The Federal Ministry of Finance (Bundesfinanzministerium, BMF) announced in a circular dated 28 March 2011 (IV C 2 – S 2770/09/10001) that the so-called dual domestic link requirement will no longer be applied to subsidiaries in a fiscal unity that are incorporated in other states of the EU or the EEA.
The fiscal unity for corporate and trade tax purposes allows the group parent and the controlled companies to add up their respective taxable results, thereby providing for a netting of profits and losses of the group companies. Under Sec. 14 (1) s. 1 and Sec. 17 s. 1 of the German Corporate Income Tax Act (CTA), only companies that have both their statutory seat and their place of management in Germany can be controlled companies in a fiscal unity (so-called dual domestic link).
Under the dual domestic link requirement, companies that were incorporated in another EU/EEA state but have only their place of management in Germany could until now not be controlled companies in a fiscal unity. In the view of the European Commission, this is in breach of the freedom of establishment which is laid down in the Treaty on the Functioning of the European Union (TFEU) and the Agreement on the European Economic Area (EEA Agreement). In its reasoned opinion dated 30 September 2010 (case reference number 2008/4909, press release IP/10/1253) the Commission formally requested Germany to end such discrimination of companies from other EU/EEA states.
In order to avoid the initiation of an infringement procedure before the European Court of Justice (ECJ), the BMF dispenses the dual domestic link requirement for group companies in the case of companies with their corporate seat in another EU/EEA country. For the time being, this is done by way of a circular. Probably, the CTA will be amended accordingly in the near future.
The BMF-circular is in our view of limited practical relevance. Due to the close link of tax requirements with the corporate law aspects of the profit and loss transfer agreement (PLTA) required between group parent and a controlled company to establish a fiscal unity, the fiscal unity is already in a purely domestic context rather error-prone. In all probability, fulfilling the corporate and tax law requirements (e.g. the effective conclusion of a PLTA, the correct computation and transfer of the subsidiary’s total profits, limitations on the booking of revenue reserves, the minimal term of the PLTA and the limited scope for a termination of the PLTA with cause during the minimum term) by a controlled company that is governed by the corporate law of another country will be subject to such a degree of uncertainty that choosing a company incorporated under foreign law as a controlled company should be practically out of question.
As a matter of legal policy, the European Commission has not gone far enough by merely concentrating on the dual domestic link requirement in its infringement investigations. Preferably, the Commission should have taken the provisions on fiscal unity as a whole into consideration, which (irrespective of the dual domestic link requirement) represent an unjustifiable obstacle to the freedom of establishment due to their link with corporate law requirements that are factually only appropriate in a purely domestic context. For now, the German tax authorities escape the immediate need to get to work on the much needed reform of the current fiscal unity concept to a modern group taxation regime that is compatible with internationally integrated businesses.