Cross-border loss relief jurisprudence and its impact in Portuguese domestic rules (II)

2.5 – LIDL BELGIUM[40]

In this case we had a German head office, Lidl Belgium GmbH & Co. KG, with a PE in Luxembourg.[41] In 1999, the PE suffered losses but the head office in Germany made profits. Lidl tried to deduct the losses suffered by the PE at the level of the head office but German tax authorities denied the deduction alleging the DTT between Germany and Luxembourg exempted the profits made by PEs in Luxembourg and, thus, losses incurred by that same PE were also not deductible in Germany. Lidl did not agree with this decision and brought the proceeding before a Court which led to the referral to the ECJ.

This case is a variation of Marks & Spencer judgment because instead of parent-subsidiary there was a head office-PE and instead of final losses we have a temporary losses situation. Thus, in this case the PE did not cease to exist in the following years and the head office was capable of carrying forward the losses suffered by the PE to the following years. Under analysis was the possibility of deducting the losses suffered by the PE immediately (in the same year they are accumulated) and with this avoid a cash flow disadvantage[42] originated by the number of years the losses must wait to be used at the PE’s level.

This is an origin case where the German domestic rules are denying Lidl Belgium the deduction of temporary cross-border losses. Applying the migrant/non-migrant test we need to find the purely domestic comparable to check if the rules constitute discrimination or a restriction to the exercise of the freedom of establishment. The right comparator is a German head office with a German PE. In contrast from the Deutsche Shell case in Lidl we can find a similar comparable because the same problem of PE’s losses can arise in a purely domestic situation.

If the same losses occurred in a purely domestic situation the PE would be immediately able to deduct them at the level of the head office. This opens the possibility of different treatment given to comparable situations. However, in this situation there was no discrimination because the purely domestic and the cross-border situations are not comparable in a comparable position.

The difference between the two amounts consists in the taxation of the profits. Due to the allocation of taxing rights between Germany and Luxembourg the profits arising in a PE in Luxembourg are exempt from German tax while the profits arising from a PE in Germany are subject to tax in Germany.

Considering the purpose of the rules and the facts, the two companies are not in a similar position when it comes to deduct the losses in Germany because the profits in earned by the PE in Luxembourg are not taxed in Germany. Nevertheless, the difference in treatment can be considered to be a restriction because the German domestic rules hinder and treat less favourably a company which chooses to establish its business cross-border. When migrating, a company can be discouraged to do so because of the rules concerning the deduction of losses incurred cross-border. This difference constitutes a disadvantage to migrating companies which have been consistently considered by the ECJ in violation of the freedom of establishment[43].

Hence, the possibility of speeding up the losses’ relief suffered by the PE constitutes an advantage to the non-migrant companies which is prohibited by the ECT unless justified by imperative reasons of public interest.

In Marks & Spencer the ECJ said:

“Group relief such as that at issue in the main proceedings constitutes a tax advantage for the companies concerned. By speeding up the relief of the losses of the loss-making companies by allowing them to be set off immediately against the profits of other group companies, such relief confers a cash advantage on the group. The exclusion of such an advantage in respect of the losses incurred by a subsidiary established in another Member State which does not conduct any trading activities in the parent company’s Member State is of such a kind as to hinder the exercise by that parent company of its freedom of establishment by deterring it from setting up subsidiaries in other Member States.”[44].

Within this reasoning the ECJ concluded German domestic rules had a restrictive effect on the freedom of establishment and needed to be justified in order to be in accordance with the ECT. The relevant justification in this judgment was once again the balance allocation of the taxing rights with its three justifications. The Court used its reasoning from Marks & Spencer and Oy AA to agree with the German government stating the domestic rule was necessary to prevent the undermining of the taxing rights negotiated between the two Member-States.

However, proportionality was still necessary and the Court went on to check if the tax regime went beyond what was necessary to attain the objectives pursued. This was the most important part of the judgment because the ECJ considered the German domestic rules to be proportional confirming the Marks & Spencer judgment and disagreeing with the Advocate General opinion[45].

