German Exit Taxes in the light of de Lasteyrie du Saillant and N

• Author: Randolf Schnorr
• Pages: 1-25

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1. Introduction

In the two fundamental decisions - de Lasteyrie du Saillant¹² and N³ - the ECJ had to deal with challenges of the assessment and methods of enforcing income tax on profits from substantial shareholdings where residence is moved to another Member State. The ECJ has made it clear that Exit Tax regulations that result in unfavourable treatment of people who have exercised their right to free movement, with respect to resident taxpayers within the territory of one state, are capable of restricting the freedom of establishment under Article 48(2) EC⁴.

Provisions intended to ensure coherent taxation on capital gains on substantial shareholding which have occurred during residence within the territory can however - according to the Court - be justified by pressing reasons of public interest.

The following article will first of all deal with the impact of these Court rulings on the German Exit Tax regulations for private investors. Since the German Page 2 government has already taken measures and enacted a new Exit Tax regulation for private investors for the fiscal year 2007, which will also apply to all impending cases with retroactive effect, it will be necessary to differentiate between the old and the new law. The new Exit Tax regime for private investors is part of a wider approach taken by German legislators to adapt the existing German Exit Taxes to European requirements. The amendment of the Exit Tax for private investors therefore has been enacted as part of the SEStEG⁵ (a bill regarding tax measures accompanying the introduction of the European company) which implements the tax framework for Societas Europaea (SE) set forth in the amended EU Merger Directive as of February 17, 2005⁶, the EU directive as of October 26, 2005 on cross-border mergers of limited liability companies⁷ and the SEVIC decision⁸ by the ECJ.

Besides the German Exit Tax for private investors, one has to take account of special Exit Tax regimes for the relocation of business assets for individuals and legal persons. As far as legal persons are concerned, German Law differentiates furthermore between the relocation of business assets and the relocation of legal persons as such. Within the Exit Tax regime for the relocation of legal persons special rules also apply to the relocation of an SE. Page 3

2. Exit Taxes for Private Investors

2.1. The former German exit tax provisions in section § 6 of the Foreign Relations Tax Act

As already mentioned in the introduction, the German government has reacted to the de Lasteyrie⁹ and N¹⁰ rulings by enacting a new Exit Tax regulation for private investors moving to another EU Member State or EEA country for the fiscal year 2007 which will also apply retroactively to all impending cases (see § 21 (13) sentence 2 AStG (Foreign Relations Tax Act) in the new version of the law¹¹).

The former Exit Tax regulation in § 6 (1) AStG¹² did not differentiate between shareholders who move to another EU Member State or EEA country. It moreover stated that an individual taxpayer who has been subject to unlimited German income tax liability for at least 10 years prior to moving to another country, and who thereby ceases to be subject to unlimited tax liability in Germany, becomes liable to tax with respect to the unrealised increase in the value of his/her shares in a domestic company in Germany in which that individual directly or indirectly owns or has owned at least 1% of the share capital at any time within the five years preceding the transfer. The qualification of the deemed sale did not require that the shareholder moves to a country with low tax rates. Furthermore the same applied to a shareholder who did not move to a foreign country, but transferred free of charge the Page 4 shares in the German corporate entity to people living abroad, for example spouse or children.

Under § 6 (5)¹³ of the Foreign Relations Tax Act, the owed income tax was due upon application and against security payable in regular instalments for a period of up to five years subsequent to the time when the tax debts was first originated, if its immediate collection resulted in considerable hardship for the taxpayer. In case of disposal of shares during the instalment period, instalments were to be adjusted accordingly.

Soon after the Court rendered its de Lasteyrie du Saillant¹⁴ ruling on March 11, 2004, a large debate took place in Germany on the impact of this decision upon the existing German exit tax regime. In the light of paragraph 65 of de Lasteyrie du Saillant it was argued that the ECJ had explicitly left open the question whether the coherency of national tax system justified a general taxation of as yet unrealised increases of value by the former State of residence¹⁵. According to the submissions of the French Government, the only purpose of the provisions in dispute in de Lasteyrie du Saillant was to prevent tax avoidance, and were not aimed at ensuring in general that increases in value were to be taxed, in the case where a taxpayer transferred his/her tax residence outside France, in so far as the gains in question are shown during the latter's stay on French territory. Arguably the broader German regulations were not intended to prevent tax avoidance but to enable the practical Page 5 implementation of a coherent system of taxation allocated according to the principle of territoriality.

Other German commentators on de Lasteyrie du Saillant were however of the opinion that the principles of the decision must apply in every case where the sole transfer of residence to another country, without any real form of realisation, would lead to the taxation of a fictitious capital gain¹⁶. Though it was held that the violation of EU Law did not result from the fact of taxing capital gains as such, nevertheless the violation was deemed to result from the fact that the tax liability was activated before the gains were realised and only in casea of tax payers who moved abroad, whereas by contrast, capital gains are taxed for residents in Germany only if they are realised¹⁷.

The N decision and most notably the Opinion of the Advocate General Kokott¹⁸in the N case have now brought more light into this controversy. The Court has now clearly stated that the allocation of the power to tax between Member States is a legitimate objective and that in the absence of any unifying or harmonising Community measures, Member States retain the power to define, by treaty or unilaterally, the criteria for allocating their powers of taxation¹⁹. The Court of Justice deemed the Netherlands tax provisions compliant with EU Law insofar as they took a clear territorial element as their starting point for the taxation and connected this to a time-based component, namely residence within the territory of the State during the period in which the taxable profit emerged. On the contrary, the problem with French regulations was that they Page 6 took for their starting point not the principle of territoriality but the countering of tax avoidance. The Opinion of the Advocate General made it clear that de Lasteyrie du Saillant must be interpreted in such a way that it would be disproportionate if the tax were assessed on the basis of transfer, solely in order to counter the risk of tax avoidance, because tax avoidance or tax fraud cannot be inferred generally from the fact that a natural person wishes to transfer his/her tax residence to another Member State²⁰. The former German regulations resembled more the Dutch provisions in so far as they took for their starting point not the countering of tax avoidance but the principle of territoriality.

Albeit, taking account of the case law of the European Court of Justice and in particular the de Lasteyrie du Saillant ruling, the European Commission on April 19, 2004 formally requested Germany to abolish its "exit tax" provisions²¹. The formal request took the form of a so-called 'reasoned opinion' under EC Treaty infringement procedures (Article 226 of EC Treaty)²². The Commission considered that Germany's exit tax regime (§ 6 of the Foreign Relations Tax Act²³) was incompatible with EC Treaty rules on people's right to reside, work and establish themselves in another Member State (Articles 18, 39 and 43²⁴ of the EC Treaty), since the change of residence to another Member State gave rise to taxes which were not due if taxpayers simply moved their residence within Germany. The Commission held that there was no valid justification for such an obvious hindrance to the free movement of people within the Internal Market. The Commission recognized...