The German rules on the set-off of losses within a group of companies have been subject to debate for some time in light of the EU freedoms. The EU Commission initiated already in 2009 treaty violation proceedings against Germany concerning the so-called dual domestic link requirement that the controlled company within a fiscal unity must have both its seat and its place of effective management in Germany in order to qualify as eligible for purposes of the rules of the German fiscal unity. The tax authorities now reacted by way of issuing a circular dated 28 March 2011 according to which the rules on the fiscal unity shall be – notwithstanding the wording of the law to the contrary – applicable, provided the respective company is a EU/EEA company (for a detailed analysis of the circular cf. above III.1).
While such extension of the scope of the fiscal unity rules is a first and expected step in order to correct potentially discriminatory German tax rules, tax authorities have not commented on the much more critical question as to whether EU law requires an extension of the scope of the fiscal unity rules to foreign subsidiaries that do neither have their seat nor their place of effective management in Germany and are thus no subject to (unlimited) tax liability in Germany.
In this respect it is unclear to what extent the principles developed by the European Court of Justice (ECJ) in its rulings Marks & Spencer (C-446/03), Oy AA (C-231/05) and X-Holding (C-337/08) apply to the German fiscal unity as well. In its rulings the ECJ held that the denial of a set-off of losses generated by a foreign subsidiary is justified unless the losses are of a final nature. The ECJ thus takes the view that in respect of the setoff of losses of foreign subsidiaries the same principles apply as for the set-off of losses generated by a foreign permanent establishment (see ECJ ruling dated 15 May 2008, Lidl Belgium(C-414/06)). In the meantime in various rulings also the Federal Fiscal Court (Bundesfinanzhof, BFH) commented on the set-off of losses generated by a foreign permanent establishment (e.g. BFH ruling dated 9 June 2010 (I R 100/09)). On the basis of the principles developed by the ECJ the BFH held that losses are only to be taken into account at the time they become final. The BFH takes the view that for this purpose losses do not qualify as final if they forfeit due to loss utilization limitation rules in the source state only (e.g. the forfeit of losses after a certain period of time), i.e. losses are accepted of being of a final nature only if they do not forfeit due to legal restrictions but to actual conditions (what would e.g. be the case if a permanent establishment is shut down).
While the afore-mentioned ruling addresses losses generated by a permanent establishment only, the BFH held – in accordance with the ECJ – in its ruling dated 9 November 2010 (I R 16/10) that the same principles apply to losses generated by foreign subsidiaries. However, since in the case underlying the ruling the losses were not of a final nature, the BFH left the question unanswered whether or not losses of foreign subsidiaries which are of a final nature are allowed for set-off under the rules of the German fiscal unity.
In particular, it is unclear whether the requirement of the existence of a profit and loss pooling agreement is to be modified in order to comply with EU law requirements. While the Fiscal Court of First Instance of Lower Saxony (ruling dated 11 February 2010 (6 K 406/08)) dealt in detail with the question and required at least the existence of a legally binding obligation of the parent company to compensate the subsidiary for the losses incurred, the BFH did not finally decide on this issue. However, it seems that the BFH indicates in its ruling that — if a modification of the requirement of the existence of a profit and loss pooling agreement were allowed — the “virtual” fiscal unity between the German parent and the foreign subsidiary would require that such fiscal unity were agreed in a legally binding manner and were actually carried out. Therefore, it could be advisable to enter into and effectively carry out a loss compensation agreement within a group of companies. However, it should be taken into account that the BFH apparently takes the view that a set-off of current losses must not be provided for in order to comply with EU law requirements. Therefore, the question remains whether the possibility to set-off final losses (i.e. not losses that forfeit due to legal restrictions), if any, at that time only justifies the additional liability created as a result of entering into a loss compensation agreement.