The Court of Justice of the European Union (hereinafter 'CJEU'), in its judgment in Case C-538/20 of 22 September, ruled that a Member State may deny a deduction of final losses of a permanent establishment resident in another state, where the country of residence has waived its power to tax the profits of that permanent establishment under a double taxation convention.
A public limited company established in Germany (hereinafter 'W AG'), manages a German securities bank. In August 2004, it opened a branch office in the United Kingdom, which did not generate any income during the first three years and it was decided to close it in the first half of 2007. Since those losses could not be carried forward for tax purposes in the United Kingdom, W AG included them in its German tax return for 2007 but the competent tax office did not recognise them for the purposes of calculating corporation tax (Körperschaftsteuergesetz, hereinafter 'KStG') and trade and industry tax (Gewerbesteuergesetz, hereinafter 'GStG'). W AG appealed to the Hessen Tax Court (Hessiches Finanzgericht), which upheld this appeal in its judgment of 4 September 2018, and the Tax Office subsequently appealed against this judgment by cassation to the Federal Tax Court (Bundesfinanzhof).
The latter pointed out that although W AG is subject to corporation tax in Germany for all its income (Paragraph 1(1) and (2) of the KStG), the losses incurred by its permanent establishment in the United Kingdom are excluded from the basis of assessment for corporation tax pursuant to Paragraph XVIII(2) of the German/UK Double Taxation Agreement and is likewise excluded from the basis of assessment for trade and industry tax (GStG). On the basis of these elements, the appeal should be allowed. However, the Federal Tax Court judge raised the question of whether the losses incurred by the permanent establishment in the United Kingdom should not be taken into account for the calculation of the tax owed by W AG in Germany in view of the freedom of establishment and, as he did not consider the relevant ECJ ruling to be sufficiently clear, decided to suspend the proceedings by submitting the following questions to the ECJ for a preliminary ruling:
Is Article 49 in conjunction with Article 54 of the Treaty on the Functioning of the European Union ('TFEU') to be interpreted as precluding a tax system of a Member State under which a company resident in that Member State may not deduct from its taxable profits the final losses of a permanent establishment in another Member State where that State has waived its power to tax the results of that permanent establishment under a double taxation convention? If the answer to the first question is in the affirmative:
do the same Articles 49 and 54 also preclude the provisions of the German Law on Trade and Industry Tax prohibiting a resident company from deducting from its taxable profits the final losses incurred by a permanent establishment situated in another Member State?
whether, in the event of the closure of the foreign permanent establishment, the losses may be considered definitive by virtue of the theoretical possibility that the company may open a new permanent establishment in the same foreign State and its profits may possibly be set off against the previous losses;
whether in the event of the closure of the foreign permanent establishment, losses that may be carried forward under local law to a subsequent financial year may also be considered final;
whether final cross-border losses are limited in quantum by the amounts of losses that the company could have claimed in the State of location of the permanent establishment.
Analysis of the CJEU
With regard to the first question, the CJEU notes that companies resident in Germany are subject to tax on all income pursuant to § 1 (paras. 1 and 2) of the KStG and, however, under the Double Taxation Agreement, if a German company carries on its industrial or commercial activity in the United Kingdom through a permanent establishment, profits attributable to that permanent establishment (and therefore losses) are excluded from the basis of assessment for corporation tax payable in Germany.
A recent CJEU ruling, in particular Judgment C-650/156 'Bevola and Jens W. Trock' of 12 June 2018, affirmed that the freedom of establishment guaranteed by Articles 49 and 54 TFEU includes the right for companies of one Member State to carry out their activities in another Member State through a subsidiary, branch or agency (and this freedom must not be impeded by the legislation of the Member State where the company is located). This ruling states that resident companies enjoy a tax advantage in determining their taxable income consisting of being able to take into account losses incurred by a resident permanent establishment. Excluding this possibility in the case of losses incurred by a foreign permanent establishment may dissuade a resident company from carrying on its business through that permanent establishment, and therefore such a difference in treatment is only permissible when it concerns situations that are not objectively comparable (or justified by a general interest motive).
In its previous judgment C-388/14 'Timac Agro Deutschland' of 17 December 2015, the CJEU had ruled that where the Member State of residence of a company has waived, by virtue of a double taxation convention, the exercise of its power of taxation on the profits of a permanent establishment resident in another Member State, the situation of that company is not comparable to that of a resident company with a permanent establishment.
This conclusion was not called into question by the judgment C-650/156 'Bevola and Jens W. Trock' of 12 June 2018. In that case, the CJEU held that the situation of a company with a foreign permanent establishment that had definitive losses, which were no longer deductible following the closure of the permanent establishment, was no different from that of a resident company with losses attributable to a resident permanent establishment. However, in that case, the Member State of residence of the company seeking recognition of the definitive losses of its foreign permanent establishment had not waived its power to tax the income of that establishment by virtue of the application of a double taxation convention. It had unilaterally decided not to take into account profits and losses realised by non-resident permanent establishments, although it would have had the power to do so, and therefore that situation was not comparable to that in Case C-388/14 'Timac Agro Deutschland'.
In Case C-538/20 of 22 September 2022, the Federal Republic of Germany waived its power to tax the profits made by a permanent establishment in the United Kingdom (and symmetrically to take into account its losses) under the existing double taxation convention, and as a result, a resident company with such a permanent establishment is not in a comparable situation to a resident company with a permanent establishment in Germany.
The CJEU therefore concludes that no restriction on the freedom of establishment can be discerned in the present case and that Articles 49 and 54 TFEU must be interpreted as not precluding a tax regime of a Member State under which a company resident in that Member State cannot deduct from its taxable profits the losses permanent establishment situated in another Member State where the Member State of residence has waived its power to tax the results of that permanent establishment by virtue of a convention for the prevention of double taxation, and in view of that conclusion there is no need to answer the other questions referred for a preliminary ruling.