German income tax law provides for rollover relief in its Sect. 6b of the Income Tax Act (ITA). Upon sale of some long-lived assets, such as land and buildings, the taxpayer has a choice. He can have any capital gains taxed immediately. Alternatively, he can defer taxation and transfer the hidden reserves to a newly acquired asset. The deferred capital gain can be reinvested in similar assets within four fiscal years. There is no upper limit for the amount of capital gains thus deferred. However, if replacement assets are not found within four fiscal years, a penalty applies. The deferred capital gain must be taxed, with a 6% interest penalty per fiscal year added on top.
German domestic permanent establishment necessary
As a precondition, Sect. 6b ITA requires the taxpayer to have held the eligible asset as part of fixed assets. The condition must be fulfilled continuously for at least six years prior to the realization event. Additionally, the asset must have been attributable to a German domestic permanent establishment for this time span. The newly acquired “replacement asset” must also be attributable to a domestic permanent establishment.
Restrictions under EU law
In outbound cases, such requirements had been in conflict with EU law, in particular the freedom of establishment. In a landmark decision in 2015, the ECJ ruled that Sect. 6b ITA was in breach of Art. 49 TFEU. The German legislature remedied the infringement by introducing a new paragraph to Sect. 6b ITA. The new rule deals with cases where the replacement assets are attributable to an EU/EEA permanent establishment. Sect. 6b(2a) ITA allows for a payment of the tax on the underlying capital gain in five yearly installments. The payment in installments applies to any income or corporation tax on the capital gain. Due to its wording, the application of this rule to trade tax due on the capital gain is in doubt.
Rollover relief in inbound cases
In inbound cases, a German permanent establishment is not always present. Particularly in the case of rental income, it may even be actively avoided. Without a domestic permanent establishment, no trade tax is due on the rental income, lowering the tax burden substantially. Upon sale of the real estate, however, corporation tax applies for foreign corporations. Non-resident taxpayers are – in principle – entitled to rollover relief as well. To defer the capital gain, rollover relief rules require attribution of the real estate sold to a domestic permanent establishment. In cases without a German permanent establishment, German rollover relief is hence denied.
Compliance with EU law in doubt
Whether this rule of the German Income Tax Act is compatible with EU law is doubtful. The denial of rollover relief may deter foreign taxpayers from investing in Germany. The EU commission has launched infringement proceedings against Germany with regard to these restrictions. However, a regional tax court in Bavaria ruled in April 2019 that no violation existed in such inbound cases. The court pointed – among other arguments – to the savings on German trade tax in cases without domestic permanent establishment. Since no appeal has been lodged against the decision, the Federal Tax Court will not rule on the dispute. The outcome of the proceedings at the level of the EU commission may, however, shed more light on this issue.
More comprehensive information on the German rules on rollover relief can be obtained from M. Weiss, Recent Amendments to the German Tax Rules on Rollover Relief, European Taxation 2016, p. 198.