European and international tax law Case Lidl C-414/06 – Cross border loss relief Sonja Leppänen

Background and facts Lidl Belgium a part of Lidl and Schwarz group, and a limited partnership with its registered office in Germany, which has a permanent establishment in Luxembourg Reference for preliminary ruling made in proceedings between Lidl Belgium GmbH & Co. KG and the Finanzamt Heilbronn The PE had been established in Luxembourg in 1999, and it was generating losses Lidl Belgium stated, that they should have the right to offset the generated losses in Luxembourg against its domestic profits in Germany The reference for preliminary ruling concerns the interpretation of Articles 43 EC and 56 EC Freedom of establishment and freedom of capital movement The case was final on May 15, 2008

Legal context The second subparagraph of the first paragraph of Article 2 of the Convention between Luxembourg and Germany defines ”permanent establishment” as ‘a fixed place of business at which the undertaking carries on all or part of its activities’. Article 5 of the Convention When the activities of the business are extended to another State, the income coming from those activities are taxable in the other State only in so far as it is sourced from the permanent establishment situated in the territory of that state Income attributed to permanent establishment similar to a situation, where the permanent establishment would be independent company Article 6 (1) of the Convention: Participation in the management or financial structure of an undertaking of the other State

Legal context Article 20 of the Convention states When the state of residence (=host state) is entitled to tax the income/capital, the other state is not allowed to tax such income/capital Any income/capital taxable (according to proceeding articles) in the other state has to be excluded from the tax base of the residence state (unless paragraph 3 applies) Taxes on income/capital are taxed in the residence state according to the rate applicable to the taxpayer’s total income/capital

European Court of Justice The goals of the EU: Single market and freedom of establishment (Art. 49 TFEU) Right of companies to set up branches or subsidiaries in other EU member states German law restricts the freedom of establishment of Lidl Belgium (?) Restriction justified, since it didn’t succeed the legitimate objectives of EC law Principles established in the Marks and Spencer -case When exemption method is applied, EU law doesn’t require deduction of losses in the residence state as long as such losses may be deducted in the host state in the future Balanced allocation of taxing rights between the member states Prevention of double dipping and ”loss shopping”

German-Luxembourg tax treaty Under Germany’s double tax treaty with Luxembourg exemption method applies Losses are not included in the tax base of the firm which has a PE in another member state or losses are temporarily included but are ”recaptured” as soon as profits arise for the PE Taxing rights allocated to Luxembourg: Luxembourg tax rules allow taxpayer’s losses to be deducted in future periods (=Lux legislation provides Loss-Carry forward method) justification in the restriction of freedom of establishment Home state doesn’t have the right to tax under the treaty -> tax regime protects the symmetrical treatment of profits and losses

European Court of Justice If Lidl Belgium would be allowed to decide whether to utilize losses applicable to its permanent establishment either in Germany or Luxembourg, the balanced allocation of taxing rights would be very much violated The restriction in the Germany-Luxembourg Tax treaty proportionate -> has to attain EC law’s legitimate objectives

The Advocate General Immediate offset of losses allowed, subject to recapture if the losses were used in the country of origin Is there a ”possibility to use” the losses in the country of origin? Similar principle should be used in cases of group relief The scope of application of Articles 43 EC and 56 EC Does the restriction of the freedom of establishment exist? The two justifications mentioned earlier justify the restriction on the freedom of establishment arising from the tax treatment by the Member State in which the seat of a company is located When it comes to the justification of the restriction of the freedom of establishment, not all three of them have to be fulfilled cumulatively

Sources https://taxpublications.deloitte.co.uk/tis/dtp.nsf/0/7D42D6F509C7B2658025744 B0055713E/$file/Lidl.pdf https://www.pwc.com/gx/en/eu-tax-news/pdf/pwc_eudtg_newsalert2008-014.pdf http://www.mondaq.com/x/60802/Income+Tax/C+41406+Lidl+Belgium+Judgmen t+15+May+08+Cross+Border+Relief+For+Utilized+Losses+Tax+Payer+Loses http://curia.europa.eu/juris/document/document.jsf?text=&docid=71756&pageInd ex=0&doclang=EN&mode=lst&dir=&occ=first&part=1&cid=751140