Update from Germany – September 2006

Overview


German Taxation of Migrations and Cross-Border Transformations

On July 12, 2006, the German government approved the draft of the SEStEG (a bill regarding tax measures accompanying the introduction of the European company). In particular, the draft bill implements the tax framework for a European company set forth in the amended EU Merger Directive as of February 17, 2005, the EU directive as of October 26, 2005 on cross-border mergers of limited liability companies, and the European Court of Justice (ECJ) SEVIC Systems decision of December 13, 2005. However, it is doubtful whether these proposals fully comply with European law. The draft basically provides an instant taxation of built-in gains if the German right to tax these gains is limited or excluded. Among other things, these proposals substantially affect the taxation of companies migrating from Germany as well as cross-border mergers. If these changes become effective, U.S. groups with German investments planning a reorganization—e.g., the implementation of a European holding structure—need to carefully review the proposed changes.

Migration from Germany
The draft bill imposes a general exit tax on companies migrating from Germany. According to this, an instant realization of the built-in gains in business assets will be assumed if the German authorities lose the right to tax hidden reserves, i.e., an exit tax is imposed on a migrating company if the business assets do not remain in a permanent establishment in Germany. Contrary to current law, a realization is assumed even if the assets are transferred to a permanent establishment in a country to which Germany applies the tax credit method. The tax credit method does not exclude the German right to impose taxes on the built-in gains of the transferred assets as the gains are still being taxed upon realization abroad. The foreign tax is granted as tax credit on the German tax.

However, although the German taxation rights are not excluded, an instant exit taxation would occur. If such a taxable event arises, the business assets would be valued at their fair market value on the relevant transfer date, not the going concern value. The taxable gain or loss would be calculated as the difference between the fair market value and the tax basis of the business assets.

This exit taxation would apply not only to German corporate forms (limited liability company, GmbH, or stock corporation, AG) but also to a migrating European company (Societas Europaea, SE) and to migrating foreign corporate forms, such as a UK limited which has had its effective place of management in Germany.

It is questionable whether the exit tax on emigrating companies complies with European law. For the reverse case of an immi-grating company it is widely undisputed that the EU freedom of establishment requires Germany to accept that corporation, i.e., the transfer of the effective place of management and/or registered office may not trigger any corporate or tax con-sequences. Several landmark ECJ decisions have prompted Germany to do so (Centros, Überseering, Inspire Art). As a result, approximately 15,000 UK limited companies have their effective seats of management in Germany.

Instant taxation at the moment of migration also raises questions of EU law compatibility regarding the exit taxation clause and its timing. Following the ECJ de Lasteyrie du Saillant decision, the draft bill defers taxes for individuals migrating to another EU Member State or European Economic Area (EEA) country until the capital gains are actually realized. As the ECJ regards a deferred taxation as less incriminatory than an instant one, this differentiation between migrating companies and individuals might violate the EU freedom of establishment.

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