EC Takes Germany To Task Over Tax Rules

by Ulrika Lomas, for LawAndTax-News.com, Brussels

23 March 2009

The European Commission has announced its decision to refer Germany to the European Court of Justice for its tax provisions concerning outbound dividend payments to companies, and for its discriminatory tax depreciation rules applied to buildings situated abroad.

Regarding the first case, the Commission notes that Germany taxes dividends paid to foreign companies more heavily than dividends paid to domestic companies. The Commission considers the higher taxation of outbound dividends to be contrary to EU law as it restricts the free movement of capital and the freedom of establishment, as provided for in Article 56 of the European Treaty and Article 40 of the European Economic Area (EEA) Agreement.

Outbound dividends are those paid by a German company to a foreign shareholder, while domestic dividends are those paid by a German company to a German shareholder. The German tax rules may lead to outbound dividends being taxed at a higher rate than domestic dividends. While there is a tax exemption for domestic dividends, outbound dividends are subject to withholding taxes of up to 25% (plus solidarity surcharge).

The discrimination concerns outbound dividends paid to EU member states and to those EEA and European Free Trade Association countries (which includes the 27 EU member states plus Iceland, Liechtenstein, Norway and Switzerland) which provide exchange of information.

In the Denkavit ruling of December 14, 2006 the Court of Justice confirmed the principle that outbound dividends may not be subject to higher taxation in the source state than domestic dividends.

"Given that the German tax rules were not amended to comply with the reasoned opinion sent to Germany in June 2007 the Commission has decided to refer the case to the Court of Justice," the Commission announced on March 19.

In addition, Germany has been referred by the Commission to the ECJ for tax depreciation rules which it says discriminate against buildings situated abroad.

Under German law higher percentages of depreciation may be applied in the first year(s) of construction or acquisition of buildings situated in Germany than for buildings situated abroad. The Commission considers this difference in treatment to be incompatible with the principle of free movement of capital.

"According to German law, buildings are generally depreciated for wear and tear using the linear depreciation method. Section 7(5) of Income Tax Act [EStG] provides, by way of derogation, for reducing-balance depreciation in case of construction of rental housing in Germany, ie higher percentages are applied in the first year(s) and lower percentages in subsequent years. However, this advantage (tax deferral) is not granted for buildings situated outside Germany," the Commission stated.

"As the financial burden is likely to be particularly heavy in the first years after the purchase of a building, the investment in buildings situated abroad becomes less attractive due to these less favourable depreciation rules and investors may be deterred from purchasing a building in another EU member state," the statement added.

Although the section of German law in question was repealed for all buildings acquired and constructed after January 1, 2006 the Commission has decided to continue the infringement procedure because the depreciation provision continues to have effect for a period of up to 18 years. Consequently, buildings situated abroad that were constructed before January 1, 2006 and meet the requirements of the repealed law would still be denied the advantage of the increased depreciation for the remaining part of this period.

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