ECJ misjudged that § 20 para. 3 UmwStG 1995 calls for a doubling of the German taxation law in the present case. Finally, the legislature demanded for tax neutrality not only the right to tax the assets transferred but also the right to tax the shares received, even though the latter had not existed before the transfer. Regrettably, in paragraph 50, the ECJ interpreted the shares received in DMC GmbH as an aliud of the assets transferred and erroneously saw the loss of German taxation law. However, the economic goods and the existing German taxation law are rightly unchanged. The aforementioned justification should not have been allowed in the first place.[761]

3.2 ECJ: Proportionality of the measure to ensure tax liability

Nor is the judgement of proportionality convincing, for the following reasons:

On closer examination of the judgment, it is noticeable that the ECJ authorized the departure state to collect the tax in five annual instalments in order to reduce its risk of not collecting the tax and – if there is a justified risk – can additionally require the provision of bank security. However, there is no need for the two measures to ensure tax liability to be parallel; finally, the granting of bank security virtually excludes the loss of tax liability. To demand the taxpayer in addition to the bank guarantee then the early collection of the tax in five annual installments in such cases cannot be justified with the aim of avoiding tax losses.

DMC KG is still subject to its tax return obligations after the transfer, so that the information access of the German tax administration with regard to the whereabouts of the assets remains unchanged in the course of the transfer.

The possibilities of the German financial administration to enforce corporate tax claims from the sale of DMC KG assets are not threatened, but improved. Finally, prior to the transfer, corporate tax claims should have been recovered from the limited Austrian shareholders (S-GmbH and K-GmbH). After the transfer, the German DMC GmbH is a corporation tax tax entity for the tax profits of DMC KG. In this respect, it is also questionable who, in the opinion of the ECJ, has to provide a bank collateral; since it is a tax liability of DMC GmbH, collateral of DMC KG or of the Austrian shareholders would only be realisable if it were linked to debt relief or a guarantee. It is therefore all the more regrettable that the judgment has an indirect influence on the European assessment of § 4g EStG and ATAD. In the light of this decision, both § 4g EStG[763] and the deregulation regulations in Art. 5 ATAD to respect the principle of proportionality, which – as has been shown – is not the case.