date | theme

25. February 2021 | Tax assessment & tax collection at the German tax easing

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

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

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

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

03. June 2020 | Exit taxation & tax easing: Critical analysis of (early) immediate taxation

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)

26. May 2020 | Legal tax easing in light of the changed understanding of the agreement by the BFH (task of the final extraction theory)

25. May 2020 | Tax easing in light of the changed understanding of the agreement by the BFH (this contribution)

The BFH has fundamentally changed its view on the final extraction theory through judgments in 2008 and 2009. The “final extraction theory” developed until then was abandoned by the BFH due to the changes by the SEStEG. In the case of cross-border transfers, it is therefore no longer mandatory to assume that the economic goods have been removed, so that tax-neutral cross-border transfers are now also possible. However, the legislature makes high demands so that cross-border contributions are granted tax neutrality and no tax easing takes place. In this article you will therefore find a development of the final extraction theory, how the BFH ultimately abandoned it and what consequences this has for the understanding of the BFH agreement.

A tax deregulation means that the tax arrest of the economic asset ends in the Federal Republic of Germany and thus the taxation right of future profits is transferred to a foreign state. The tax easing can be brought about, for example, by the transfer of assets to foreign permanent establishments, the transfer of business assets to foreign corporations, the revision of DBA[201] or the departure of the taxpayer.

However, a derailment does not necessarily mean that the State of origin also loses the right to tax on the profits generated up to the date of the derailment. Finally, it is an interpretation of the relevant DTA article whether the State of origin continues to have the right to tax the profits generated but not yet realised to date and, through the act of entanglement, only the right to tax future profits is transferred to the host State.

According to an earlier understanding of the agreement[202], the Federal Republic of Germany was entitled to the taxation right only for assets of the domestic permanent establishment. According to the understanding of the time, the source state had the exclusive taxation right for assets of a foreign DTA permanent establishment even if the asset had previously been transferred from a domestic permanent establishment.[203] According to the understanding of the time, the transfer led to the loss of German taxation law, so that the BFH developed the final extraction theory in 1969 to avoid tax losses. The final extraction theory was justified by the fact that the domestic parent company and the foreign exemption establishment would represent two different “tax areas”. This is because assets transferred from the domestic to the foreign permanent establishment could no longer serve the domestic “tax area” of the company and would thus have been transferred to “non-business purposes”. The use of an economic good for "non-business purposes" is subject to § 4 para. 1 S. 2 EStG constitutes an extraction event, so that the transfer of the economic asset by the BFH was assessed as extraction and in accordance with § 6 para. 1 no. 4 EStG led to the discovery of the hidden reserves. The decisive factor was the partial value.

The jurisprudence on the final withdrawal theory concerned only assets of the fixed assets that were transferred to a DBA permanent establishment. On the other hand, assets transferred to an accounting establishment were still subject to the world income of the German taxpayer and were thus not exempt from German taxation. Such economic goods did not leave the German “tax area” anyway and were not subject to final taxation. This was true even if the German tax law was completely lost at a later date by the conclusion of a DTA.[205] The application of the final extraction theory to economic goods of circulating assets remained as unanswered as the assessment of cases of entanglement.

The theory of final extraction developed by jurisprudence, however, was not a proven means of securing domestic control substrate in the long term and was found to be contrary to the system in much of the literature. In the framework of the SEStEG, tax easing was therefore codified by law as an extraction event. According to § 4 para 1 p. 3 EStG and § 12 para. 1 S. 1 KStG, the exclusion and restriction of the German taxation law with regard to the profit from the sale or use of an economic good are since then treated as an extraction, which according to § 6 para. 1 No. 4 Hs. 2 EStG with the common value. With the implementation of the SEStEG, the legislature was forced to include cross-border restructuring in the scope of the UmwStG. In order to ensure that assets cannot be withdrawn from German tax law in a tax-neutral manner in the course of a cross-border transfer, the legislature also had to include extensive de-integrating regulations in the UmwStG in the course of the SEStEG. In connection with the wording of § 4 Abs. 3 EStG, a conversion operation de lege lata can take place at book values only to the extent that the right of taxation of the Federal Republic of Germany with regard to the taxation of the profit from the sale of the transferred assets is not excluded or limited. Since 2006, very similar de-knitting standards have been found both in the EStG and KStG and in the UmwStG.

Compared to the final extraction theory, however, these legal de-integrating facts are more strictly formulated.[209] In the material scope of application, the restriction of domestic taxation law – for example by transferring the asset to an accounting permanent establishment – is now also covered. The personal scope was extended to current assets. According to § 52 para 8b p. 2 EStG a.F. or § 34 para. 8 S. 3 KStG a.F., this extended scope of application of the general derailment standards is to be applied retroactively and thus also for transfer matters before the entry into force of the SEStEG.

