On 4 November 2009, the German Federal Finance Court published a decision from 25 August 2009 in which it held that the so-called “exit tax” imposed by Sec. 6 of the Foreign Tax Act (Außensteuergesetz or AStG), is compatible with the German Constitution and European law.

In the case under consideration, two spouses each held more than 25% of the shares of two German public limited companies (Aktiengesellschaft or AG). In 1998, the couple moved from Germany to Belgium thereby ending their unlimited liability to German taxation. In 2001 the couple moved from Belgium to Switzerland.

In 2000, during the course of a tax audit, the local tax authority became aware of the holdings and, applying Sec. 6 AStG, assessed income tax on the value of the shares minus their initial acquisition costs. The couple took legal action against the tax assessment but the local finance court decided (in 2007) in favour of the tax authority. Upon the couple’s appeal, the Federal Finance Court (in its November 2009 ruling) upheld the lower court’s decision.

Sec. 6 AStG imposes an exit tax on persons who had been subject to unlimited German tax liability for a minimum of ten years prior to leaving Germany, thereby ending their unlimited German tax liability. The exit tax applies to participations in a limited liability company but only if the shareholder held a minimum participation during the 5 years prior to ending the unlimited German tax liability. The application of Sec. 6 AStG results in the assessment of income tax at the time of emigration irrespective of whether or not income is generated (e.g. through sale of the participation). This exit tax is based solely on the discontinuance of unlimited German tax liability. When the plaintiffs emigrated from Germany, the minimum participation which led to imposition of exit tax was 25% (it is currently 1%).

In a decision from November 2004, the European Court of Justice (ECJ), struck down a French regulation, which was similar to the original wording of Sec. 6 AStG, as incompatible with EU law since it discriminated against persons moving to EU member states as compared to those remaining in their original country of residence. In response to this ruling, the German legislature amended Sec. 6 AStG in December 2006 to include an interest-free suspension of taxation for taxpayers who emigrate to EU member states. Suspension ends when the taxpayer ends the participation in the German company or when he/she emigrates to a country outside of the EU. The amendment, which entered into force in 2006 and became effective as of 1 January 2007, enacted the suspension provision with unlimited retroactive effect.

The taxpayers in the case under consideration argued that at the time they emigrated from Germany to Belgium the previous version of Sec. 6 AStG had been in effect which, however, was contrary to EU law (applying the decision regarding the similar French regulation) and therefore could not have been used as the basis of a tax assessment. Since, however, Sec. 6 AStG was subsequently amended to remove the conflict with EU law, the taxpayers also challenged the lawfulness and the retroactive effect of the amended provision.

The Federal Finance Court held that the present Sec. 6 AStG is in line with European law since no obstruction of movement to other EU-member-states exists and that the retroactive effect is in line with the German Constitution since the amendment was in favour of taxpayers and beneficial amendments may be made with retroactive effect. Furthermore, the Court held that the plaintiffs could not rely on the assumption that the non-compatibility of the AStG provision with EU law would not be cured by the German legislature.

Since this decision is binding on the lower tax courts and it is unlikely that the Federal Fiscal Court will overrule its decision in the near future, any person looking to challenge the lawfulness of Sec. 6 AStG based on a breach of European law will have to be prepared to go before the European Court of Justice.