Justification of a Tax Exemption

Prevention of excessive taxation may justify tax exemption. Prevention of abuse may justify limits to the tax exemption.
A tax exemption may not constitute state aid if it is justified by reasons which are linked to the nature or general scheme of the tax system. This is what the Court of Justice said on 19 December 2018, in a preliminary ruling in case C374/17, Finanzamt v A-Brauerei.The case arose from a dispute between A-Brauerei, a German company, and Finanzamt which refused to grant an exemption from a property transfer tax. The exemption is allowed when companies acquire property in the context of restructuring procedures within groups of companies.In Germany, companies may be restructured through merger, division or asset transfer. Although acquisition of property or acquisition of the right to use property results in liability for a transfer tax, the tax is not levied whenever the transfer of property takes place in the context of restructuring. The eligible restructuring must involve a controlling company that owns at least 95% of one or more dependent companies.A-Brauerei held 100% of the shares in T-GmbH, which owned a number of properties and was in turn the sole shareholder of another company. T-GmbH transferred all of its assets, including properties to A-Brauerei when the latter acquired sole ownership of it.

Finanzamt demanded payment of property transfer tax from A-Brauerei because it considered that T-GmbH was not a “dependent company” in the meaning of the relevant German law. A-Brauerei objected to the request for payment of tax and lodged an appeal. Eventually, the case reached an appellate court which, although it agreed with A-Brauerei, it questioned whether the tax exemption was in fact state aid that, in addition, it had not been notified according to Article 108(3) TFEU.

Conditions for selectivity

The German government had argued before the referring local court that the tax exemption was not state aid because according to the judgment in case T-219/10, Autogrill España v Commission it would be “impossible to characterise the undertakings benefiting from that advantage as a favoured category by reason of properties specific to them”. The problem, of course, is that in the meantime the Court of Justice annulled that judgment of the General Court. In fact, the Court of Justice rejected in the present ruling the same argument of the German government when Germany repeated it before the Court.

The Court of Justice first recalled the definition of state aid and reiterated that general measures fall outside the scope of Article 107(1) TFEU. Then it explained that “(22) a condition for the application or the receipt of tax aid may be grounds for a finding that that aid is selective, if that condition leads to a distinction being made between undertakings despite the fact that they are, in the light of the objective pursued by the tax system concerned, in a comparable factual and legal situation, and if, therefore, it represents discrimination against undertakings which are excluded from it”. “(23) On the other hand, national measures applicable to all economic operators in the Member State concerned without distinction constitute general measures and are not, therefore, selective”.

Then the Court added an important clarification. “(24) The fact that only taxpayers satisfying the conditions for the application of a measure can benefit from the measure cannot, in itself, turn it into a selective measure”. This probably means that if, for example, only investors in risk finance measures for SMEs receive a tax benefit, it does not automatically follow that the measure is selective in relation to investors [such a measure, of course, is selective in relation to SMEs]. By contrast, “(25) the fact that the measure at issue applies regardless of the nature of the undertakings’ activity is of no account for the purposes of characterising it as a ‘general measure’”. Therefore, a measure can be selective even if it does not specify the activities of beneficiary undertakings.

The Court went on to make a further nuance. “(26) The a priori selective nature of a measure conferring an advantage need not necessarily be based on a condition linked to the sector in which an undertaking operates, but may be based on other conditions, such as a condition relating to the legal form of the undertaking which may benefit from that advantage”. That is, a measure can be selective if it lays down conditions that limit its applicability in terms of type of activity, legal form, size, sector, region, age, etc.

