Krankenheim case

                        Krankenheim  Case  -­‐  ECJ,  23  October  2008,  Case  C-­‐157/07,   Krankenheim  Ruhesitz  am  Wannsee-­‐Seniorenheimstatt  GmbH  v   Finanzamt  für  Körperschaften  III  in  Berlin  

Carlotta Fontana – mat.1444041

Contents 1. Introduction  ..................................................................................................................................  3   2. Facts and legal background  ......................................................................................................  4   3. Judgement: preliminary ruling of the ECJ  ...........................................................................  5   3.1 Applicability of Article 31 of the EEA Agreement  .........................................................................  5   3.2 Justification and Proportionality  ......................................................................................................  5   3.3 Conclusion of the ECJ  .......................................................................................................................  6   4. Analysis (legacy and precedents to the case)  .........................................................................  7   4.1 Coherence of the Tax System  ............................................................................................................  7   4.2 Deduction and Recapture rules  .........................................................................................................  8   4.2.1 Marks & Spencer case  .................................................................................................................................  8   4.3 The Permanent Establishment and the Subsidiary  ......................................................................  10   5. Conclusion  .................................................................................................................................  11   References  ......................................................................................................................................  13    

 

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1. Introduction It appears that in the area of cross-border loss relief, there is a particularly urgent need for more clarity in the Court’s case law. As the famous Amid1 case ruled in December 2000, the ECJ issued several other decisions dealing with losses compensation in an international – European – context. A problem that could be raised in international taxation deals with the choice that has to be made between taxing the worldwide or the territorial income. The choice by the State of residence between worldwide or territorial taxation is determined by reasons of tax policy, tax administration, tax efficiency and equity. A worldwide taxation system may generate double taxation of the foreign source income: this double taxation can be removed through the exemption or the tax credit methods. Tax authorities and other courts of the Member State of the European Union are seeking for solutions, they want to know how to deal with parallel cases, and the national legislators may be required to amend tax rules suiting cross-border cases. Taxpayers (and their advisors) have an urgent need for legal certainty as regards the exact consequences of the exercise of rights guaranteed by EU law. Many cases deal with the import of losses incurred by foreign subsidiaries or tax-treatyexempt permanent establishments into the taxpayer’s home state. In Marks and Spencer case the possible inclusion of foreign subsidiaries in the UK group relief system reached the ECJ, Member States were still so impressed by the Court’s case law on the EU fundamental freedoms that some of them decided to introduce cross-border group taxation system before the case had even been decided2. Likewise, in Lidl case the ECJ had ruled that the exemption method under a double tax treaty should not exclude foreign PE losses from the head office’s domestic tax base. The disappointment regarding ECJ’s decision comes both from their outcome and with respect to the underlying reasoning. In Marks and Spencer case the Court first identified an infringement of the freedom of establishment, but then started to show a much more relaxed attitude towards Member States’ defence arguments and proportionality requirements, refusing to accept that a recapture mechanism would be a less burdensome and practicably alternative to a general exclusion of foreign losses. The same approach was applied in Lidl case to losses suffered by a foreign permanent establishment in a situation where the relevant bilateral tax treaty excluded those foreign losses from the head office’s domestic tax base3. However, later on, the ECJ held in Krankenheim case that the Member State of the head office was not obliged to adjust its own behaviour to ‘particularities’ in other Member States’ legislation and therefor did not have to take foreign PE losses into account where these losses had become ‘final’ due to a specific legal limitation for the use of carryforwards in the PE state. Based on Krankenheim, the German Federal Tax Court took a decision concerning a German head office with a foreign permanent establishment and got the conclusion that the penalisation of a loss carry-forward in the permanent establishment state after five years did not make those losses ‘final’ in the sense of Lidl.                                                                                                                 1  ECJ, 14 December 2000, case C-141/99, Algemene Maatschappij voor Investering en Dienstverlening NV (AMID) v Belgische Staat. Italy (‘consolidato mondiale’ as of 2004), and Austria (‘Gruppenbesteuerung’ as of 2005). Concerning the Swedish group taxation regime, the decision by Länsrätten I Vänersborg of 30 May 2005, discussed by Brokelind, Tax Analysts of 20 July 2005.   3  ECJ, 15 May 2008, case C-414/06, Lidl Belgium, para. 29.   2  See