With its decisions in 2008 and 2009, the BFH has abandoned the final extraction theory. These decisions are based on the fact that the Federal Republic of Germany does not lose the right to tax the hidden reserves created in Germany by transferring the asset to a foreign permanent establishment. Because according to today's understanding of the art. 13, par. 2 OCED-MA capital gains are not to be allocated rigidly to a Contracting State in full, but are to be distributed proportionally among the Contracting States which participated in the formation of assets. This principle has always applied to the distribution of profits by type. 7 OECD-MA[213] and has now also been published by the BFH on Art. 13 para 2 OECD-MA extended. Accordingly, the Federal Republic of Germany retains the right to tax the hidden reserves created in Germany.[214]

In the event of a subsequent sale of the asset from the foreign permanent establishment, the Federal Republic of Germany is entitled to the share of the profit that would have arisen in the event of a fictitious sale at the time the asset was transferred to the foreign permanent establishment. Although the decisions of BFH were expressly made regarding the legal situation before the SEStEG, BFH made it clear that the mere transfer of an asset to a DBA permanent establishment neither restricts nor excludes the right of domestic taxation on the hidden reserves created up to then. Until now, the de-knocking standards – both those of the EStG, KStG and those of the UmwStG – have been linked exclusively to the fact that the German tax law was restricted or excluded. Following the earlier decisions of the BFH[215] on the final extraction theory, the legislature has obviously assumed that the transfer of an economic good from a domestic to a foreign permanent establishment in any case restricts or excludes the German taxation law with regard to the profit from the sale of the economic good. According to this now changed understanding of the BFH, both the general and the special de-knitting standards of the SEStEG in many cases ran empty.

With the Annual Tax Act 2010, therefore, § 4 para. 4 EStG and in § 12 para. 1 p. 2 KStG, according to which an exclusion or a restriction of the taxation right with regard to the profit from the sale of an asset is to be present in particular if an asset previously assigned to a domestic permanent establishment of the taxable person is to be assigned to a foreign permanent establishment. According to the explanatory memorandum[217], the regulatory examples clarify the main application of § 4 para. 3 EStG and thus anchor the historical will of the legislator of the SEStEG expressly in the law.[218] Since the explanatory memorandum of law is intended to clarify the previous legal situation, the legislator does not see any constitutional concerns in laying down the regulatory example according to § 52 para. 6 EStG shall also be applied retroactively to untaking operations carried out after 13.12.2006. However, the control example was included exclusively in the general de-knitting controls. A change in the conversion tax deregulation standards has so far been omitted, so that the distinction between the general and special deregulation standards is of decisive importance.[219]

But also for the general norm of control unengagement, the effect of the regulatory example can be called into question.[220] Because the wording used by the legislature in § 12 para. 1 S. 2 KStG “An exclusion or restriction of the taxation right with regard to the profit from the sale of an economic good exists in particular if an economic good previously attributable to a domestic permanent establishment of a corporation, association of persons or asset is attributable to a foreign permanent establishment of this corporation, association of persons or asset” is expressly in contradiction with the two decisions of the BFH[221] on the final withdrawal theory. Finally, BFH decided at that time that the assignment of a domestic asset to a foreign permanent establishment did not lead to an exclusion of German taxation law. Whether this different viewpoint now undoubtedly leads to a fictitious exclusion of the taxation right – as desired by the legislature – is controversial.[222]

The literature considers that the example of regulation included in sentence 2 cannot exceed the scope of application of the basic standard (sentence 1).[223] Despite the vague wording, however, the will of the legislator expressed by this (unfortunate) formulation is clear, so that an application of the regulatory example to mere transfer cases can be assumed.[224] Nevertheless, a more precise choice of words would have been desirable. Conceivable here would have been the fiction of a restriction of the German taxation law by means of the choice of words “applies as”.

Most hidden reserves of current assets are tied up in reserve assets. Often the assets are produced in the parent company and then transferred to foreign sales facilities. The total profit of the company resulting from the sale is then composed of a production profit and a sales profit.

The one referred to in Art. 7 para. 2 AOA incorporated in OECD-MA allocates to the permanent establishment the profit it could have obtained ‘if, as a separate and independent undertaking, it had carried out the same or similar business under the same or similar conditions’. If, for example, an asset produced in the German parent company is transferred to a foreign DBA sales establishment and sold there, the total profit is to be divided between both establishments in accordance with the context of its creation. At the time of sale of the German production site, the share of the total profit that it contributed to the added value is due; this is the proportionate production profit. The foreign sales establishment shall be assigned the distribution profit. As a result, in the case of current assets, the German taxation law on the profit shares created in Germany is retained if the permanent establishment of the asset changes.

Because immovable property cannot be transferred to another Member State and the right of taxation by art. 13, par. 1 OECD-MA is always assigned to the local state, a change of permanent establishment membership and thus a loss of the taxation right is hardly conceivable.

