C-347/04, Rewe Zentralfinanz

>> German income tax incompatible with freedom of establishment

>> Court reiterates that direct taxation legislation must comply with Community law


Paragraph 2a of the German Law on income tax provided that a parent company established in Germany might deduct from its taxable profits the losses it had incurred in relation to write-downs to the book value of shareholdings in its subsidiaries established in Germany.

However, losses of the same kind stemming from shareholdings in subsidiaries established in another Member State were deductible only where those subsidiaries subsequently generated positive income of the same kind or if they carried on an activity of a commercial nature.

The referring Court asked whether such legislation was compatible with the freedom of establishment and the free movement of capital.

The Court of Justice reiterated that although direct taxation fell within their competence, the Member States must none the less exercise that competence consistently with Community law.

Even though, according to their wording, the provisions of the Treaty concerning freedom of establishment were directed to ensuring that foreign nationals and companies were treated in the host Member State in the same way as nationals of that State, they also prohibited the Member State of origin from hindering the establishment in another Member State of one of its nationals or of a company incorporated under its legislation

The difference in tax treatment and the disadvantageous tax situation which stemmed from it for German-resident parent companies having a subsidiary which was established in another Member State were capable of constituting an obstacle to freedom of establishment by such companies, by discouraging them from creating, acquiring or maintaining a subsidiary in another Member State. They accordingly constituted a restriction on freedom of establishment for the purposes of Arts 52 and 58 EC.

Such a restriction on freedom of establishment could be accepted only if it pursued a legitimate aim compatible with the Treaty or was justified by overriding reasons of public interest. But even if that were so, application of that measure would still had to be such as to ensure achievement of the aim in question and not go beyond what was necessary for that purpose.

The Court held that the restriction could not be justified. First of all, a balanced allocation of the power to impose taxes between the Member States could not in itself justify a Member State systematically refusing to grant a tax advantage to a resident parent company, on the ground that that company had developed a cross-border economic activity which did not have the immediate result of generating tax revenues for that State.

The need to maintain the coherence of a tax system could justify a restriction on the exercise of the fundamental freedoms guaranteed by the Treaty. The Court, however, reiterated that for an argument based on such reasoning to succeed, a direct link must be established between the tax advantage concerned and the offsetting of that advantage by a particular tax levy. According to the Court, t
he German Government had not established the existence of such connection .

Text of Judgment