Although no competence has been conferred to the European legislator in the area of direct taxation, the judgments by the CJEU in Schumacker v Finanzamt Köln-Altstadt, and X v Staatssecretaris van Financien illustrate again, how the free movements as enshrined in the TFEU, directly influence the domestic tax laws of the Member States in matters relating to direct taxation. It can therefore reasonably be argued that the CJEU case law on direct taxation has been very important in the development of the international dimension of direct tax systems of EU Member States.1
The aim of this paper is to shine a light on how the aforementioned judgments by the CJEU have been interpreted and implemented in Germany’s domestic tax law. In order to be eligible to do so, this paper will firstly summarize the previously mentioned judgments and then discuss how the cases interrelate. Finally, before reaching its conclusion, this paper will outline the implementation of the Schumacker-doctrine by the German legislator and assess whether the X-case introduces the need for a paradigm change. Reference will be made to conventional academic literature by legal scholars, as well as to domestic legislation.
2 Analysis
2.1 Summary of the C-279/93 “Schumacker v Finanzamt Köln-Altstadt” Case
Roland Schumacker was a Belgian national, who was employed in Germany but continued to reside in Belgium with his wife and children. Mrs. Schumacker was unemployed and received unemployment benefits from the Belgian Government, and Mr. Schumacker’s only source of income was the salary he received from his work carried out in Germany.2 His German employer deducted at source the tax due on his salary as in accordance with the German rules applicable to non-resident tax payers, who are limited liable to tax in Germany.3 As a consequence thereof, the German employer failed to take into account Mr. Schumacker’s personal circumstances (i.e. personal deductions and allowances), which would have been done in the case of German resident taxpayers. When Mr. Schumacker asked the German tax authorities to calculate his tax liability on the basis of the rules applicable to German resident taxpayers, the authorities rejected the request4, which ultimately ended in legal proceedings. The German Federal Finance Court asked for a preliminary ruling by the CJEU on the interpretation of the free movement of workers, as enshrined in the TFEU and in the light of the German provisions on the taxation of non-resident employees.5
The CJEU reiterated that, as a general rule, resident and non-resident taxpayers are not in comparable situations as regards to direct taxation.6 However, the CJEU continued by arguing that the situation of Mr. Schumacker was different as he obtained his major income from his activity performed in Germany. He had no significant income in Belgium (his state of residence). Consequently, the Belgian state could not take into consideration his personal and family circumstances and this would ultimately deprive him of a more beneficial tax treatment. The court continued that in this context, there is no objective difference between the situations of a resident taxpayer and a non-resident taxpayer that are engaged in comparable employment.7 Consequently, discrimination arises from the mere fact that the personal and family circumstances of Mr. Schumacker, who receives almost all of his income in Germany, are neither taken into account in his state of residence (Belgium), nor in the state of employment (Germany).8
Finally, the CJEU rejected the justifications as brought forward by the German government and held that the refusal to grant non-resident EU Member State nationals the benefit of annual adjustment procedures that are normally available to resident nationals, constitutes an unjustifiable discrimination, which is prohibited under Community law. 9
2.2 Summary of the C-283/15 “X v Staatssecretaris van Financien” Case
X is a Dutch national, who was a resident in Spain. In Spain, he lived in a dwelling which was considered his own for Dutch tax law purposes. X had a mortgage on which he was required to pay interest and X’s only sources of income were the dividend payments of his majority shareholding in a Dutch and a Swiss company. He received 60% of his overall income from the Dutch company and the remaining 40% from the Swiss company. X had no income in Spain.10 Under Dutch law, X had initially elected to be treated as a Dutch resident, which would normally enable him to deduct his interest payments on the mortgage from his taxable income.11 Yet, it turned out that his overall tax burden was higher than it would have been, had X not elected to be treated as a Dutch resident taxpayer.12 X appealed against his tax assessment and argued that the fundamental freedoms as provided for under the TFEU, should allow him to deduct the mortgage interest expenses without having to elect to be treated as a resident taxpayer to be eligible to do so.13
The CJEU reiterated that under settled case law it is not discriminatory to grant a tax advantage to residents while withholding this advantage from non-residents. Again, residents and non-residents are in objectively different situations.14 The court continued by stating that X would only be in comparable situations to a resident taxpayer in the Netherlands, if Spain (as the resident state), would not be able to grant the tax advantages related to X’s personal and family circumstances.15 Yet, due to the fact that X has no income in Spain and only 60% of income in the Netherlands, X cannot have his personal and family circumstances taken into account in neither Spain, nor the Netherlands, which puts him in a situation that is comparable to that of a resident taxpayer. The fact that he is not treated like one results therefore in a discriminatory treatment of X, which is prohibited under Community law.16 Ultimately, the CJEU held that each of the Member States concerned must grant the deduction of the mortgage interest expenses in proportion to the income received by the taxpayer in the Member State of activity. The fact that part of the income was derived from Switzerland (as a third state) is irrelevant.17
2.3 How do the Schumacker-Judgment and the X-Judgment interrelate?
The judgments of the Schumacker-Case, as well as the X-Case illustrate that in principle, a source state does not have to take into consideration the personal and family circumstances of a non-resident taxpayer. The exception to this general rule has been provided for on the basis of the Schumacker-doctrine, which applies when
i) a non-resident taxpayer earns substantially all of his income in the Member State of his employment, and
ii) the Member State cannot take into account of his personal or family circumstances.