“(27) In addition, the fact that a measure, which is a priori or potentially accessible to any undertaking, does not enable a particular category of undertakings to be identified which are exclusively favoured by the measure concerned and which can be distinguished by reason of specific properties that are common to them and characteristic of them, is irrelevant for the purposes of characterisation as a ‘general measure’”. This is the principle emanating from the landmark World Duty Free case. It is not necessary to identify a priori a group of companies that can benefit from a certain measure. The only thing that is relevant, the Court said in World Duty Free, is whether two otherwise similar situations are treated differently from perspective of the objective of that measure. For example, investors in risk finance measures may receive an extra tax credit if they invest more than a certain amount. Even though no beneficiary is identified ex ante, those investors whose amounts are below the threshold are treated differently from those whose amounts are above the threshold for investments which from the perspective of the risk finance measure are in a similar situation.


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Conditions for derogation

Then the Court examined the facts of the case before it. It noted that the measure in question was a derogation from property tax. It also noted that the derogation “(29) sought, in essence, to facilitate the restructuring of undertakings and, in particular, the structural changes involving the transfer of property between companies, in order to make them more competitive in the face of the financial crisis affecting the Federal Republic of Germany since 2008.” Furthermore, “(31) the tax exemption … is such that it favours only the groups of companies envisaged, which carry out restructuring procedures, whereas companies not forming part of such groups are excluded from that advantage even if they carry out restructuring procedures identical to those carried out by those groups.”

“(32) In that regard, it is true that regulatory technique is not decisive for determining whether a measure is selective or general, in the sense that, as is apparent in particular from paragraph 101 of the judgment of 15 November 2011, Commission and Spain v Government of Gibraltar and United Kingdom (C106/09 P and C107/09 P, EU:C:2011:732), even a measure which is not formally a derogation and founded on criteria that are in themselves of a general nature may be selective, if it in practice discriminates between companies which are in a comparable situation in the light of the objective of the tax system concerned.”

“(33) However, while the regulatory technique used is not decisive in order to establish that a tax measure is selective, so that it is not always necessary for that technique to derogate from a common tax system, the fact that it is, like the measure at issue in the main proceedings, a derogation is relevant for those purposes where the effect of that technique is that two categories of operators — those who fall within the scope of the derogating measure and those who continue to fall within the scope of the ordinary tax system — are distinguished and are subject, a priori, to different treatment, even though those two categories are in a comparable situation in the light of the objective pursued by that system”.

“(35) The assessment of the condition relating to the selectivity of the advantage concerned, which is a constituent factor in the concept of ‘State aid’ within the meaning of Article 107(1) TFEU, requires a determination, in the first place, of whether, under a given legal regime, a national measure is such as to favour ‘certain undertakings or the production of certain goods’ over other undertakings which, in the light of the objective pursued by that regime, are in a comparable factual and legal situation and which accordingly suffer different treatment that can essentially be classified as discriminatory”.

The reference system

In order to establish the existence of discrimination or derogation, it is first necessary to identify a benchmark from which a certain measure can be shown to deviate. The benchmark for tax measures is the normal or reference tax system or tax regime. Consequently, in the context of tax measures, the Court explained that, “(36) in order to classify a national tax measure as ‘selective’, the Commission must begin by identifying the ordinary or ‘normal’ tax system applicable in the Member State concerned, and thereafter demonstrate that the tax measure at issue is a derogation from that ordinary system, in so far as it differentiates between operators who, in the light of the objective pursued by that ordinary tax system, are in a comparable factual and legal situation”.

“(37) In the present case, …, the reference framework in the light of which an examination of comparability must be carried out is composed of German law rules on real property transfer tax which, taken together, determine the subject matter or the chargeable event covered by that tax.”

“(38) Secondly, the question [arises] whether the tax advantage conferred [by the relevant German law] — whereby the benefit thereof is restricted to a restructuring procedure involving only companies in a group of companies linked by a shareholding of at least 95% during a minimum, uninterrupted period of the five years before and five years after the procedure concerned — gives rise to a difference in treatment with regard to operators which, in the light of the objective pursued by the common tax system at issue in the main proceedings, are in comparable factual and legal situations, in that companies carrying out those restructuring procedures without being linked by such a shareholding are excluded from that exemption.” [I inserted the word “arises” because without it the sentence is grammatically incorrect and difficult to understand.]

