The Advocate General of the EU Court of Justice (AG) has issued another opinion on the notion of final losses, this time addressing when the State of a parent company must allow a deduction for losses of a foreign subsidiary the context of a merger.
In her 10 January opinion in the Memira Holding case (C-607/17), Advocate General (AG) Juliane Kokot affirms that the cross-border setting-off of losses can occur when it is legally possible to use the losses in the subsidiary’s State and when that possibility is taken by the taxable person. Such possibility of use includes a realisation of losses by way of a merger with a third party or a realisation by way of a sale of the company to a third party.
Therefore, in accordance with the Marks & Spencer case, only in the case of final losses is it possible that cross-border use of losses is necessary for reasons of proportionality. As the fundamental freedoms do not in principle require cross-border use of losses within a group. Thus losses arising abroad would thus be forfeited.
In the case at stake, the point at issue is whether a Swedish parent company has the right, on the basis of Article 49 TFEU in conjunction with Article 54 TFEU, to deduct the losses in a wholly-owned subsidiary established in Germany from its profits if that subsidiary is wound up by way of a merger with the parent company and the subsidiary was not able fully to use its losses made in Germany there.
In particular, Memira Holding AB is the parent company of a group with subsidiaries in a number of countries, including Germany. The German subsidiary accumulated losses from previous years of around EUR 7.6 million.
The group is now considering allowing the subsidiary to merge with the Swedish parent company in a cross-border merger and to use the German losses in Sweden. The merger means the subsidiary will be dissolved without liquidation. After the merger, the group will have no company remaining in Germany. The group will not operate there, either through the parent company or through any other company in the group.
Under German law, the losses may be deducted from tax by the subsidiary in Germany and unused losses may be carried over and deducted from any profits the subsidiary makes in future years, without limit of time. However, under German law it is not possible through a merger to carry over losses to another company which is liable for tax in Germany.
Hence, the question is whether the German losses can be considered final losses and thus used by the Swedish parent company in the merger.
The AG states that final losses cannot be used in the country of the parent company on the basis of the justification of preservation of the balanced allocation of the power to impose taxes, for two reasons.
First, use of the subsidiary’s losses made in Germany over the years would undermine the fiscal autonomy of the other Member State. Second, the condition of losses which are usable in law but not in fact is not satisfied in this case.
Regarding fiscal autonomy, the AG considers that the fundamental freedoms cannot have the effect of requiring the Member State of parent company’s residence to grant that company the use of losses originating from the tax system of another Member State; otherwise, the first Member State would see its fiscal autonomy limited by the exercise of fiscal power of the other Member State.
Moreover, the AG points out that losses cannot be characterised as definitive because the Member State of the subsidiary’s residence precludes all possibility of losses being carried forward. This must also apply to a preclusion of a transfer of losses to a third party (here in the context of a merger). For that reason, the Swedish rules are not disproportionate.
Then, the AG notes that carried forward losses which are regarded as non-final in one year (because they can be carried forward or setting off the losses was precluded under national law) cannot subsequently become final losses because they cannot be carried forward further on account of the liquidation.
In this case, the consequence would be that the initially successful activity in Germany would be taxed solely in Germany, while the subsequently loss-making activity would be financed by the tax revenue of other States. Clearly, this would run counter to the preservation of an appropriate allocation of the power to impose taxes, the AG says.
On the principle of fiscal autonomy, the AG finally adds that it is precluded the right to choose for taxable persons. On the contrary, the principle of a balanced allocation of the power to impose taxes between the Member States would be undermined.
The consequence would be that mergers with subsidiaries having high accumulated losses could be shifted to countries which — like Sweden — permit losses to be transferred by way of a merger if it is not possible to preserve losses in a merger in the subsidiary’s State.
Such a merger would be most effective depending on the Member State in which the group has relevant profits and would have to pay the highest tax. This holds all the more since the Swedish merger rules do not require both companies to belong to one group.
Moreover, we may infer from the Marks & Spencer case, in accordance with the principle of territoriality, a precedence of loss utilisation in the State of establishment, in this case Germany, the AG points out.
Even though German tax law does not permit losses to be transferred by way of merger, it does allow losses to be preserved and therefore used by the new shareholders where shares are transferred to restructure an ailing company. For this reason, too, the Swedish parent company cannot elect to have its losses taken into account in Sweden.
Regarding the condition of losses which are usable in law, but not in fact, the AG states that losses which cannot be used because they are not legally recognised in the Member State in which they arose or are not usable because of legal restrictions (for example, they cannot be carried forward or back) are not intended to constitute final losses in accordance with the Court’s case-law. Only losses which would be usable in law but cannot be used in fact in future could be regarded as final losses.
Hence, if the use of losses is precluded by law in the State of the subsidiary, there are no final losses. If it is possible for that State to use losses, the taxable person must have exhausted those possibilities.
Therefore, the AG concludes that the preclusion by Sweden of the allocation of losses of a subsidiary resident abroad and not taxed in national territory in the context of a merger is not disproportionate.
It is interesting to note that the AG also examines the case under the Mergers Directive, as article 6 of the Mergers Directive contains a provision also on the takeover by the receiving company of losses of the transferring company which have not been exhausted for tax purposes.
However, the AG concludes that the use of the loss carried over in Germany for purposes of Swedish taxation does not follow from the Mergers Directive, in any case.
In fact, article 6 of the Mergers Directive applies to a situation in which the receiving company (the Swedish parent company) may transfer losses of a transferring company resident in another Member State (the German company) to a permanent establishment of the receiving company in that Member State (Germany), if such a transfer is possible between companies of that State.
Therefore, the AG notes that article 6 of the Mergers Directive provides, at best, for an accumulated loss of the transferring company to be taken into account in Germany and that there is no mention of losses carried over being taken into account in the Member State of the parent company (in this case Sweden).
Davide Anghileri is a PhD candidate at the University of Lausanne, where he is writing his thesis on the attribution of profits to PEs. He researches transfer pricing issues and lectures for the Master of Advanced Studies in International Taxation and Executive Program on Transfer Pricing.
Anghileri, a Contributing Editor at MNE Tax, previously worked as a policy advisor to the Swiss government on BEPS issues.
Davide can be reached at [email protected] .