 

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Recently, the German Tax Court has tried to make the ruling clear. It decided two cases on foreign permanent establishments4. While in the first case it affirmed the application of Krankenheim, in the second the result was favourable to the taxpayer. We can affirm that all national players need clear guidance from the ECJ. EU law is supposed to be given ‘full force and effect’ within the domestic legal borders of Member States. But what is happening is the creation of unclear and sometimes contradictory indications and judgements from the ECJ. Especially concerning cross-border loss relief, the Tax system of the Union need much more legal certainty. In this paper Krankeheim case will be analysed in details. A comparative view will be given through these pages, in order to achieve a clear perspective about the European need of certainty in cross-border loss relief within Member States of the Union.

2. Facts and legal background The Krankenheim5 case concerns cross-border loss relief and the taxation of positive income of permanent establishment. Krankenheim Ruhesitz am Wannsee-Seniorenheimstatt was a limited liability company established in Germany. It had a permanent establishment (hereinafter ‘PE’) in Austria from 1982 to 1994. Although the tax treaty between Germany and Austria (DTC) exempted income of permanent establishments, Germany did not tax on a strict domestic basic, but deducted foreign losses and applied a recapture mechanism: the German legislation allowed for a deduction in Germany of foreign losses incurred by a permanent establishment, followed by a taxation of the permanent establishment once it became profitable. The reintegration of losses took place in 1994. The decision of the German tax authorities (Finanzamt) to recapture those losses of the Austrian PE, was not accepted by Krankenheim. It argued that the reintegration of the PE’s losses was unlawful as the possibility to carry forward losses in Austria was permitted within seven years. Krankenheim argued that the loss relief rules were incompatible with article 31 of the EEA Agreement, which applied provisions equivalent to the freedom of establishment in relation to EAA states. The applicable German tax law added the profits from the PE from 1991 to 1994 to the taxable income deriving from Germany and retrospectively taxed the sums that had been deducted in the context of national taxation, deriving from the losses of the PE in Austria. Profits of Krankenheim for the 1994 tax year were increased. In Austria the losses of the PE that were previously incurred were not taken into account6. As explained, the reintegration of the losses was unlawful according to Krankenheim point of view. The matter came before the ECJ by way of a preliminary ruling from the German Bundesfinanzhof.

                                                                                                                4  See Perdelwitz, European Taxation 51 (2011), 31. 5

ECJ, 23 October 2008, case C-157/07, Krankenheim Ruhesitz amWannsee-Seniorenheimstatt GmbH v Finanzamt für Körperschaften III in Berlin. 6 ECJ, 23 Octorber 2008, case C-157/07, Krankenheim Ruhesitz amWannsee-Seniorenheimstatt GmbH v Finanzamt für Körperschaften III in Berlin, para 13-14.

 

