date | theme

05. June 2020 | Anti-Tax Avoidance Directive (ATAD): Critical analysis of early taxation in cases of departure and tax easing

06. June 2020 | European law-compliant interpretation and European law inconsistencies in cases of departure and tax easing

04. January 2021 | Tax easing: Taxes on the departure of business assets abroad

09. February 2021 | Tax de-engagement & deferral: period and time of payment

22. December 2021 | Legal Status of Exit Tax: Violation of EU Standards? (this contribution)

With regard to the legal status of the new exit tax, as it applies from 2022, there are some doubts that it complies with current EU law. Let us enumerate three arguments. Firstly, it is legally questionable whether, as the legislature did, the exit tax of corporations should be equated with that of natural persons. Secondly, under the new rules, double taxation at home and abroad can hardly be ruled out. And thirdly, real estate companies can continue to tax again at a later date in Germany despite the departure tax and the applicable double taxation agreement (DTA). However, this means that the freedom of establishment of EU citizens can be regarded as restricted. As a consequence, it follows that the status of the exit tax is in all probability hardly able to withstand a future legal examination by the European Court of Justice (ECJ).

The legal changes introduced in Germany on 01.01.2022 should harmonize with applicable EU law from the point of view of the Federal Government. At the same time, however, they should also strengthen the possibilities of the Federal Republic of Germany to collect the exit tax. Although the reform of the Foreign Tax Act was originally aimed at implementing the EU Directive on Tax Avoidance, namely the “Anti Tax Avoidance Directive” (ATAD), this was certainly also a good opportunity to improve German law on exit taxation. Many aspects of the existing regulations have been tightened up, but some others have also been simplified. This raises the question of whether the status of the new exit tax is in line with European law. This is the question we want to address in the following.

But before we begin our analysis of the status of the exit tax in its new guise, we are still providing the legal tools for our trip.

First we look at the Foreign Tax Act. After all, it forms the basis for most tax matters in international tax law at national level. § 6 AStG deals with the exit tax. Thus, it also contains all changes that bring about the changes in the collection of exit taxation from 2022.

Another law that is relevant as a reference source for the foreign tax law is the income tax law. In addition, the provisions of the Corporate Income Tax Act on the incidence of exit taxation for corporations accompany our considerations, albeit only indirectly. In addition, DBAs are also relevant for our considerations.

Furthermore, we must also take European law into account. The Treaty on the Functioning of the European Union (TFEU) is in the foreground. In particular, it lists the four fundamental freedoms. More specifically, this concerns the free movement of persons, the free movement of capital, the free movement of goods and the freedom to provide services. In the case of the free movement of persons, a distinction is made, among other things, between general freedom of movement and freedom of establishment. For our considerations here, however, the freedom of establishment in particular should be important. It is codified in Article 49 TFEU. The freedom of establishment includes the guarantee that an EU citizen can set up a company freely in all EU member states. At the same time, this means that he must not be disadvantaged in this respect by moving to another EU Member State.

In addition, we also include corresponding case law of the European Court of Justice (ECJ) in our considerations. After all, it is only through such a court procedure that a review of the legal status of the exit tax in the national law of the Member States can be established. The decision of the ECJ in the case of National Grid Indus is of particular importance in this regard.

So far, the exit taxation regime has been such that a shareholder of a limited company in Germany could apply for a permanent deferral of the exit tax when moving to an EU member state. Exit tax only occurred under certain conditions. As a shareholder, on the one hand, you had to have been unrestrictedly taxable in Germany for at least seven years within the last twelve years before leaving. The most important condition, however, was that in the last five years before leaving, at least 1% of the company had a shareholding in Germany. § 6 (1) sentence 1 AStG refers to the conditions as contained in § 17 (1) sentence 1 EStG.

Furthermore, if such a shareholder moved to a third country, there was no possibility of paying the exit tax. So it came up immediately.

Overall, one can say about the status of the previous exit tax that it was in a way a burden. Finally, there is a tax on a purely fictitious profit without an actual increase in assets. But if you moved within the EU, you could at least gain some time by the deferral.

But the reformed exit tax now provides for an installment payment over seven years instead of a permanent deferral. This approach will apply from 2022 onwards both for moving within the EU and for moving to third countries.

In our analysis of the status of the exit tax in its form applicable from 2022, we list three arguments that are intended to prove that the exit tax is unjustified. Two of the three arguments directly concern the freedom of establishment within the meaning of Article 49 TFEU. Therefore, we now want to show that the exit tax violates the freedom of establishment and thus fundamental EU law. In particular, the abolition of deferral by introducing a seven-year instalment payment of the exit tax has led to a tightening up, which we view critically.

In the first argument we would like to make, we need to look at the development history of the exit tax. First, we look at how the ECJ previously assessed the exit taxation of corporations in the EU. Based on this, we analyze the conclusions and measures of the German legislature.

4.1.1. Status of the Exit tax for corporations in the light of the ECJ case-law

Some time ago, the exit tax status in the Netherlands was such that a corporation that moved to another EU member state was subject to immediate exit taxation. In the case of National Grid Indus, the ECJ ruled that the exit tax affected the freedom of establishment of the company concerned. As a result, this is incompatible with European law. Subsequent judgments, however, indicated that a payment in instalments of the early departure tax over a period of at least five years was acceptable in order to safeguard the taxation right of the State, which loses its taxation right as a result of the departure. The restriction of the freedom of establishment in order to safeguard tax sovereignty was therefore to a certain extent given.