The Court confirmed its Marks & Spencer ruling and decided the German rules were compatible with the ECT because they were justified and proportional according to the Kraus and Gebhard[46] jurisprudence. The first point to notice in this judgment is the difference between final and temporary losses which the Court made clear. The ECJ established in Marks & Spencer the guidelines on this area clearly stating that unless all possibilities have been exhausted in the host state, the offsetting of cross border losses will not be mandatory to Member-States. In this case the final situation did not happen as the PE in Luxembourg continued with its business and the losses accumulated were deducted from profits in the following years.

Therefore, the requirements established in Marks & Spencer were not fulfilled. When there is still possibility of offsetting the losses in the host country we have temporary losses and they only become final if the requirements established in Marks & Spencer occur. Also, the ECJ rejects the possibility of obliging Member-States to implement less restrictive rules which would allow the cross-border losses to be offset[47].

Within these was the German deduction and recapture regime which existed prior to 1999 and allowed the deduction of losses providing for the recapture of the loss relief in future profitable periods[48]. However, the Court clearly states that in the absence of harmonization in the area of direct taxation Member-States are free to introduce rules in order to safeguard the allocation of taxing rights negotiated between Member-States and are not required to come up with less restrictive measures unless any harmonization occurs at the level of the UE.

3. Conclusions

In the conclusion of this paper we will explain which guidelines drove the Court to its Marks & Spencer judgment and their impact in other areas of direct taxation.

Given the lack of harmonization on the area of direct taxation Member-States cannot guarantee that migration of companies, workers or capital is completely neutral from a tax perspective as the Court has shown us in Gilly[49], Lasteyrie du Saillant[50] and Lidl Belgium. Some disparities may occur arisen from the difference between the tax rules of two or more Member-States. However, when the problem is created by the rules of only one of the Member-States this may constitute a restriction prohibited by the ECT.  The Court must come up with a balance between the right of Member-States to introduce rules in their domestic laws to protect their tax revenue because they still have the competence in the area of direct taxation and the freedoms provisioned in the ECT.

This balance can be achieved only by taking into consideration all the factors and consequence in a case by case scenario. However, it should be noted a certain pattern in the jurisprudence of the ECJ which, in our opinion, comes from Schumacker and De Groot[51].

In the cross-border loss relief area the balance is found resorting to the Marks & Spencer[52], AMID and Deutsche Shell judgments. In a normal situation, where the allocation of taxing rights is established according to article 7 of the OECD Model, a PE should only be allowed to deduct its losses in a foreign head office if they are final losses (whether because the PE has ceased trading or the limit to carry losses forward was exhausted). [53]

Thus, when balancing the two rights discussed above the court concluded that proportionality of the domestic provision is guaranteed provided that no final loss situation occurs leaving the company with no possibility of offsetting the losses in either Member-State. This is the balance between both rights.

However, in our opinion a similar balance had already been achieved in the area of direct taxation back in 1993, with regard to individuals and free movement of workers.

As with business profits, income from employment is also allocated between Member-States when negotiating their DTTs. Article 15 of the OECD Model concerning employment states that income from employment exercised in a Contracting State other than the Residence State is normally taxed in the State where the employment is exercised (host State).

As in cross-border loss relief this allocation of taxing rights created problems concerning the deduction of personal and family circumstances of the worker. In this case workers, which had exercised their profession in more than one Member-State, were having difficulties when trying to take into consideration on their tax return their personal family circumstances with regard to the income earned in the host Member-State. 

With regards to this issue the ECJ considered that

“in relation to direct taxes, the situation of residents and non-residents in a State are generally not comparable, because the income received in the territory of a State by a non-resident is in most cases only a part of his total income which is concentrated at his place of residence, and because a non-resident’s personal ability to pay tax (…) is easier to assess at the place where his personal and financial interests are centred, which in general is the place where he has his usual abode[54].”

