Update - Moving to Switzerland: Tax obstacles removed?!

BMF only insufficiently implements ECJ ruling of 26.02.2019 - Further uncertainty when moving to Switzerland

In its ruling of 26 February 2019 (C-581/17, Wächtler case), the ECJ decided that the German rules on exit taxation (Section 6 AStG), according to which hidden reserves in capital company participations are immediately taxable in the event of a transfer of residence abroad, constitute an unjustified restriction of the freedom of establishment in relation to Switzerland. With the letter published on 13.11.2019, the Federal Ministry of Finance now comments on the administrative application of the decision. The following update of the article of 28.02.2019 shows that the regulations provided by the tax administration only inadequately implement the ECJ ruling. For domestic taxpayers with capital company shares who want to transfer their residence to Switzerland, a considerable uncertainty (still) remains.

In a letter dated 13 November 2019, the Federal Ministry of Finance (BMF) commented on the administrative application of the ECJ ruling of 26 February 2019 regarding the German regulations on exit taxation in relation to Switzerland. According to this, Section 6 of the German Income Tax Act (AStG) is to be applied as follows in the event of a departure to Switzerland - until a new legal regulation is adopted:

In deviation from the statutory regulation, at the request of the taxpayer, a deferral is

• in five equal annual installments, on which interest is to be paid in accordance with Section 234 of the German Fiscal Code (AO); i.e. the exit tax due is to be repaid in five equal annual installments,

• where significant hardship is not a factor in the event of immediate confiscation, and

• a security deposit is not required; unless the tax claim appears to be at risk.

BMF only insufficiently implements ECJ ruling - deferral in partial amounts inadmissible

The simplifications with regard to the immediate taxation of the tax triggered by the departure are to be welcomed in principle. However, this does not fully implement the ECJ ruling. In its ruling of February 26, 2019, the ECJ stated that the possibility of paying the tax due in installments was not suitable to offset the liquidity disadvantage represented by the taxpayer's obligation to pay part of the tax due for the deferred appreciation of the relevant company shares at the time of the transfer of its residence to Switzerland. Furthermore, the deferral with payment in installments - now provided for by the BMF - would remain more costly for the taxpayer than the deferral of the tax owed until the sale of his company shares.

Accordingly, the ECJ is of the opinion that payment of the tax due in installments places the taxpayer in a worse position than a deferral of payment until the sale of the shares - which is provided for in the case of a move to a foreign EU/EEA country. Accordingly, the German provision of Sec. 6 AStG violates the Agreement on the Free Movement of Persons (FTA) precisely because of the lack of possibility of deferral until the sale in the case of a move to Switzerland.

However, the BMF is now refusing to grant the full deferral required by the ECJ until the shares are sold. This means that the German tax authorities are not sufficiently implementing the ECJ ruling.

The previous decision of the ECJ in the "DMC" case (judgment of 23.01.2014 - C-164/12), in which the ECJ considered an extension of payment over five years in the then Reorganization Tax Act to be in conformity with European law, should not be relevant in the present case. This is also contradicted by the clear positioning of the ECJ in its current ruling.

Scope of application of ECJ ruling possibly restricted by BMF

Furthermore, the currently existing legal regulation - according to the BMF letter - shall only be broken in cases as mentioned above, in which the principle of equal treatment of Article 9 (2) of Annex I of the FMPA is to be observed. However, Article 9 of Annex I deals only with employees. The corresponding regulations for self-employed persons - which, according to the case law of the ECJ, may also include shareholder-managers under certain circumstances - are found in Art. 15 of Annex I. From the isolated reference to Art. 9 (2), it could be concluded that the relief granted by the BMF is intended to apply only to employees, but not to self-employed persons. This would be a considerable disadvantage for self-employed persons who move their place of residence and activity to Switzerland.

Conclusion

The relief provided for in the BMF letter of November 13, 2019 does not take sufficient account of the ECJ ruling of February 26, 2019. The BMF letter does not provide for the full deferral of the tax until the actual sale of the shares as required by the ECJ; instead, only a deferral in five equal annual installments is granted. It also remains open whether the tax authorities intend to apply the ruling to self-employed persons who relocate to Switzerland.

Moving to Switzerland: Tax obstacles removed?!

Comment on ECJ, judgment of 26.02.2019, ref. C-581/17

The ECJ has ruled - following a referral order by the Baden-Württemberg Fiscal Court - that the German rules on exit taxation, according to which hidden reserves in equity interests are immediately taxable in the event of a transfer of residence abroad, constitute an unjustified restriction of the freedom of establishment in relation to Switzerland.

