Seite 131.05.2012 Prof. Dr. Steffen Lampert

Research Council International Tax Law

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How the ability-to-pay principle affects the

interpretation of DTCs

Les Ateliers de Droit Fiscal,

Université Paris I Panthéon - Sorbonne

24 mai 2012

Seite 231.05.2012

Structure

- The ability to pay-principle under German income tax law (constitutional background and influence on taxation of income)

- Example of a cross-border situation: Conflict of allocation of income and two alternatives to interpret the DTC – which interpretation is in conformity with the ability-to-pay principle?

- In General: How to justify tax exemption?

- Conclusions for the case in point

- Application of Art. 3(1) GG in cross-border situations?

- Interpretation of a DTC in conformity with the constitution possible?

Prof. Dr. Steffen Lampert

Seite 331.05.2012

The ability to pay-principle under German income tax law

„ability to pay principle“ =

„Taxation in accordance with the personal economic capacity“

- Not mentioned in the constitution (Grundgesetz)

- Art. 3(1) GG: „All persons shall be equal before the law”

� Constitutional court: Essentially similar situations must be treated equally, whereas essentially different situations must be treated differently.

� But which criteria are decisive?

Prof. Dr. Steffen Lampert

Seite 431.05.2012

The ability to pay-principle under German income tax law

Personal Income Tax Act:

- Tax burden depends on taxable income:

� income reflects personal economic capacityby taxing net income

� Capacity = World-wide assessment base

- Requirements of Art. 3(1) GG:

- Persons who generate the same taxable income must be treated equally

- Persons who generate a different taxable income must be treated unequally

- Unequal treatment of equal situations must be justified

Prof. Dr. Steffen Lampert

Seite 531.05.2012

Fair taxation in cross-border-situations:

Introductary Example

Example (based on dispute between K.Vogel and F. Wassermeyer):

A (resident in Germany) is partner of apartnership (P) which is resident and subject totax in state F. The partnership derives dividendsfrom a corporation resident in Germany.

Prof. Dr. Steffen Lampert

Seite 631.05.2012

Different allocation of income according todomestic tax law

Taxation of dividends:

- German tax law: Transparency principle

� partner A derives income (sec. 20(1) EStG)

- Tax law of state F: F treats partnership P as taxable entity

� P derives income

� Economic double taxation

Prof. Dr. Steffen Lampert

Seite 731.05.2012

Application of OECD-MTC in Germany

Presumption:

DTC in force between Germany and F which follows OECD-Model

Art. 10(1) OECD-MTC:

“Dividends paid by a company which is aresident of a Contracting State to a resident ofthe other Contracting State may be taxed in thatother State.”

� State of source has a limited right to tax

� State of residence of the shareholder avoidsdouble taxation by crediting foreign tax (Art.23A(2) OECD-MTC)

Prof. Dr. Steffen Lampert

Seite 831.05.2012

Interpretation of OECD-Model in Germany

� Alternative 1: “Domestic” perspective:

� Who derives dividends?

� A derives income (corresponds to allocation)

� Why not P? P is no person/company (most German DTCs do not include “other body of persons”; even if: P is not subject to tax in Germany and does not derive any income)

� No cross-border situation; requirements of Art. 10 OECD-MTC are not met

� cf. Art. 21 OECD-MTC

� A is taxed at 25 % flat or 60 % of the dividend is taxed at personal tax rate (up to 45 %)

Prof. Dr. Steffen Lampert

Seite 931.05.2012

Interpretation of OECD-Model in Germany

� Alternative 2: “Autonomous” interpretation:

� Who derives dividends?

� A? No: It is sufficient that P is a resident company according to domestic law of state F

� P derives income

� Allocation of income according to nat. law is not decisive to secure identical application of DTC

� Art. 10(1) OECD-MTC (+)

� Germany is only entitled to tax at a limited rate of 5-15 % (in particular case 0 %)

Prof. Dr. Steffen Lampert

Seite 1031.05.2012

Which result is appropriate with respect to Art. 3(1) GG?

1. Step: Standard of comparison

Taxpayer B, resident in Germany, is partner of a foreign partnership which is treated according tothe „transparency principle“ in its state of„residence“. B derives same amount of income.

� B is taxed in Germany at regular rate

� No economic double taxation as P is not taxed in foreign State

Prof. Dr. Steffen Lampert

Seite 1131.05.2012

Which result is appropriate with respect to Art. 3(1) GG?

Step 2: Are A and B in essentially similarsituations?

Alt. 1:

A and B are: Both derive income from a German corporation, both are resident in Germany

� Both should be taxed in Germany at the same tax rate

� But: foreign taxes paid by A must be takeninto account (deduction/tax credit)

Prof. Dr. Steffen Lampert

Seite 1231.05.2012

Which result is appropriate with respect to Art. 3(1) GG?

Step 2: Are A and B ijn essentially similarsituations?