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3. Judgement: preliminary ruling of the ECJ The ECJ found that the German rules that first deducted foreign losses and later taxed the permanent establishment up to the amount of losses previously deducted were a “restriction” of the freedom of establishment, but the restriction could be justified by the need to guarantee the coherence of the German tax system. 3.1 Applicability of Article 31 of the EEA Agreement The Republic of Austria became a member of the European Union only with effect from 1 January 1995, during the year at issue (1994) the provisions of freedom of establishment in the EEA Agreement applied to the case involved. The ECJ stated that these provisions were identical to those in Article 43 of the ECT, and both had to be interpreted uniformly. The Court assessed the existence of a restriction on the right implied by Article 31 of the EEA Agreement. It observed that provisions that allow losses incurred by a PE to be taken into account in calculating the profits and taxable income of the principal company constitute a tax advantage and, accordingly, a factor likely to affect freedom of establishment. The Court explained that companies may exercise freedom of establishment by setting up subsidiaries, branches and agencies in a host Member State. Furthermore, under the EC Treaty provisions, where a company exercises freedom of establishment, host Member States must grant “national treatment7”. However, the benefit of this tax advantage was withdrawn when the losses were subsequently reintegrated. This meant that Germany treated resident companies with branches in other Member States less favourably than those with branches in Germany. This less favourable tax treatment amounted to a restriction on the right of establishment set out in article 31 of the EEA Agreement unless it could be justified. After having determined the presence of a restriction, the Court evaluated the existence of justifications. 3.2 Justification and Proportionality According to Germany, to ensure the coherence of the tax system, its rules were needed. In the case, Austria taxed only the income of the PE, as ruled in the Double Taxation Convention (DTC). As a consequence, Germany took only the losses of the Austrian PE into account on the condition that they could be reintegrated at a later date when the PE made profits. The Court underlined the connection between the “recapture” of losses incurred and the fact that these losses had previously been taken into account in terms of deductibility from the taxable profits of the German company owning the permanent establishment: this reflected a logical symmetry of the German tax system. A direct and personal link existed, and the reintegration rules were “the logical complement of the deduction previously granted”8.                                                                                                                 7  T.O’Shea, National Treatment, The Tax Journal, 26 January 2009. 8

ECJ, 23 Octorber 2008, case C-157/07, Krankenheim Ruhesitz amWannsee-Seniorenheimstatt GmbH v Finanzamt für Körperschaften III in Berlin, para 42.

 

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The necessity to preserve the coherence of the German tax system justifies, in the eyes of the Court, the restriction applied on the freedom of establishment. This analysis of the link between a deduction of the permanent establishment’s losses and the later recapture of its profits indicates that the ECJ favours the fiscal principle of territoriality. Maybe, the Court would not have accepted a taxation of the permanent establishment in the home State, if no losses had been deducted in Germany. This can also bring us thinking about a preference of the ECJ of the fiscal principle of territoriality, over the principle of worldwide taxation. The proportionality analysis may confirm this. The risk of double compensation of the foreign loss is recognised by the ECJ as a valid element of justification of the restriction. A worldwide taxation system usually deals with double loss compensation and results from the distribution of the power to impose taxes between the States of residence. In our analysis we should keep in mind that worldwide taxation has as a direct consequence cross-border loss compensation. According to this justification of the ECJ, a question rises: is the territoriality applied to cross-border losses in accordance with the idea of an internal market? Another point the Court took into consideration was whether the German rules were proportionate. On one hand, the only reintegration of deducted losses made deduction and reintegration rules appropriate for achieving their objectives. On the other hand, there was a proportionality of the restriction because the reintegrated losses were reintegrated only up to the amount of profits made. The ECJ considered that “that restriction is entirely proportionate to the objective pursued, since the reintegrated losses are reintegrated only up to the amount of the profits made9”. No rules of the Union were capable to deal with the problem associated to double taxation of companies with PEs in another Member State. This highlighted the lack of harmonisation in this area at Union level. There was an impossibility to deduct losses at the level of the Austrian PE as in principle such a possibility was not ruled out by Austrian fiscal rules. Germany was supposed to deal with the problems of double taxation, acting accordingly to DTCSs. The Court noted that in those circumstances, “a Member State cannot be required to take account, for the purposes of applying its tax law, of the possible negative results arising from particularities of legislation of another Member State applicable to a permanent establishment10”. In the exercise of a competence concerning DTCs, Member States are not obliged to consider potentially harmful consequences relating only to specific situations and caused by particular rules provided by the legislation of the other contracting Member State.

3.3 Conclusion of the ECJ The Court concluded that article 31 EEA Agreement does not prevent the fiscal system of a national Member State from reintegrating losses incurred by a permanent establishment                                                                                                                 9

ECJ, 23 Octorber 2008, case C-157/07, Krankenheim Ruhesitz amWannsee-Seniorenheimstatt GmbH v Finanzamt für Körperschaften III in Berlin, para 45. 10 ECJ, 23 Octorber 2008, case C-157/07, Krankenheim Ruhesitz amWannsee-Seniorenheimstatt GmbH v Finanzamt für Körperschaften III in Berlin, para 49.