Thus, in a normal situation the host Member-State was not forced to take into consideration the personal and family circumstances of the non-resident worker unless, according to relevant case law, the worker earned 90% or more of his total income in the host Member-State, because in this case he was considered to be in a comparable situation to a resident worker with the right to an equal treatment.

The conclusion was that the residence Member-State should normally take into consideration all of the worker’s deductions concerning his personal and family circumstances even if related to income earned in other Member-State and not subject to tax in the residence Member-State. The reasons behind this decision were simple, because the residence State is the place in which the worker has his main interests and family it is the State in better position to assess the personal and family circumstances of the worker.

The exception to this rule occurred in a situation where the worker although earning less than 90% of his total income in the host State could not have his personal deductions taken into consideration in the residence State because the latter was not in a position to do it, for example in situations where the income earned in the residence State is exempted from tax.

In this case even if the residence State should have been the one to accept the worker’s personal deductions, the court decided the host State should bear that burden because otherwise the worker would be in a situation where he could not have his personal deductions taken into consideration in either Member-State. Even if against the normal allocation of income any other decision would have been unbalanced and disproportionate.

Therefore, the court had to come up with a balance between the sovereignty of the Member-States and ECT’s freedoms, between their competence in the area of direct taxation and the demands of the single market.

The ECJ clearly stated this in their De Groot judgment:

“the mechanisms used to eliminate double taxation or the national tax systems which have the effect of eliminating or alleviating double taxation must permit the taxpayers in the States concerned to be certain that, as the end result, all their personal and family circumstances will be duly taken into to account, irrespective of how those Member States have allocated that obligation amongst themselves, in order not to give rise to inequality of treatment which is incompatible with the Treaty provisions on the freedom of movement for workers and in no way results from the disparities between the national tax law.[55]”.

Therefore, the allocation of taxing rights with regard to income from employment and deductions between Member-States is compatible with the ECT provided that it allows the worker’s personal circumstances to be taken into account at least in one of the Member-States, residence or host. If a situation arises where the domestic rules of a Member-State have the effect of denying this benefit they will be considered incompatible with the ECT.

A parallel can easily be established between the workers and the corresponding freedom of workers and companies and the corresponding freedom of establishment.

Thus, although in a normal scenario the deduction of subsidiaries’ losses is a responsibility for residence Member-State because they have the taxing rights of the profits when residence Member-State cannot grant such deduction that role must be taken by the Member-State of the parent company. This is because the Member-State of the parent company is the only one in position to do it. Establishing this balance the ECJ avoids situations where a loss cannot be offset in either Member-State.

[1] Case C-141/99 Algemene Maatschappij voor Investering en Dienstverlening NV (AMID) v Belgische Staat. http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:61999J0141:EN:HTML

[2] In paragraph 29 of the AMID judgment the Court states: “A Belgian company which, having no establishments outside Belgium, incurs a loss during a given tax year finds itself, for tax purposes, in a comparable situation with that of a Belgian company which, having an establishment in Luxembourg, incurs a loss in Belgium and makes a profit in Luxembourg during that same tax year”.

[3] Subject to the Double tax treaties’ provisions.

[4] For an better explanation concerning the migrant/non-migrant test see Tom O’Shea articles, Marks and Spencer v Halsey (HM Inspector of Taxes): Restriction, Justification and Proportionality [2006] 15(2) EC Tax Review 66-82, ISSN: 0928-2750 and Current & Quotable: From Avoir Fiscal to Marks & Spencer (Editor) [2006] 41 Tax Notes International 587-612, ISSN: 1058-3971.

[5] Case C374/04 Test Claimants in Class IV of the ACT Group Litigation [2006] ECR I11673. http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:62004J0374:EN:HTML

[6] Case C-319/02 Petri Manninen [2004] ECR 1-7477.

[7] Paragraph 22.