Alt. 2:

A and B are not: P is treated as taxable entity

� Income of A must be exempt from taxationin Germany

� B is subject to regular taxation in Germany

Prof. Dr. Steffen Lampert

Seite 1331.05.2012

General question: Tax credit/deduction vs. (full or partial) Tax exemption

Which method corresponds to the ability-to-pay principle?

- PITA and CITA basically provide for a comprehensive taxation

� Economic capacity = worldwide economic capacity (worldwide assessment base)

� Taxes levied abroad have to be taken into consideration when levying domestic taxes (tax credit; tax deduction if taxation is not justified from German perspective)

� Tax exemption/reduction must be justified

Prof. Dr. Steffen Lampert

Seite 1431.05.2012

Justification of the exemption method in general

- Competitive neutrality abroad (+)

- Requirement: Taxpayer is exposed to conditions in foreign country significantly

- Efficient allocation of resources (+/-)

- Tax exemption?

- Tax credit?

- taxation should not have impact on investment

- Principle of equivalence („interstate justice“) (+)

- Development aid (+)

Prof. Dr. Steffen Lampert

Seite 1531.05.2012

Justification of the exemption method in general

Have the grounds of justification to be of a certain weight?

� Constitutional Court:

- does not make clear statements with respect to exemption method

- logical consistency and targeting („Zielgerichtetheit“) of legislation

- fiscal considerations are not sufficient

Prof. Dr. Steffen Lampert

Seite 1631.05.2012

Justification of the exemption in case

- Competitive neutrality abroad?

� A does not participate in market of state F

� P is weak link (A not sustainable exposed to F)

- Principle of equivalence („interstate justice“)?

� From German perspective no economic link to state F

- Clear decision of legislator?

� Tax reduction does not depend on a cleardecision of the German legislator but on thestructure of the foreign tax system

� No justification of tax exemption

Prof. Dr. Steffen Lampert

Seite 1731.05.2012

Consequences for taxation in Germany?

- Regularly tax credit is appropriate

- In case: no tax credit in Germany

� dividends are no foreign income

� taxation of P is no consequence of world wide taxation of Germany

� Foreign tax is (only) treated as business expense

� Consequences for interpretation of DTC?

Prof. Dr. Steffen Lampert

Seite 1831.05.2012

Is Art. 3(1) GG applicable on cross-bordersituations?

Art. 1(3) GG: state is bound by the constitution

� to which extent? Depends on agreement

- DTCs:

- Legal consequences in Germany, not abroad

� DTC ≠ agreements on extradition and on mutual legal assistance (lowered standard because of reciprocity)

- German legislator could issue a ruling whichprovides identical legal consequences on national level and would be bound to theconstitution

� No reason to restrict application of theconstitution in cross-border-situation

Prof. Dr. Steffen Lampert

Seite 1931.05.2012

Interpretation of DTCs in conformity with theGerman constitution

- DTCs do not have same status asconstitutional law

� Treaties which violate the constitutionmust not be applied

� Disputed: any violation or only violation of fundamental principles of the constitution?

� Unjustified deviation of the concept of world wide taxation (and therefore of Art. 3(1) GG) is always a violation of a fundamental principle

Prof. Dr. Steffen Lampert

Seite 2031.05.2012

Interpretation of DTCs in conformity with theGerman constitution

- Constitutional Court: treaties are subject toa constitutional interpretation

� Consequence of„Völkerrechtsfreundlichkeit“

� If several methods of interpretationlead to different results the courts andfiscal administration have to select theresult which is most closely in conformity with the constitution

� Practitioner should apply 1st alternative

Prof. Dr. Steffen Lampert

Seite 2131.05.2012

Further Example: the dispute about the subject-to-tax clause in sec. 50d(9) EStG

Case: A generates profits from the disposal of „shares“ in a foreign partnership which is treated as a taxableentity abroad.

- Germany applies Art. 13(2) OECD-MTC

� Tax Exemtion in Germany

- State F applies Art. 13(5) OECD-MTC

� Tax Exemtion in F

� No taxation in Germany and state F

Prof. Dr. Steffen Lampert

Seite 2231.05.2012

Further Examples: the quarrel about the subject-to-tax clause in sec. 50d(9) EStG

- Sec. 50d(9) EStG: Taxation in Germany regardless of DTC

� Provision is widely regarded as “treaty override”

� Constitutionality of a “treaty override” is disputed

� But: Sec. 50d(9) EStG leads to the same result as interpretation of DTCs in conformity with the constitution

Prof. Dr. Steffen Lampert

Seite 2331.05.2012 Prof. Dr. Steffen Lampert

Research Council International Tax Law

Prof. Dr. Steffen Lampert

Universität Osnabrück

Institut für Finanz- und Steuerrecht

Martinistraße 10

49078 Osnabrück

Germany

Phone: 0049-541-9696168

Fax: 0049-541-9696167

Mail: rcinststr@uos.de

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