 

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in a host Member State. It did not preclude the German deduction and reintegration loss relief at issue. “Article 31 of the Agreement on the European Economic Area of 2 May 1992 does not preclude a national tax system which, after having allowed the taking into account of losses incurred by a permanent establishment situated in a State other than the one in which its principal company is situated, for the purposes of calculating the tax on that company’s income, provides for a tax reintegration of those losses at the time when that permanent establishment makes profits, where the State where that same permanent establishment is situated does not confer any right to carry forward losses incurred by a permanent establishment belonging to a company established in another State, and where, under a convention for the prevention of double taxation between the two States concerned, the income of such an entity is exonerated from taxation in the State in which the principal company has its seat”11.

4. Analysis (legacy and precedents to the case) 4.1 Coherence of the Tax System The ECJ’s acceptance of the coherence of the tax system as a justification is shown in the Krankenheim case. There are several cases and judgements through which the Court set out the content of the concept of the coherence of the tax system. The first one is the Bachmann12 case, where the Court found that it was not possible to ensure the cohesion of the Belgian tax system. The ECJ found on a public interest the justification of the cohesion of the tax system, invoked by Belgium, in relation to rules concerning the deductibility of pensions contributions. “As regards the need to preserve the cohesion of the tax system, the Court held, in its judgement delivered today in Case C-300/90 Commission v Belgium13, that there exits under the Belgian rules a connection between the deductibility of contributions and the liability to tax of sums payable by the insurers under pension and life assurance contracts. According to Article 32a of the CIR, cited above, pensions, annuities, capital sums or surrender value under life assurance are exempt form tax where there has been no deduction of contributions under Article 54.” According to the Court, the balance between recognition of a tax advantage and right to tax income resulted from the accumulation of contributions that have benefited from that tax advantage and this lead to cohesion. There would be a balance between the loss of revenue                                                                                                                 11

ECJ, 23 Octorber 2008, case C-157/07, Krankenheim Ruhesitz amWannsee-Seniorenheimstatt GmbH v Finanzamt für Körperschaften III in Berlin, para 56. 12 ECJ, 28 January 1992, case C-204/90, Hanns-Martin Bachmann v Belgian State. 13 ECJ, 28 January 1992, case C-300/90, Commission of the European Communities v Kingdom of Belgium; T. Otmar, “Non-Deductibility of Premia for Foreign Life Insurance Approved by European Court of Justice. A Change in the Court’s Jurisprudence on Direct Taxes?”, Intertax 1992, p.298.

 

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due to the reduction of the taxable profits by reason of contributions deductibility and the tax liability on the pensions payments. A connection between deductibility and liability to tax expressed the cohesion in Bachmann. Since this case, the Court have been reluctant to find a direct link between the granting of the particular deduction and the taxing of the future income to which the deduction relates. Only in 1995, in the Court’s subsequent Wielockx14 judgement, it developed its concept of coherence of the tax system considering how DTCs might have affected it15. In Wielockx case, the Court placed much more emphasis on the role of Double Tax Conventions play in ensuring the coherence of a Member State’s tax system. It stated that a State imposed tax on all pensions paid to its residents, regardless of where the related contributions had been paid. At the same time, the State was not entitled to tax pensions paid abroad, even though they had been built up through contributions paid and deducted in its territory. Here, the Bachmann’s coherence as a direct link between deductibility of contributions and tax liability on sums paid out of related pensions becomes reciprocity in the application of the fiscal provisions laid down by each of the contracting states. In Krankenheim, the coherence of the tax system was clearly found by the Court in the direct link between the recapture of the losses and the deduction accorded. The German resident company with a PE in Austria was not taxed on the profits attributable to the PE. Austria taxed the profits. As a consequence Austrian law contained no provision for the carrying forward of the losses when the undertaking as a whole made profits. The Court found that the “deduction and recapture” rules were necessary to ensure the coherence of the German tax system. In Krankenheim the concept of coherence is applied in a cross-border loss relief environment, while in Bachmann the deductibility of pension contributions was linked to fiscal imposition of the pensions created through the deducted contributions. Finally, we can assert that the concept of coherence of the tax system is a potentially valid justification of a restriction whenever a direct link reflecting a complementary relation between a tax advantage and a tax liability can be found. 4.2 Deduction and Recapture rules 4.2.1 Marks & Spencer case16 On December 2005, the ECJ dealt with this case. Marks & Spencer plc, a UK resident company with several subsidiaries in continental Europe that became loss making during the 1990s. Under the UK’s group relief regime, Marks & Spencer sought to offset these losses against its UK profits. Group relief, however, was only available to UK resident companies or non-resident companies that carried on trade in the United Kingdom through a permanent establishment17. Marks & Spencer denied the requested cross border group relief. According to the ECJ this constituted a restriction on the freedom of establishment that was however,                                                                                                                 14

