Germany: M&S principle excluded by DTT provision

The CJEU has held that the provisions of the Germany/UK double tax treaty giving exclusive taxing rights to the UK on the profits of a PE in the UK prevented the operation of the M&S principle regarding the use of cross-border losses: W AG v Bundesministerium der Finanzen (Case C-538/20). As a result of the provisions of the treaty, the UK PE of a German company was not in a comparable position with that of a German PE, such that the right to freedom of establishment had not been restricted by the refusal to allow the offsetting of the losses made by the UK PE against German profits.

Background

W AG, which operated as a securities trading bank, opened a branch in the UK in 2004. That branch was unprofitable and was closed in 2007 so that the losses it had incurred could no longer be carried forward in the UK. W AG sought to deduct those losses from its German profits for the purposes of German corporation and business tax, but that application was rejected. W AG appealed and the matter was eventually referred to the CJEU.

Decision of the CJEU

The Court noted that companies which have their place of management or registered office in Germany are subject to corporation tax on all their income. However, in accordance with the provisions of the Germany/UK treaty, where a company which has its place of management or registered office in Germany carries on an industrial or commercial activity in the UK through a PE, the profits attributable to that PE are excluded from the basis of assessment for corporation tax payable by that company in Germany. The same applies, symmetrically, to losses attributable to such a PE.

In that situation, German companies with German operations enjoy a tax advantage compared to those with non-German operations which consists in allowing them to take into account the losses incurred by a resident PE. To exclude the possibility of deducting losses incurred by a PE situated in another Member State creates a difference in treatment which could discourage a German company from carrying on its business through such a PE (and exercising its freedom of establishment). Such a difference in treatment is permissible only if it involves situations which are not objectively comparable, or if it is justified by an overriding reason in the public interest proportionate to that objective.

Was the position of a German PE and a UK PE in this case comparable? The Court noted that domestic and foreign PEs are not, in principle, in comparable situations unless the national tax legislation treats those two categories of PE in the same way. Accordingly, where the Member State in which a company is resident has waived, pursuant to a double taxation treaty, the exercise of its power to tax the profits of the non-resident PE, the situation of a resident company possessing such a PE is not comparable to that of a resident company possessing a resident PE “in the light of the measures taken by the first Member State in order to prevent or mitigate the double taxation of profits and, symmetrically, the double deduction of resident companies’ losses”.

As a result, the CJEU has held that this situation does not give rise to a restriction on the freedom of establishment.

Comment

We seem to have come a long way from the original M&S decision in which the CJEU held that the UK was, in principle, required to provide relief for the losses made by overseas subsidiaries in other Member States provided that they were final losses. In fact, that ground-breaking decision is not even referred to in the latest iteration of cases looking at relief for cross-border losses.

One might note that in the original M&S case the profits of the overseas subsidiaries were not taxable in the UK (at least directly) and it did not require a double tax treaty to exclude them from UK tax. Judged on this basis, it is perhaps not entirely convincing that the existence of a double tax treaty excluding the right to tax the profits of the foreign PE should make a significant difference. However, in practice the case law of the CJEU does appear to have moved on in this regard and be more sympathetic to Member States’ arguments that the symmetry of tax systems should be respected.