[8] In the Marks & Spencer plc v David Halsey judgment the ECJ states: “in tax matters profits and losses are two sides of the same coin and must be treated symmetrically in the same tax system in order to protect a balanced allocation of the power to impose taxes between the different Member States concerned.” (paragraph 43).

[9] In paragraph 31 The AG clearly states this in his opinion on the AMID case: “causes of the disadvantage experienced here are not differing rates of taxation in the individual Member States, or diverging assessments of the personal situation of the party required to pay tax, such as was the case in Gilly. The disadvantage experienced by the plaintiff is due much more to the fact that, in the present case, Belgium offsets the losses with the tax-exempted profits made by the Luxembourg establishment instead of deducting them from profits made in Belgium”.

[10] Case C-446/03  Marks & Spencer plc v. Commissioners of Customs & Excise [ECR I-10837]. http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:62003J0446:EN:HTML

[11] See the following articles: Simon Whitehead, “Cross border group relief post Marks & Spencer”, Euro. T.S. 2008, Jun, 4-7; Heike Jochum, “Marks & Spencer: the case continues! - how  to interpret the ruling of the ECJ”, C.T.R. 2007, 5(3), 17-23; Julien Saiac, “Deduction of losses incurred in another Member State by a non-resident subsidiary following Marks & Spencer”, Euro. Tax. 2007, 47(12), 550-561; Timothy Lyons, “Marks & Spencer: something for everyone?” , B.T.R. 2006, 1, 9-14 and Tom O’Shea article, Marks and Spencer v Halsey (HM Inspector of Taxes): Restriction, Justification and Proportionality [2006] 15(2) EC Tax Review 66-82, ISSN: 0928-2750.

[12] As we can see in the figure shown in this page the comparison is between the real situation and the hypothetical situation involving a UK subsidiary.

[13] This was confirmed by the Court in its judgment when it states: “Group relief such as that at issue in the main proceedings constitutes a tax advantage for the companies concerned. By speeding up the relief of the losses of the loss-making companies by allowing them to be set off immediately against the profits of other group companies, such relief confers a cash advantage on the group” (paragraph 32).

[14] Marks & Spencer was the first judgment where this argument was invoked to justify the restriction created by a domestic rule. The argument consisted of three different justifications.

[15] See Marks & Spencer, paragraph 43.

[16] See Case C290/04 FKP Scorpio Konzertproduktionen [2006] ECR I9461, paragraph 54; Case C374/04 Test Claimants in Class IV of the ACT Group Litigation [2006] ECR I11673, paragraph 52; and Case C231/05 Oy AA [2007] ECR I0000, paragraph 52.

[17] See Marks & Spencer, paragraph 47.

[18] See Marks & Spencer, paragraph 49.

[19] Council Directive 77/799/EEC of 19 December 1977 concerning mutual assistance by the competent authorities of the Member States in the field of direct taxation ( OJ L 336, 27.12.1977, p. 15–20) with subsequent amendments.

[20] With effect, article 2 (1) states the following: “The competent authority of a Member State may request the competent authority of another Member State to forward the information referred to in Article 1 (1) [on the correct assessment of taxes] in a particular case”.

[21] Marks & Spencer, paragraph 53.

[22] Case C-19/92 Kraus v Land Baden-Wuerttemberg [1993] ECR I-1663, paragraph 32 and Case C-55/94 Gebhard [1995] ECR I-4165.

[23] Paragraph 55.

[24] In the case of the French company which was sold a payment was received for the losses in terms of their value to the purchaser. Hence, in relation to the French losses Marks & Spencer have dropped their claim.

[25] As was said above these types of losses have become known as final losses.