ECJ, 11 August 1995, case C-80/94, G. H. E. J. Wielockx v Inspecteur der Directe Belastingen. T. O’Shea, “Commission v Denmark: Can Cohesion Work as a Justification?”, Tax Notes Inernational, 2 April 2007, page 47. 16 ECJ, 13 December 2005, case C-446/2003, Marks & Spencer plc v David Halsey. 17 The United Kingdom’s group relief rules that applied for accounting periods ending on or before 31 March 2000 required both the surrendering company and the claimant company to be resident in the UK. For later periods, the availability of group relief has been extended to non-resident companies that carry on trade in the United Kingdom through a branch or agency (sec. 402 ICTA). 15

 

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justified based on a threefold justification ground: preserving balanced allocation of taxing powers, preventing losses from being used twice, and averting tax avoidance18. However, when the ECJ assessed the proportionality of the outright denial of cross border group relief, it held that allowing for the compensation of “final losses” would make the United Kingdom’s group relief regime less restrictive19. The ECJ recognized that the restrictions on the freedom of establishment may be justified by the need to preserve balanced allocation of taxing powers. In Krankenheim case the ECJ held that the logical symmetry of recapturing the previously deducted losses was necessary to guarantee the coherence of the German tax system and hence establish that the restriction that followed from the recapture was justified. The fact that the possibility to compensate the losses under the Austrian rules could not be put into effect in the specific situation, and that the taxpayer ended up with a “final loss”, was treated as a disparity by the ECJ. In other words, as a disadvantage that did not arise from the German tax system itself, but from the allocation of taxing powers between Germany and Austria. What emerges in these cases is that the ECJ has created a barrier against the crossborder compensation of losses by attaching importance to the need to preserve a balanced allocation of taxing powers. In Marks & Spencer, the ECJ formulated the conditions under which losses can be characterized as “final losses”20. There are two main conditions: firstly, the non-resident subsidiary has to have exhausted the possibilities available in its State of residence of having the losses taken into account for the accounting period concerned by the claim for relief and also for previous accounting periods, if necessary by transferring those losses to a third party or by offsetting the losses against the profits made by the subsidiary in previous periods; and, secondly, there should not be any possibility for the foreign subsidiary’s losses to be taken into account in its State of residence for future periods either by the subsidiary itself or by a third party, in particular where the subsidiary has been sold to that third party. The exhaustion of losses is achieved if a series of requirements are met: the subsidiary’s losses cannot be carried forward, nor can they be carried back against the subsidiary’s own profits; the subsidiary’s losses cannot be utilized by transferring them to a third party; and, the subsidiary’s losses cannot be utilized by a third party. If these conditions are fulfilled, the freedom of establishment prevails over a given allocation of taxing powers provided the exercise of the latter power places a disproportionate burden on the exercise of this fundamental freedom. The “no possibilities test” was introduced in Marks & Spencer case. Its nature is an application of the principle of proportionality “stricto sensu”. In the contest of cross-border loss compensation, this means a balancing act between the objective of preserving a balanced allocation of taxing powers and the gravity of the restriction of the freedom of establishment. The exhaustion of the possibilities of loss utilization may generate “final losses”, which should be deductible in another Member State. In Marks & Spencer case, it was argued that group relief cross-border could be made conditional on the “subsequent profits of non-resident subsidiary being incorporated in the taxable profits of the company which benefited from the group relief up to an amount equal                                                                                                                 18