Then, the Member State of employment must, on the basis of the Schumacker judgment, grant the non-resident the same tax advantage as it provides for under its domestic law, to its own residence with respect to these circumstances.18 On the basis of the X-judgment, the CJEU managed to bring more clarity into the applicability of the ‘Schumacker-exception’19 and further developed this doctrine.20 It addressed an unresolved issue, relating to the situation when a taxpayer works in two countries in which necessary income threshold is not met in either state and one of these states is not an EU Member State.21
As mentioned previously, the CJEU held that European Union law precludes the denial to deduct interest expenses relating to a dwelling of a non-resident tax payer, where he receives part of his income from that Member State and does not receive sufficient income in the Member State where the property is located, in order to qualify for such a deduction in the latter state. Thus, what one can learn from the X-Case is that a Member State should take the personal and family circumstances into account on a pro rata basis if the non-resident taxpayer receives a part of the income in a non-Member State.22 On the basis of the X-judgment, it is therefore not a necessary condition, that all or almost all income must be derived by the state of employment.
2.4 Implementation of the C-279/93 “Schumacker v Finanzamt Köln-Altstadt” Judgment in Germany: time for a paradigm change?
The Schumacker-judgment has been heavily debated and criticized amongst legal scholars23 and many authors rightfully claim that the CJEU left a considerable amount of uncertainty as regards to the interpretation of having 'his income entirely or almost exclusively from the work performed in the host state'. Prof. M. Lang points out that the Court had to determine what 'almost all of his income' means and illustrated that it accepted a 90 % threshold, which has been correctly criticized as arbitrary.24 Furthermore, although the Schumacker judgment intends to guarantee that personal and family circumstances are taken into account somewhere, either in the resident or in the host-state, it has been emphasised that this result cannot be achieved even in a bilateral situation, since neither state is de facto obliged to take into account such circumstances at all.25 It is therefore surprising that the CJEU has neither given up nor at least silently stopped applying the Schumacker-doctrine, but has even confirmed and extended that approach, as seen in its judgment in X.
Nonetheless, despite the criticism put forward in the academic commentary, it was clear that after the Schumacker judgment, Germany had to change its domestic tax law as it has been declared incompatible with Community law by the CJEU.26 Although the EU Commission recommended to introduce a threshold of 75%27, the German legislator opted for the introduction of the so called ‘90% rule’ instead, which it implemented in §1 Abs 3 of the ‘Einkommenssteuergesetz’ (EstG). This legal provision enables a taxable person who neither has his domicile nor his residence in Germany, to opt for residential tax treatment and have his personal and family situation taken into consideration if at least 90% of that person's taxable income is earned in the state of employment (Germany).28 Consequently, the German legislator interpreted the requirement of having 'almost all of his income in the state of employment' to be met, if a person had at least 90% of its taxable income arising from activities in Germany.
However, in the light of the X-judgment, it can reasonably be argued that the German legislator will most likely have to reconsider the Schumacker-doctrine and its implementation by means of the 90% rule. As it has been thoroughly explained previously, the CJEU made clear in its X-judgment that it is no longer a requirement that all or almost all of the taxable income is earned in the state of employment, and thus, §1 Abs. 3 of the EstG, will consequently have to be revised.29
3 Conclusion
The CJEU judgment in Schumacker constitutes a landmark decision which had an enormous impact on the development of direct taxation throughout the Member States of the European Union. Almost 22 years later, in the case of X, the CJEU further developed the Schumacker doctrine to the extent that, for the Member State of employment to be obliged to take into account the personal and familiy circumstances of a non-resident taxpayer, it is not necessary that all or almost all the income is earned in this state. However, the employment state should only take these circumstances into account when the state of residence cannot sufficiently take the family and personal circumstances into consideration. The Member State(s) of employment should then grant these allowances on a pro rata basis.
This brief paper illustrated that the German legislator has interpreted and implemented the Schumacker-doctrine by means of a '90% rule', which can be found in §1(3) EstG. It remains, however, to be seen if the German legislator will implement the CJEU decision in the X-case and if so, how such a pro-rata calculation, as demanded by the CJEU, will be designed.30