The CJEU's decision on tax deferral on asset transfers could have implications for similar regimes in other EU Member States.
Section 6 b Income Tax Act exempts the capital gain from the sale of a fixed asset, provided the gain is re-invested in a replacement asset, so-called roll-over relief. This replacement asset has to be located in a German operation. Such tax deferral is beneficial and preserves liquidity in situations in which the taxable capital gain cannot be set off against loss carry-forwards and/or current losses of the taxpayer. The roll-over relief is only applicable if in particular (i) the taxpayer owned the sold fixed asset for at least six years; (ii) the sold fixed asset was attributable to a German fixed place of business for that period; (iii) the replacement asset purchased by the taxpayer is also attributable to a German fixed place of business; and (iv) the replacement purchase is made within four years after the sale. The question was raised – and adjudicated by the European court of justice ("ECJ") – whether the disqualification of a re-investment in an asset attributable to an operation located outside of Germany, but in the EU, would violate the freedom of establishment.
The operation of this deferral provision has the effect that the tax on a capital gain is no longer “frontloaded”, but taken into account indirectly through a lower tax base in the replacement asset. The business is thus saved from having to pay tax upfront on a realised capital gain at the expense of its liquidity. It follows that the tax benefit available under this deferral provision can have a substantial impact on the return on investment expected from the re-investment, whether it takes place domestically or abroad. The ECJ reiterated that the freedom of establishment also applies to the transfer of activities from one member state to another. Absent the availability of the deferral, the investment in a replacement asset outside of Germany triggers tax payable immediately. This presents a substantial liquidity detriment when compared to a re-investment within Germany and this detriment violates the freedom of establishment.
In line with prior case law (National Grid Indus), the ECJ held that a re-investment in another EU country does not imply that Germany would have to relinquish its taxes on the original capital gain. Instead of requiring the immediate payment of taxes on the original capital gain, the taxpayer could be offered the alternative of staying the payment of taxes until the sale of the replacement asset while tax authorities would keep track of the stay in Germany. The ECJ also did not accept that the coherence of national tax systems would justify the disallowance of a qualifying cross-border re-investment. The purpose of the deferral could still be seen as supporting the enterprise and its activities in Germany even if the re-investment took place in an operation of the same enterprise in the EU.
Germany now has the choice between accepting EU re-investments as qualifying for deferral or abolishing the deferral provision altogether. Although the present climate of maintaining high tax revenues wherever possible might lead to a complete abolition of the deferral provision, the impact on investment activities by German enterprises could be seen as so detrimental to future growth that the acceptance of EU re-investments may have a good chance of making into German law.
In any case, we recommend seeking updated tax advice if and when such transaction should be anticipated in the future since the German legislator may change the rules and/or even cancel the possibility of roll-over relief even for local re-investments.