ECJ, 13 December 2005, case C-446/2003, Marks & Spencer plc v David Halsey, para 42-51. ECJ, 13 December 2005, case C-446/2003, Marks & Spencer plc v David Halsey, para 55. 20 ECJ, 13 December 2005, case C-446/2003, Marks & Spencer plc v David Halsey, para 55. 19

 

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to the losses previously set off21”. This argument was rejected by the Court, because it asserted that even if other and less restrictive measures might be identified, they would have required harmonisation rules adopted by the legislation of the European Union. This could be reconciled with Krankenheim case, because in the latter the matter was not about the creation of new rules and measures: the loss deduction and recapture rules actually existed. In Marks & Spencer the rules did not exist. The existence of rules in Krankenheim allowed the Court to take them into account in determining whether the tax rules of the Member State (Germany) breached Article 31 of the EEA Agreement. They were a necessary part of the German tax regime, and the Court was free to determine that the rules were necessary to ensure the coherence of the German tax system. The fact that, in Marks & Spencer no rules were available or already created brought the ECJ to have no power to force the United Kingdom to introduce the rules. The reason why this happened is because the Court’s role is only one of a “negative harmonisation”. The European Court of Justice ensures that EU law is complied with, and that the treaties are correctly interpreted and applied. It has no legislative powers. 4.3 The Permanent Establishment and the Subsidiary The freedom of establishment is one of the fundamental freedoms recognised by the European Union. It acknowledges to a company the possibility to establish itself in any other of the Member State that they would like to carry out its business in. Establishment can be divided into dependant and independent establishment. The difference between the two is that the former is recognised as ‘permanent establishment’ and it lacks a legal personality of its own. The permanent establishment can not be separated form the general enterprise as a subsidiary can be. The permanent establishment is not considered to have a legal personality of its own and in that sense is not a limit of the financial risks as a subsidiary. The term permanent establishment is used in referring to “ a non-resident’s business presence in a particular country which is of a sufficient level to justify that country’s taxation of attributable profits22”. Under private law, a PE is considered to be an extension of the principal office even if the business that is conducted does not need to be of the same character. One main difference between a subsidiary and a permanent establishment is to be found in the taxation of the two. A subsidiary is automatically subject to tax based on the status of residence. A PE is a threshold of taxation and therefore considered as a foreign investment in a form of branch that requires certain substance and length before it qualifies to taxation in the host state. Under EC law, we can find three different definitions of PEs: the Parent-Subsidiary Directive23, the Interest and Royalties Directive24 and the Merger Directive25. These are not uniform definitions and there is no universal definite of the PE under EC law. According to tax treaties based on the OECD model convention, the PE is defined under Article 5. It states that a permanent establishment is “a fixed place of business through                                                                                                                 21

ECJ, 13 December 2005, case C-446/2003, Marks & Spencer plc v David Halsey, para 54. IBFD International Tax Glossary, revised 5th edition, IBDF, Amsterdam, 2005. 23  The Parent-Subsidiary Directive (2013/123/EC). 24  The  Interest  and  Royalties  Directive  (2003/49/EC).   25  The Merger Directive (90/434/EEC).   22  Larking,

 

