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Germany: Tax Treatment of European Losses

(Sept. 9, 2010) On June 9, 2010, the German Federal Fiscal Court (Bundesfinanzhof) issued two decisions that describe the circumstances under which losses incurred by a permanent establishment in a foreign country can be claimed as a deduction by a German resident owner (Docket Nos. I R 100/09,
& I R 107/09,
; Press Release, No. 69, Federal Finance Court, Ausländische Betriebsstättenverluste dürfen nur ausnahmsweise berücksichtigt werden (Aug. 11, 2010), For German owners, these decisions are likely to increase the deductibility of losses incurred in other Member States of the European Union (Steuerentlastung für international tätige Konzerne, FRANKFURTER ALLGEMEINE ZEITUNG 9 (Aug. 19, 2010)).

In both cases, a permanent establishment located in France suffered losses, and the question arose as to whether these should be attributable to the tax base of the German resident owner. The applicable version of the Double Taxation Treaty between Germany and France (signed July 21, 1959, BUNDESGESETZBLATT 1961 II at 397, last amended by Supplementary Agreement of Dec. 20, 2001, BUNDESGESETZBLATT 2002 II 2370) provides that the income of permanent establishments is taxed only in the source country, and until the European Court of Justice's landmark decision of Lidl Belgium v. GmbH&Co.KG v. Finanzamt Heilbronn (Case C-414/06, (last visited Sept. 7, 2010) [search by case number]), such treaty provisions were interpreted in Germany and many European countries as limiting the deductibility of losses to the source country that taxes the income (see list of amicus briefs in Lidl Belgium).

In Lidl Belgium, however, the European Court of Justice held that, if the tax system of the country where the permanent establishment is located provided no further possibilities for a loss to be deducted (and the loss is therefore final), then a denial of the deductibility by the owner's country of residence violates the freedom of establishment of article 43 of the Treaty Establishing the European Community (Mar. 25, 1957, Consolidated Version, 2002 OFFICIAL JOURNAL OF THE EUROPEAN UNION (O.J.) (C325) 33, available at; now art. 49, Treaty on the Functioning of the European Union, Sept. 5, 2008, O.J. (C 115) 47). The European Court explained that a denial of the tax benefit of the loss disadvantages the permanent establishment in a manner that might discourage further investments in the country where the permanent establishment is located.

The two German decisions of June 9, 2010, clarify what a final loss would be from the German point of view. In one of these cases (Docket No. I R 107/09), the loss was considered final and therefore deductible in Germany. In this case, the German company's permanent establishment in France had suffered losses from 1998 through 2001. In September 2001, the German owner disposed of the permanent establishment. Although French law grants a loss carry forward for five years and also a loss carry back, the permanent establishment was not able to utilize these for the losses incurred in 2000 and 2001, because the permanent establishment ceased to exist. Under these circumstances, the German Federal Fiscal Court held that the loss had in fact become final.

In the other case (Docket No. I R 1000/09), the loss was not considered final. The French permanent establishment of the German resident was shut down in 2005, after it had incurred net operating losses in 1999, which, according to French law, the permanent establishment could have used through loss carry forwards through 2004, but which, for various reasons of expediency, it did not claim. Under these circumstances, the German Federal Fiscal Court held that the loss had not become final in 2005, the year the taxpayer claimed the loss in Germany, because the permanent establishment could have claimed the loss until 2004 in France.