[26] Case C231/05 Oy AA [2007] S.T.I. 1863. http://eur-lex.europa.eu/RECH_jurisprudence.do

[27] See the following articles: Graham Airs, “Oy AA - limitations on transfers of profits to domestic situations not precluded by the EC Treaty” , B.T.R. 2007, 5, 597-604; Daniel Gutmann, “Taxation of groups of companies: lessons to be drawn from Oy AA”, Euro. T.S. 2008, Feb, 20-22.” , B.T.R. 2006, 1, 9-14; Ben J. Kiekebeld and Daniël S. Smit, Cross-Border Loss Relief in the European Union: Uncertainty Remains After Oy AA, Tax Notes Int'l, Dec. 17, 2007, p. 1149; 48 Tax Notes Int'l 1149 (Dec. 17, 2007); Tom O’Shea article “EU Cross-border Loss Relief: Which View Will Prevail?” Worldwide Tax Daily, April 4, 2008, 2008 WTD 66-3 “Finland’s Intra-group Financial Transfer Rules Compatible with EU Law”, Tax Notes International, August 13, 2007, 634-638.and Tiago Rodrigues article “Will Lidl get its supermarket refund? ITR 2008, Vol 13, Issue 3, p. 75-91.

[28] For a better explanation of the national treatment principle see paragraphs 57 and 58 of Compagnie de Saint-Gobain, Zweigniederlassung Germany v Finanzamt Aachen-Innenstadt (C-307/97), [2000] S.T.C. 854.

[29] In Case C-279/93 Schumacker ECR 1995, I-225 the Court adopted the principle of discrimination explained by the Advocate General in his opinion on this case where he defended the principle of discrimination implied treating equal things in an equal way and different things differently.

[30] Paragraph 49.

[31] Paragraph 38.

[32] Lasertec Gesellschaft fur Stanzformen mbH v Finanzamt Emmendingen (C-492/04) European Court of Justice, 10 May 2007, [2007] 3 C.M.L.R. 5.

[33] Test Claimants in the Thin Cap Group Litigation v Inland Revenue Commissioners (C-524/04) European Court of Justice (Grand Chamber), 13 March 2007, [2007] S.T.C. 906. http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:62004J0524:EN:HTML

[34] Paragraph 56.

[35] For a better explanation of this concept see ICI Plc v Colmer (Inspector of Taxes) (C-264/96), [1998] S.T.C. 874, paragraph 26 and Cadbury Schweppes plc and Cadbury Schweppes Overseas Ltd v Commissioners of Inland Revenue, [2006] S.T.C. 1908.

[36] Case C-293/06 Deutsche Shell GmbH v. Finanzamt für. Großunternehmen in Hamburg, [2008] ECR I- [2008] SWTI 366. http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:62006J0293:EN:HTML

[37] See the following articles: Tom O’Shea article “German Currency Loss Rules Incompatible With EU Law, ECJ Says”, Worldwide Tax Daily, 2008 WTD 44-2; Gerard T.K. Meussen, “Cross-border loss compensation and permanent establishments: Lidl Belgium and Deutsche Shell”, Euro. Tax. 2008, 48(5), 233-236; Anno Rainer, “ECJ holds German rules on exchange rate losses on repatriation of PE's start-up capital violates EC Treaty”, Intertax 2008, 36(6/7), 326-327.

[38] This is also the conclusion of the Court which states: “(…) the tax system concerned in the main proceedings increases the economic risks incurred by a company established in one Member State wishing to set up a body in another Member State where the currency used is different from that of the State of origin. In such a situation, not only does the principal establishment face the normal risks associated with setting up such a body, but it must also face an additional risk of a fiscal nature where it provides start-up capital for it”. (paragraph 30).

[39] Paragraph 44.

[40] Judgment of the Court (Fourth Chamber) of 15 May 2008, case C‑356/04 Lidl Belgium [2006]. http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:62006J0414:EN:HTML

[41] See the following articles: Gerard T.K. Meussen , “Lidl Belgium: no obligation to apply cross-border loss release unless...”, Euro. T.S. 2008, Jun, 19-21; Tom O’Shea article “ECJ Rejects Advocate General's Advice in Case on German Loss Relief”, 2008 WTD 123-2 (June 25, 2008) and Tiago Pedro Rodrigues, “Will Lidl get its supermarket refund?” (C-414/06), O. & I.T. Rev. 2008, 13(3), 75-91.