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which the business of an enterprise is wholly or partly carried on26”. This article is used to determine if business is conducted through a PE, and if there is a PE in a Member State, this entitles the state where the PE is set up the right of taxation of a company that is residence in another. A PE is taxed in the state where the economic activity has taken place, and is to be seen as only being liable to taxation in the State where the PE is conducting business. Taxation of a permanent establishment is often made under the tax exemption by the origin state: profits and losses in the permanent establishment are taken into account when calculating the primary establishment, the head offices, worldwide taxable income and then deducted by the amount that would have been taxed in the home state27. However, where there is a tax treaty between the countries involved, the taxation may be different, but it shall be compatible with Community rules according to case law28. In the Krankenheim case, the ECJ asserted that measures that make the exercising of the freedom of establishment shall be seen as restrictions and is also applicable to the exercising the freedom through a PE. The Court stated that provisions which allows losses from the PE to be taken into account when calculating the taxable income of the principle office is to be seen as a tax advantage. After all reasoning the ECJ came to the conclusion that the German rules were compatible with Community rules. National tax system are allowed to have rules that does not confer any rights to carry losses forward in accordance with the tax treaty and in order to prevent double taxation. 5. Conclusion The outcome of Krankenheim case may be interpreted as a preference for the fiscal principle of territoriality, as the Court refused Germany (a Member State) the application of the principle of worldwide taxation through the taxation of a foreign permanent establishment’s profits. Anyway, the reasoning of the ECJ is difficult to understand and one may not rely on this case to support a preference for the fiscal principle of territoriality over the principle of worldwide taxation. Criticism may rise from the ECJ’s decision: resident companies with foreign permanent establishments were treated less favourably than if such permanent establishments were located in the State of residence. The principle of worldwide taxation has been found incompatible with EU law by the ECJ in Krankenheim case. Inconsistency rises in the Court’s case law: the principle of worldwide taxation has been accepted in many cases, particularly Columbus Container. On the one hand, in Columbus Container the Court accepted the principle of worldwide taxation applied widely and without connection to the prevention of tax avoidance. On the other hand, however, in Krankenheim the ECJ has clearly limited the scope of the principle of worldwide taxation to the very recapture of losses previously deducted, implicitly favouring the fiscal principle of territoriality. The conflict that the Court found in Krankenheim was between the objective of achievement of the internal market through a promotion of the freedom of establishment and the exercise of tax jurisdiction on the basis of the principle of worldwide taxation.                                                                                                                 26  Article 5.1 OECD Model Convention. 27  Terra, B & Wattel, P, European Tax Law, p. 644.   28  See eg. ECJ, 21 September 1999, case C-307/97, Compagnie de Saint-Gobain, Zweigniederlassung Deutschland v Finanzamt Aachen-Innenstadt.

 

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The conflict between these two cases may confuse Member States as well as the European Institutions as to which the principle of taxation should be favoured for taxing permanent establishments’ profits in the Member State of residence. Krankenheim could have major consequences on Member States’ tax systems, depending on the way this case is interpreted. Potentially, it is a ground-breaking case. The difficulties in interpreting it may lead to an isolated decision in ECJ’s case law. The incompatibility of this decision with previous case law, may be not have been taken into consideration by the ECJ while deciding on it. Although, some scepticism of the ECJ towards the principle of worldwide taxation was already identified with regard to Cadbury Schweppes29 case. The incoherence legal reasoning of the Court and its inability to provide guidelines that would allow for more legal certainty in this area is amplified by all these contrasting cases and judgements. The revival of coherence principle on the one hand increased the number of potential successful justifications put forward by the Member States, but on the other hand it complicated even more the already obscure distinctions between the commonly accepted justifications (balanced allocation of taxing powers, danger of losses being used twice and the danger of tax avoidance). Contrary to the Lidl Belgium case, which was similar on the facts, where the Court justified the restriction at issue on the need to maintain a balanced allocation of taxing powers, in the Krankenheim judgement it chose to justify the German recapture rule under the fiscal coherence principle, without providing clear reasons for such a rather unjustified choice. As a conclusion, Krankenheim is difficult to interpret. The impact of this decision on cross-border loss relief cannot be identified with all certainty. However, it will be argued that the final losses of a permanent establishment should not remain unrelieved.                                

                                                                                                                29  ECJ, 12 September 2006, case C-196/04, Cadbury Schweppes plc and Cadbury Schweppes Overseas Ltd v Commissioners of Inland Revenue.    

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