If the asset is to be assigned to the permanent establishment of another contracting state – e.g. due to a changed functional assignment – it has been assumed according to the old understanding of law that, with the changed allocation of the permanent establishment, the taxation right on the entire hidden reserves of the asset will also be transferred to the new permanent establishment state. This legal understanding was based on the assumption that both economic goods and the concealed reserves associated therewith can only ever be fully allocated to a State Party.

Wassermeyer[225] took the view early on that art. 13, par. 2 OECD-MA provides for a rigid allocation only for the assets themselves, but not for the associated hidden reserves. According to his opinion, now confirmed by the BFH[226], the hidden reserves are according to Art. 13 para 2 OECD-MA to be distributed among those operating sites that were involved in the added value. This means that the change of permanent establishment does not end the taxation right of a Contracting State. According to this new understanding of the DTA, the capital gain is to be distributed among all contracting states involved in the asset formation, regardless of which permanent establishment the asset was attributable to at the time of its sale.[227] As a result, the transfer of the asset to a foreign permanent establishment therefore does not lead to the loss of the taxation right on the previously created hidden reserves.

The shipping principle is based on the location of the management. Only a change in the taxation power can occur if the place of management is transferred to another state. If this is the case, the State of origin retains the right to tax the hidden reserves created up to the time of tax deregulation and may do so in accordance with the nature. 13 para 2 OECD-MA also after departure in the form of (sustainable) domestic operating income.[228]

Due to the 13, par. 4 OECD-MA for real estate corporations is a loss of the taxation right of the local state – as well as in Art. 13 para 1 OECD-MA – not conceivable.

Because profits from the sale of the remaining assets by art. 13 para 5 OECD-MA can be taxed ‘only in the country in which the vendor is established’, there is a risk that a prior departure of the vendor would result in a complete exclusion of the taxation right of the previous country of residence. However, a distinction must be made between private assets and business assets:

For tax easing in private assets, this collection has particular relevance. According to Art. 13 para. 5 OECD-MA, the taxation right is always liable to the taxpayer. If he moves abroad, the exiting state loses according to art. 13 para 5 OECD-MA the right of taxation on all assets assigned to him until then.[229]

Ob Art.13 para. 5 OECD-MA also applies to investments held in operating assets is controversial.[230] In jurisprudence and literature, however, the clear tendency is recognizable that even for participations the premises reservation of art. 13 para 2 OECD-MA applies if the participation is attributable to foreign operating assets.[231] The fact that holdings are not movable operating assets according to the German understanding is irrelevant. Finally, it follows from the connection with art. 13 para 1 OECD-MA, that movable operating assets as defined in Art. 13 para. 2 OECD-MA is that which is not by art. 6 OECD-MA is defined as immovable.[232] Consequently, movable operating assets are defined in Art. 13, par. 2 OECD-MA also includes intangible assets such as participations, trademarks and patents and claims.[233] As a result, the species is included in the incident. 13, par. 5 OECD‐MA only privately held assets and assets not attributable to a foreign permanent establishment.

For the control unbundling in the company assets is the interaction of the type. 13 para 5 OECD-MA with Art. 13 para 2 OECD-MA. After all, Article 13(5) of the OECD-MA only intervenes in the field of operations to the extent that capital gains do not already interfere according to Art. 13 para 2 OECD-MA can be assigned to a foreign permanent establishment state. In this regard, BFH has already decided that ‘the transfer of the operation of an independent inventor abroad [...] does not lead to the acceptance of a (fictitious) operational task even if the future profits of the foreign fixed establishment (permanent establishment) are not taxable in Germany or exempted from taxation in Germany on the basis of a DTA’[234]. Even after the departure of the taxpayer, he remains with his permanent establishment income to be assigned to the German permanent establishment according to § 49 para. 1 no. 2 lit. a EStG (or § 49 para 1 no. 3 EStG in the case of self-employment) remains subject to limited taxation. The Federal Republic of Germany also stands by Art. 13, par. 2 OECD-MA retains the right to tax the profits from the sale of assets insofar as they have arisen in the German permanent establishment.[235]

The receiving state is above art. 13, par. 5 OECD-MA, on the other hand, grants the right of taxation only to the extent that the capital gains do not by art. 13 para 2 OECD-MA of the German (foreign) establishment. Even if the taxpayer no longer maintains a permanent establishment after his departure in the Federal Republic of Germany, the German taxation law remains, because the BFH continues to assign the taxpayer subsequent commercial income from a former domestic permanent establishment (subsequent permanent establishment income).

As a result, the departure of the taxable person in the private property leads to the loss of the taxation right on the whole via art. 13 para 5 OECD-MA allocated assets. However, in the field of business, the taxable person remains after his relocation according to type. 13 para 2 OECD-MA continues to be subject to limited taxation in the country of departure with the profit from the sale of assets under (subsequent) permanent establishment income, insofar as these have arisen in the country of departure; In this respect, there is no loss of taxation rights in the case of business assets.