“(39) In that regard, … the objective of the tax regime relating to real property transfer tax is to tax any change in owner of the rights (Rechtsträgerwechsel) attaching to a property or, in other words, to tax any transfer of the right of ownership in a property from one natural or legal person to another natural or legal person within the meaning of civil law.”

“(41) The examination of comparability — within the meaning of the principle enshrined in the case-law referred to in paragraph 35 above — must be carried out, as the referring court suggests, in the light of the objective in question, which is to tax any change in proprietor of the ownership rights attaching to the properties, pursued in general by the regime for the real property transfer tax …; that regime and those rules determine the subject matter and chargeable event covered by that tax and, as has been found in paragraph 37 above, constitute the reference framework in the light of which comparability must be examined.”

This is a welcome clarification of how to determine whether different companies are in fact in a similar or comparable situation. Their characteristics, sector, size, or location do not matter. What matters is whether they are liable to the tax as the tax measure itself defines its scope of application.

The Court of Justice went on to observe that “(42) it is apparent that [the relevant German law] differentiates between, on the one hand, companies carrying out a restructuring procedure within a group such as that referred to in that provision and which are capable of benefiting from the tax exemption at issue in the main proceedings and, on the other, companies carrying out that same procedure without belonging to such a group, which are however excluded from that exemption, whereas both are in comparable factual and legal situations in the light of the objective pursued by the tax in question, which is to tax the change in proprietor of the ownership rights from the point of view of civil law, implying the transfer of those rights from one natural or legal person to another natural or legal person.”

“(43) In addition, the differentiation effect stemming from the condition that only companies in the same group, linked by a shareholding of at least 95%, may participate in the restructuring procedure is strengthened by the requirement, laid down by that condition, for that shareholding to be held during a minimum, uninterrupted period of five years before and five years after that procedure.”

So, restructuring and non-restructuring companies were in a comparable situation as were companies within groups and independent companies. The only decisive element was whether property ownership was transferred because this is what determined the scope of application of the tax in question.

Justification of the derogation

“(44) It should, however, be borne in mind, in the second place, that, according to the settled case-law of the Court, the concept of ‘State aid’ does not cover measures that differentiate between undertakings which, in the light of the objective pursued by the legal regime concerned, are in a comparable factual and legal situation, and are, therefore, a priori selective, where the Member State concerned is able to demonstrate that that differentiation is justified since it flows from the nature or general structure of the system of which the measures form part”.

“(45) In the present case, it must be found, …, that the exemption … seeks to introduce a correction for the purposes of avoiding taxation that is considered excessive.”

“(46) The taxation of real property transfers resulting from restructuring procedures within a group of companies characterised by a pre-existing acquisition of a particularly high level of shareholding, of at least 95%, is considered excessive, since, …, the transfer of the property concerned is, as a rule, already taxed ‘at entry’, that is to say at the time when the company owning that property is integrated into such a group of companies. If, subsequently, the transfer of that property were again taxed because of a restructuring procedure carried out within that group, in particular as in the present case, as a result of a merger by absorption of the wholly owned subsidiary — which is the owner of that same property — this would result in the same transaction transferring the property concerned being taxed twice: on the first occasion at the time of the transfer of ownership deemed to correspond to the controlling company’s acquisition of at least 95% of the capital or business assets of the dependent company and, on the second occasion, at the time of the restructuring procedure consisting, in the present case, in the merger by absorption of the dependent company by the controlling company.”

“(48) It must be borne in mind that a measure which creates an exception to the application of the general tax system may be justified by the nature and overall structure of the tax system if the Member State concerned can show that that measure results directly from the basic or guiding principles of its tax system. In that connection, a distinction must be drawn between, on the one hand, the objectives attributed to a particular tax scheme which are extrinsic to it and, on the other, the mechanisms inherent in the tax system itself which are necessary for the achievement of such objectives”.