4.1.2. Conclusions of the German legislature

The German legislature then re-evaluated the status of its own exit tax. It was concluded from the case law regarding the exit tax of corporations in other EU member states that it can also be transferred to the exit tax of natural persons. Therefore, the deferral of the exit tax was changed to a seven-year installment payment. In other words, if the exit tax in this form for corporations is compatible with the EU's freedom of establishment, then this also applies to natural persons. Finally, the Corporate Income Tax Act (§ 12 KStG) regulated the exit tax for limited liability companies in a similar manner without materially infringing the freedom of establishment.

4.1.3. Differences between the departure of a natural person and a corporation

However, this direct comparison lags. Finally, when a company moves to another EU country, it can re-incorporate its assets into the balance sheet and consequently write them off. In fact, the ATAD regulation prescribes this balance sheet approach to the EU member states in exactly the same way. So what arises on the one hand from the exit tax as a financial burden for the company, on the other hand it gets back through the tax approach of depreciation in the new country of establishment.

However, if a natural person moves away, then there is no possibility in the country of establishment to record the hidden reserves previously discovered and taxed in Germany. Consequently, there is no depreciation on this basis.

Therefore, the exit tax of corporations and natural persons cannot be equated. A limited liability company is not subject to any significant restriction on its freedom of establishment when it moves out because it receives compensation for the exit tax. However, this compensation is denied to a natural person, so that their freedom of establishment can be considered restricted by the exit tax.

Our next objection concerns the general freedom of establishment beyond the borders of the EU. Although EU law does not play a direct role here, we want to show that the move of a shareholder of a corporation to a state with which there is no DTA with Germany leads to multiple taxation. And we think this is also unjustified.

Suppose that a natural person who meets all the requirements for an exit tax to be incurred, for example, moves to San Marino. There is currently no DBA with San Marino. It goes without saying that the exit taxation is applied when leaving the country. However, if the shareholder actually sells his shareholding in the German limited company at a later date, then the regular taxation of the hidden reserves uncovered takes place in Germany. In this case, however, Germany insists on the application of the localisation principle in the absence of a DTA. According to this principle, the state in which the tax substrate – in our case the hidden reserves of the corporation – is located – is entitled to collect taxes. However, San Marino may insist that the now unlimited taxpayer must take the capital gain into account in his income tax. In fact, the hidden reserves are taxed three times over. But in Germany alone, this represents a double taxation of the same tax substrate.

Sure, if you move to a country with a DTA, multiple taxation would be excluded. And one may also point out that Germany has concluded a DTA with most countries in the world, so that it protects against double taxation in Germany. But this is not an all-encompassing guarantee. Therefore, we consider the status of the exit tax in the version applicable from 2022 to be more than questionable.

Finally, our third argument with which we would like to underpin our doubts about the legal status of the exit tax from 2022. Although the previous argument may only occur in exceptional cases and have no relevance for moving to EU member states, thus hardly affecting the freedom of establishment in their sense, the following argument is nevertheless illuminating.

This refers to all cases in which a shareholder of a corporation moves to another state with which a DTA exists. So this also applies to all EU member states. To this end, however, we are focusing on the cases in which Germany retains the right to tax even after moving away. This is particularly the case for corporations whose assets consist of more than 50 % real estate. In such cases, DBAs regularly assign taxation jurisdiction on a location basis. And because we are interested in the departure of a shareholder of such a company resident in Germany whose real estate is located in Germany, this leads to double taxation. This is because when the shareholder moves away, he pays the departure tax for the first time and when he later sells his shareholding, the taxation of the hidden reserves is incurred for the second time in Germany.

No wonder, then, that even in these cases, double taxation in Germany is perceived as unjustified and thus as injustice. The fact that this is even possible despite DBA even exacerbates the impression. In addition, this means that Germany also violates the freedom of establishment within the meaning of Article 49 TFEU.

Our conclusion on the status of the exit tax is sobering. On the one hand, the transfer of the legal situation of a capital company moving to another EU country cannot in any way serve as a basis for the current tightening-up. Therefore, the introduction of the seven-year instalment payment for natural persons in exchange for the permanent deferral previously granted on request leads to a situation which can be regarded as a restriction on the freedom of establishment. On the other hand, the new exit tax still does not provide for any rules to which the exit tax should not apply, because the tax law of the Federal Republic is not subject to any restrictions by the departure of a shareholder. For this, at least the exceptions should have been included in the External Tax Act. Failure to do so may also result in an infringement of the freedom of establishment.

All in all, it can therefore be stated that, in pursuing its objective of protecting taxation sovereignty, the legislature was prepared both to violate the freedom of establishment within the meaning of the TFEU and to accept multiple taxation.

We have only highlighted the restriction of the freedom of establishment by the new status of the exit tax. However, there may also be a breach of other EU rights. For example, general freedom of movement can be affected, which also occurs when a natural person moves to another EU country without setting up a new company. Under certain circumstances, however, the free movement of capital may also be affected by the new exit taxation.

Whatever the legal status of the exit tax from 2022, the determination of whether there is a violation of the freedom of establishment is then the responsibility of the ECJ. But until such a case receives a legal assessment, the new exit tax will certainly remain in force for a few years.