By Dragos Dancau, Group Tax Manager – Transfer Pricing, Ericsson
On March 10, 2022, the European Court of Justice published the opinion of Advocate General Collins in the case between a company established in Germany, called W, and the German tax authorities (C‑538/20).
The opinion suggested that in this specific case, the ECJ should answer in favor of German tax authorities to the main question raised by the German Federal Finance Court.
Namely, to state that the EU freedom of establishment articles do not oppose the legislation of a Member State which prevents a resident company from deducting losses incurred by a permanent establishment in another Member State from its taxable profits where, first, the company has exhausted the possibilities to deduct those losses available under the law of the Member State in which the permanent establishment is situated and, second, it has ceased to receive any income from that establishment, so that there is no longer any possibility of account being taken of the losses in that Member State (‘final’ losses), where the legislation in question exempts profits and losses by reference to a bilateral convention for the avoidance of double taxation between the two Member States.
The Advocate General also provided the opinion on four additional questions the Federal Finance Court raised, in case the ECJ answers differently to the main question under discussion.
The background
W, a public limited company resident in Germany, opened a branch in the UK in 2004. It was closed with confirmation from the UK authorities in 2007 because the branch made no profit.
Because of the branch closure, the losses incurred between 2004-2007 could no longer be carried forward in the UK for tax purposes. W’s position was that such final losses should be considered in Germany when computing taxable income for 2007 based on EU legislation. This occurred while Germany and the UK had in place a convention for the avoidance of double taxation based on which profits (and losses) of the nonresident permanent establishments (PEs) are exempt from tax in the parent company’s state of residence.
After several German court cases, which favored either W or the German tax authorities (also involving the German Federal Ministry of Finance), the German referring court involved in the case raised several questions to the ECJ for clarification purposes.
The first and main question was related to the impact of EU freedom of establishment articles on the limitation of the deductibility of losses by a member state law. Namely, if such EU articles oppose such a local approach in the case at hand.
The second question surrounded a specific trade tax that the German authorities deemed as having a structural domestic connection. Thus, should such a tax have the same approach, assuming the answer to the first question would imply the opposition of EU freedom of establishment articles to local limitations on deductibility?
The third question raised was connected to the concept of final losses and, more specifically, if the losses—such as in the case at hand—can be considered final, assuming as a theoretical possibility that a PE may be opened again in the UK.
The fourth question raised the need for clarification regarding whether the losses incurred by a PE, which have been carried forward from tax periods preceding its closure, can be considered to be final losses.
In the fifth question, the referring court asked whether the nonresident PE’s final loss amount to be taken into account in the member state of the parent company’s residence should be limited to the amount of final losses which—had it been possible—would have been taken into account in the member state where the PE was located.
Advocate General Collins’s opinion
In respect of the main question, the key starting point of the Advocate General opinion is that a difference in treatment of the deduction of losses does not constitute a restriction of the freedom of establishment if it concerns situations that are not objectively comparable, or if it is justified by an overriding reason in the public interest proportionate to that objective.
In the case at hand, it is viewed that the situations are not objectively comparable. This is essentially the case because the parent company’s country (Germany) did not have any power to tax the UK nonresident (PE in the UK) by virtue of applying the exemption method as per the income tax treaty between Germany and the UK. This includes the period in which the PE incurred the losses in the UK.
The Advocate General makes a distinction between Timac Agro Deutschland and Bevola cases. Namely, in the first one, the state of residence concluded an income tax treaty, which applied the exemption method to income derived in the source state. It thereby waived its power to tax the income of PEs located in the source state. By contrast, in the second case, the state of residence unilaterally chose, through a provision of national law, not to tax the income generated by nonresident PEs belonging to resident companies, notwithstanding that it would have been competent so to do.
In the Advocate General’s view, this is essential as it is only in the first case that the state of residence can be regarded as having effectively and completely waived its power to tax the income of nonresident PEs. That factor is viewed as decisive to find that the respective situations of residents and nonresidents are not objectively comparable in relation to a member state’s tax regime, including to the deductibility of losses.
By having such a position, the answers to the other questions somehow decrease in importance. Nevertheless, these provide significant insights, ranging from the potential limitation of the amount of the deductions, even if these are granted; the same approach for the second question as for the first (irrespective of the position taken on the first) to what may be considered as final losses without generating the perspective of losses never being final under question three.
Lessons learned
It is not yet clear how the case will end. Nevertheless, questions the German referring court raised on how previous cases (e.g., Marks & Spencer, Timac Agro Deutschland, Bevola, etc.) should be interpreted shows the maze in analyzing the deduction of the final losses of a nonresident PE within the EU.
On the one hand, it may be stated that the Marks & Spencer approach is still alive, while on the other hand it may be interpreted that given how different facts and circumstances impact the final losses deductibility of nonresident PEs, no clear path to certainty exists.
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Dragos Dancau, Group Tax Manager – Transfer Pricing, Ericsson
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