Withdrawal taxation

The German regulations on exit taxation (Sec. 6 AStG) serve to ensure the domestic right of taxation - by way of final taxation - in the event that a tax resident who holds at least 1% of the shares in a (domestic or foreign) corporation transfers his residence abroad. If a person with unlimited tax liability in Germany moves to another country, the double taxation agreements concluded by Germany generally assign the right to tax gains from the sale of shares in the company to the country in which the selling shareholder is resident. Germany thus loses its right of taxation for such shares when the shareholder leaves the country; this also applies to hidden reserves that arose during the period of residence in Germany. This loss is counteracted by the exit taxation. The hidden reserves that have arisen up to the time of the departure are immediately taxable - even without the actual disposal of the shares (fictitious disposal upon departure). The relocated person is thus subject to income tax plus solidarity surcharge (and church tax, if applicable) without receiving any corresponding financial resources.

If, however, a taxpayer who is a national of an EU or EEA state transfers his residence to one of these states, the tax - owed due to the departure - is not due immediately, but is deferred without interest or security until the shares are actually sold, i.e. until the taxpayer receives financial means to pay the tax. This deferral is required by the freedom of establishment guaranteed under European law.

In the context of the present judgment, the ECJ had to decide whether the regulations that apply to a departure to an EU or EEA state are also applicable by analogy to a departure to Switzerland (as a third state).

Judgment Facts

The plaintiff is a German national and since the beginning of 2008 has been the managing partner of a company under Swiss law in which he holds a 50% interest. In this context, he carries out activities in the field of IT consulting. At the beginning of March 2011, the plaintiff moved his place of residence from Germany to Switzerland. In accordance with the regulations on exit taxation, the Constance tax office subject the increase in the value of his share in the company (up to the time of the move) to German income tax. A deferral was not granted, as Switzerland is neither an EU nor an EEA state.

The plaintiff defended himself against this before the Baden-Württemberg Fiscal Court with reference to the Agreement on the Free Movement of Persons (FTA) concluded between the EU and Switzerland, which grants him freedom of establishment in accordance with EU law.

Decision of the ECJ

In its decision, the ECJ states that a German national who exercises his right of establishment as an employee or self-employed person in accordance with the FMPA suffers a tax disadvantage in relation to his capital company share in comparison to other German nationals who exercise the same activity but continue to maintain their residence in Germany. The latter would only have to pay the tax on deferred increases in the value of the relevant shares in the company when these increases in value are realized by sale. In contrast, the person who transfers his residence has to pay the tax in question for the deferred capital gains already at the time of the transfer of his residence to Switzerland, without being able to obtain a deferral of payment until the sale of the shares. The German rules on exit taxation would thus be likely to discourage taxpayers from actually making use of the right of establishment to which they are entitled.

Nor can the exit taxation be justified on the grounds of the general interest, the ECJ continued. It had to be acknowledged that the rules on the preservation of the division of taxation competence between Germany and Switzerland served the effectiveness of tax controls and the avoidance of tax revenue shortfalls. The determination of the amount of the exit tax also serves to preserve the division of taxation competence. However, all of this could not justify the denial of a deferral of the tax. This is because a deferral does not mean that Germany waives its right to tax the capital gains in favor of Switzerland. Accordingly, the lack of possibility to defer the departure-related income tax constitutes a measure that goes beyond what is necessary to achieve the above-mentioned objectives. In addition, under German law it would be possible to make the deferral dependent on the provision of security (e.g. pledging of the shares in favor of the tax authorities).

Impact

In view of the fact that Switzerland is the No. 1 emigration country for Germans, the ECJ's decision is to be welcomed. The ruling significantly reduces the tax hurdles for individuals moving to Switzerland - at least with regard to company shares held - as the exit tax is not due immediately but is deferred until the shares are actually sold; there is thus an alignment with the rules on exit within the EU or the EEA.

It is currently still open how the German tax authorities will deal with the ECJ ruling. One possibility would be a statutory extension of the deferral rules to Switzerland. On the other hand, the principles of the ruling could also be taken into account by way of a decree, i.e. within the framework of a BMF letter.

If you are planning to move to Switzerland or have already done so recently, you should apply to the competent German tax office for a deferral of the exit tax with reference to this ECJ ruling.