Deferral of exit tax - in violation of EU law under old and current legislation?

If a taxpayer who is subject to unlimited income tax liability in Germany gives up his residence or habitual abode in Germany and holds a stake of at least 1% in a corporation (§ 17 (1) sentence 1 EStG) at that time, the increase in value of these shares is subject to income taxation in Germany. The resulting so-called exit tax is generally - like income tax as a whole - due for payment following the tax assessment for the year in which the relocation took place.

Since the tax burden arises without a real inflow of funds, extensive deferral regulations have been provided for, which initially applied depending on the state of relocation and were significantly modified for relocations since 01 January 2022. A decision of the BFH (Federal Fiscal Court), following a preceding ECJ (European Court of Justice) judgment, now suggests, however, that a comprehensive deferral of exit tax must always be granted for European legal reasons.

The case before the BFH

A taxpayer with unlimited tax liability in Germany moved to Switzerland in 2011. At the time of relocation, he held 50% of shares in a corporation in Switzerland.

The tax office took into account the increase in value of the shares at the time of relocation as a taxable notional gain and subjected it to German income tax after § 6 (1) AStG former version (so-called exit tax). Although § 6 (5) AStG former version provided for an interest-free deferral of exit tax until the actual realization of the increase in value for relocations to an EU or EEA member state, in cases of relocation to a third country, § 6 (4) AStG former version allowed only for an application-based deferral of the exit tax over a maximum of five years, usually only against a security deposit. The taxpayer did not apply for deferral in the form of this extended due date, so the exit tax was fully taken into account in the income tax assessment for 2011.

The taxpayer filed a lawsuit against this decision at the FG Baden-Württemberg (Fiscal Court of Baden-Württemberg) after an unsuccessful objection, arguing that the application of the exit tax according to § 6 AStG former version violated the Free Movement of Persons Agreement between the EU and Switzerland. The taxation of the hidden reserves at the time of relocation to Switzerland was likely to deter a person from such a move to Switzerland and thus violated the right of establishment. Therefore, the exit tax should not apply.

Decision of the ECJ

The FG Baden-Württemberg turned to the ECJ with a request for a preliminary ruling on whether the exit tax provided for in § 6 AStG former version violated the Free Movement of Persons Agreement with Switzerland. In its judgment of 26 February 2019 (Case C-581/17, Wächtler), the ECJ affirmed such a violation if - as in the case of the German regulation - the relocation of a national of an EU member state to Switzerland triggered an exit tax, whereas a move within the same member state would only lead to taxation of an increase in value in shares of a corporation when they were realized.

The FG Baden-Württemberg then ruled in favor of the lawsuit with a judgment of 31 August 2020 (2 K 835/19). The tax administration turned against this and filed an appeal.

Judgment of the BFH

The BFH concludes with a judgment of 06 September 2023 (Ref. I R 35/20) that in the case of a move to Switzerland before 01 January 2022, contrary to the deferral regulation provided for moves to third countries in § 6 (4) AStG former version, the exit tax must be deferred by the tax office permanently and without interest. However, the BFH contradicted the FG Baden-Württemberg in that the tax office would thus be generally prevented from assessing the income tax arising from the exit taxation.

In its reasoning, the BFH likewise referred to a violation of the right of establishment to be granted according to the Free Movement of Persons Agreement. The taxpayer who moved his residence to Switzerland was taxed less favorably than a taxpayer who moved within Germany. In the case at hand of relocation to Switzerland, increases in the value of corporate shares were taxed immediately, without being able to receive a deferral of payment until the disposal of the shares. In the domestic case, taxation only occurred upon the realization of value increases. No justification for this unequal treatment is apparent.

To enable the taxpayer to exercise his right of establishment in Switzerland, the BFH continued, an interest-free deferral of the entire exit tax until the time of disposal is required.

Ultimately, the BFH thus applies the old regulation for the deferral of exit tax in EU/EEA cases in a preserving reduction of § 6 AStG former version also in third-country cases.

Conclusions for the current regulation on exit taxation

For relocations since 01 January 2022, § 6 (4) AStG provides for a uniform deferral regulation. In the case of relocation to another EU/EEA member state or a third country, the exit tax can be paid in seven equal annual installments upon application, whereby a security deposit is usually required. The accrual of annual installments is waived upon application only if the taxpayer claims under the so-called return rule that he will return to Germany within seven years after the relocation.

Although this excludes a disadvantage for relocations to third countries compared to relocations to EU/EEA states, the tax implications of the case of relocation abroad must be compared with the move within Germany, according to the explanations of the ECJ and BFH.

In the case of relocation to Switzerland, it, therefore, seems obvious to demand at least economic equality by interest-free deferral until the realization of the increases in value to preserve the right of establishment due to the Free Movement of Persons Agreement with Switzerland. A corresponding argument could also apply in cases of relocation to an EU member state, as otherwise there could be a violation of the freedom of establishment guaranteed by EU law. If the participation held at the time of relocation is not qualified as so-called control participation, which is regularly assumed for participation of less than 25%, there is also a threat of violation of the freedom of capital movement. Since the scope of protection of the freedom of capital movement can also include third-country facts, an interest-free deferral of the exit tax until the actual realization of value increases seems to be required here as well.

Conclusion

The case law of the ECJ and the BFH clarifies that in old cases (relocations before 01 January 2022), an interest-free deferral of the exit tax until the realization of value increases must regularly be granted in third-country cases.

Regarding the new regulation for the deferral of the exit tax for relocations since 01 January 2022, there are significant doubts as to whether the option to pay the exit tax over seven years, as provided for on application, is compliant with EU law. A review of the regulation of § 6 (4) AStG in the currently valid version by the fiscal courts is likely to be only a matter of time. It may well be that the legislator will have to make improvements here, possibly even retroactively for cases of relocation since 01 January 2022.