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Deductibility of Foreign Losses Considered ‘Final’ Based on Factual Circumstances

Germany

The German Federal Fiscal Court ("Court") ruled on the deductibility of foreign losses in two recently published decisions, both dated 9 June 2010. Both decisions dealt with similar factual circumstances, namely, a German resident entrepreneur with foreign permanent establishments ("PE") that had incurred losses that could not be off set against taxable gains in the country where the PE was situated. Taxand Germany discusses why the losses incurred by German permanent establishments in foreign countries are deductible in Germany and considered 'final' based on factual circumstances.

In keeping with the general principle of symmetry and the exemption method applicable to income from a PE under the majority of double taxation treaties ("DTT"), the Court held that income and losses derived from a certain PE can only be taken into account in the country where the PE is situated and under that country's tax law.

As an exemption, according to the Court's interpretation of the ECJ decisions in the cases C-414/06 (Lidl Belgium) and C-157/07 (Krankenheim Ruhesitz am Wannsee-Seniorenheimstatt), the Court held that losses from a foreign PE can be deducted from the German taxable base if these losses are "final" due to factual circumstances such that they cannot be taken into account any more in the state where the PE is situated. The losses will then be deductable from the German tax base in the fiscal year they have become "final". According to the Court, such "finality" is inherent to situations where, for example:

i) the PE is transformed into a corporate entity
ii) the PE is transferred to a third party
iii) the PE is shut down definitively

Please note that due to the requirement of the finality being due to factual circumstances, any losses becoming non-usable for legal reasons do not allow for an exemption from the general principle outlined above. Should a PE, therefore, not be able to use losses due to a limitation of loss carry forwards according to the foreign tax law, these losses would not be "final" within the meaning of the above Court decisions and cannot be deducted from the German tax base. According to the Court, there cannot be any "finality" in the above sense if both legal and factual reasons render past losses un-useable at the same time, e.g. if a loss-incurring PE is shut down at a time when any past losses have expired.


Taxand's Take


These Court decisions deny the tax administration's interpretation of the ECJ decisions mentioned above according to which foreign losses can only be used under very limited circumstances. The decisions should enable German entrepreneurs with foreign PE to deduct "final" foreign losses from the German tax base. Due to the requirement that the losses must be "final" due to factual circumstance, not due to legal circumstance, careful tax planning measures can be necessary when handling loss-incurring foreign PE, i.e. in order to shut down the PE prior to any time-barring of loss carry forwards due to foreign tax law.

Your Taxand contact for further queries is:
Peter M. Sch?ffler
T. +49 (89) 23714 17379
E. peter.schaffler@luther-lawfirm.com

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