“(49) In its case-law, the Court has accepted that objectives inherent in the general tax system concerned could justify an a priori selective tax regime”.

“(50) In the present case, the objective related to the proper functioning of the general tax regime at issue in the main proceedings, seeking to avoid double and, hence, excessive taxation, may therefore give good grounds for restricting the tax exemption … to the restructuring procedures carried out between companies linked by a shareholding of at least 95% during a minimum, uninterrupted period of five years before and five years after that procedure.”

“(51) In addition, …, the requirement relating to the minimum period for holding such a shareholding appears justified by the intention of excluding undesirable windfall effects and, therefore, of preventing abuse, by precluding shareholdings of that level, which will come to an end once the restructuring has been concluded, from being acquired for a short period for the sole purposes of benefiting from that tax exemption. The prevention of abuse may constitute a justification linked to the nature or general scheme of the system concerned”.

“(52) It follows that even though that exemption introduces a distinction between undertakings which are, in the light of the objective pursued by the legal system at issue, in comparable factual and legal situations, that distinction is justified since it seeks to avoid double taxation and stems, to that extent, from the nature and general scheme of the system of which it forms part.”

“(53) In the light of the foregoing considerations, the answer to the question referred is that Article 107(1) TFEU must be interpreted as meaning that a tax advantage, such as that at issue in the main proceedings, which consists in exempting from real property transfer tax the transfer of ownership of a property which occurred because of a restructuring procedure involving only companies of the same group, linked by a shareholding of at least 95% during a minimum, uninterrupted period of five years prior to that procedure and of five years thereafter, does not fulfil the condition relating to the selectivity of the advantage concerned, laid down in Article 107(1) TFEU.”

Concluding thoughts

The Court of Justice states in paragraph 46 of the judgment that a property is already taxed when the owning company is integrated into a group of companies. It does not specify, however, who pays the tax. Presumably, it is the legal owner, i.e. the subsidiary. In this connection, three questions arise which have not been answered by the Court.

First, if property is taxed when it changes ownership, then why is it relevant that the property is already taxed when it is first acquired by the subsidiary when the subsidiary is later restructured and absorbed by the mother company? Since the taxable event is the transfer of the property, the same property can be taxed multiple times whenever it changes ownership. If restructuring entails transfer of ownership, then the property has to be taxed again!

Of course, the restructuring may not entail transfer of property. But then the Court should have reasoned differently. It should have said that the ultimate owner, i.e. the mother company, has already paid tax and cannot pay the tax again when it merely absorbs the subsidiary.

Second, if the tax on property belonging to a company which is owned by more than 95% by another company is effectively borne by the latter company – i.e. the mother company – as the Court implied by the reference to the tax being paid “at entry” into the group, then why did the Court find that a mother company was in comparable situation with another company that had not already borne the tax? A company that has paid tax on a property it effectively owns or controls is not in the same situation with a company that has not paid tax on property it does not own or control and therefore has to pay the tax when it acquires such a property.

Third, the German tax measure made three distinctions: restructuring, 95% ownership, and ownership by more than 5 years. The Court found that the tax exemption of restructuring companies was justified because it prevented excessive taxation and that the threshold of 5 years was also justified because it prevented abuse. But it did not examine the threshold of 95%. In what sense was ownership of 95% objectively justified or objectively different from ownership of 85% or 90%?


1 The full text of the judgment can be accessed at: http://curia.europa.eu/juris/document/document.jsf?text=&docid=209352&pageIndex=0&doclang=EN&mode=lst&dir=&occ=first&part=1&cid=3140173



Phedon Nicolaides

Dr. Nicolaides was educated in the United States, the Netherlands and the United Kingdom. He has a PhD in Economics and a PhD in Law. He is professor at the University of Maastricht and the University of Nicosia. He has published extensively on European integration, competition policy and State aid. He is also on the editorial boards of several journals. Dr. Nicolaides has organised seminars and workshops in many different Member States, and has acted as consultant to several public authorities.

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