[42] For more judgments involving cash-flow disadvantages see joined cases C-397/98 and C-410/98 Metallgesellschaft [2001] ECR I-1727, paragraphs 44, 54 and 76; Case C-436/00 X and Y [2002] ECR I-10829, paragraphs 36 to 38; Case C-268/03 De Baeck [2004] ECR I-5961, paragraph 24; Case C-446/04 Test Claimants in the FII Group Litigation [2006] ECR I-11753, paragraphs 96, 97, 153 and 154; and Case C-347/04 Rewe Zentralfinanz [2007] ECR I-2647, paragraph 29.

[43] See Cases C-397/98 and C-410/98 Metallgesellschaft [2001] ECR I-1727, paragraphs 44, 54 and 76; Case C-436/00 X and Y [2002] ECR I-10829, paragraphs 36 to 38; Case C-268/03 De Baeck [2004] ECR I-5961, paragraph 24; Case C-446/04 Test Claimants in the FII Group Litigation [2006] ECR I-11753, paragraphs 96, 97, 153 and 154; and Case C-347/04 Rewe Zentralfinanz [2007] ECR I-2647, paragraph 29.

[44] Paragraph 32.

[45] For an analysis of the AG Sharpston opinion see Wolfgang Kessler and Rolf Eicke, Lidl Belgium: Revisiting Marks & Spencer on the Branch Level, Tax Notes Int'l, Mar. 31, 2008, p. 1131; 49 Tax Notes Int'l 1131 (Mar. 31, 2008); Jérôme Monsenego, Relieving Double Taxation: A Look at Lidl Belgium, Tax Notes Int'l, May 5, 2008, p. 409; 50 Tax Notes Int'l 409 (May 5, 2008); Tom O’Shea article “EU Cross-border Loss Relief: Which View Will Prevail? Worldwide Tax Daily, April 4, 2008, 2008 WTD 66-3 and Tiago Rodrigues article “Will Lidl get its supermarket refund? ITR 2008, Vol 13, Issue 3, p. 75-91.

[46] Case C-19/92 Kraus v Land Baden-Wuerttemberg [1993] ECR I-1663, paragraph 32 and Case C-55/94 Gebhard [1995] ECR I-4165.

[47] Paragraph 58.

[48] See paragraph 23 of the Opinion of Advocate General Sharpston delivered on 14 February 2008 on Lidl Belgium GmbH & Co. KG v Finanzamt Heilbronn (C-414/06).

[49] Case C-336/96 Gilly, ECR 1998, I-2823.

[50] Case C-9/02 Hughes de Lasteyrie du Saillant [2004] ECR I-2409.

[51] Case C-385/00 (De Groot) FWL de Groot v. Staatssecretaris van Financien, [2002] ECR 1-11819.

[52] The AG Poiares Maduro found a balance in health services in the context of national social security systems. See Case C-56/01 Inizan [2003] ECR I-12403 and Case C-157/99 Smits and Peerbooms [2001] ECR I-5473.

[53] In its recent Lidl Belgium judgment concerning a cross-border loss relief situation the ECJ said the following: “a measure which restricts the freedom of establishment goes beyond what is necessary to attain the objectives pursued where a non-resident subsidiary has exhausted the possibilities for having the losses incurred in the Member State where it is situated taken into account for the accounting period concerned and also for previous accounting periods and where there is no possibility for that subsidiary’s losses to be taken into account in that State for future periods”. (paragraph 47).

[54] Gschwind v Finanzamt Aachen-Aussenstadt (C-391/97) European Court of Justice, 14 September 1999, [2001] S.T.C. 331, Paragraph 22.

[55] Paragraph 101.