The term "establishment" is mentioned in EU law, particularly in the context of the freedom of establishment under Art. 49 TFEU (Treaty on the Functioning of the European Union), but it is not defined in detail. However, the European Court of Justice (ECJ / Bundesgerichtshof (BFH)) has over the years substantiated the criteria and meaning of this term through its case law.

1. Establishment within the meaning of Art. 49 and 54 TFEU

Art. 49 TFEU guarantees the freedom of establishment for natural and legal persons within the EU. This article covers the freedom to establish oneself in another Member State, to set up companies there, and to pursue self-employed activities.

Art. 54 TFEU extends this protection to legal persons by granting companies formed in accordance with the law of a Member State and having their registered office, central administration, or principal place of business within the EU the same rights as natural persons.

Art. 54 (ex-Article 48 TEC)

For the purposes of this Chapter, companies or firms formed in accordance with the law of a Member State and having their registered office, central administration or principal place of business within the Union shall be treated in the same way as natural persons who are nationals of Member States.

"Companies or firms" means companies or firms constituted under civil (GbR) or commercial law, including cooperative societies, and other legal persons governed by public or private law, with the exception of those which are non-profit-making.

Since the term "establishment" is not explicitly defined, the BFH has clarified through various rulings what is to be understood by it:

Case Law of the BFH on Establishment

• Case Stauffer (C-386/04): The BFH ruled that a permanent presence in the state of establishment is required to benefit from the freedom of establishment. This permanent presence can be evidenced, for example, by the active management of a property in the host state.
• Case Cadbury Schweppes (C-196/04): In this case, the BFH clarified that certain substance requirements must be met for an establishment to be recognised. These include the existence of business premises, staff, and assets. The BFH emphasised that the establishment of a subsidiary in another Member State can only be regarded as an abuse of the freedom of establishment if it is a purely artificial arrangement that does not carry out any genuine economic activity.

These rulings clarify that the establishment must not only meet formal criteria but must also demonstrate an actual economic presence in the host state.

Letterbox Company Directive

Letterbox companies are to be distinguished from an establishment. The Letterbox Company Directive (also known as the "Unshell Directive") is a proposed EU directive concerned with combating so-called letterbox firms or shell companies.

The Centro di Musicologia Walter Stauffer Case (C-386/04)

The Centro di Musicologia Walter Stauffer (C-386/04) case is a significant ruling by the European Court of Justice (BFH) on the interpretation of the concept of "establishment" within the meaning of the freedom of establishment under Art. 49 TFEU.

Facts of the case:

The Centro di Musicologia Walter Stauffer (C-386/04) case addressed the question of whether a non-profit foundation resident in one EU Member State and generating income in another Member State can claim a tax exemption under the national law of the state where the income was generated.

Background:

The Italian foundation "Centro di Musicologia Walter Stauffer" owned a property in Germany, which it rented out through a property management company. Under German tax law, only domestic non-profit foundations were exempt from corporate income tax. The foundation applied for a tax exemption for its rental income, which was rejected by the German authorities because, as a foreign foundation, it could not benefit from the tax exemption.

To illustrate the BFH's review scheme in the area of fundamental freedoms using § 5 Abs. 2 Nr. 2 KStG (Corporate Income Tax Act) and the ruling in the Centro di Musicologia Walter Stauffer case, the procedure is as follows:

1. Scope of Protection

First, it is checked whether the scope of application of one of the fundamental freedoms of EU law is affected. In the case of Centro di Musicologia Walter Stauffer, the free movement of capital under Art. 63 TFEU was affected, as it concerned the tax treatment of income from the rental of a domestic property owned by a foreign non-profit foundation.

2. Restriction

It is examined whether the national regulation restricts the exercise of this fundamental freedom. In the present case, the restriction consisted of the fact that § 5 Abs. 2 Nr. 2 KStG excluded foreign non-profit entities from the tax exemption granted to domestic entities, leading to discrimination based on the seat of the entity.

3. Justification

A restriction on fundamental freedom may be justified if there are overriding reasons of public interest. Two frequently recognised grounds for justification are:

• Coherence of the tax system: The interaction means that the recognition of an organisation's non-profit purpose directly influences the possibility of tax exemption. In the "Stauffer" case, it was decisive that the foundation's non-profit purpose should also be recognised across national borders and the tax exemption granted accordingly. The need to maintain the coherence of the national tax system could thus justify different tax treatment. In the Centro di Musicologia Walter Stauffer case, it was argued that the tax exemption is tied to domestic foundations because they are integrated into national social life and perform a state task.
• Effectiveness of fiscal supervision: Another ground for justification could be the effectiveness of fiscal supervision, particularly the difficulty of monitoring foreign entities. This was also discussed in the Stauffer case.

4. Proportionality

Finally, it is examined whether the national measure is proportionate, i.e., whether it is suitable, necessary, and appropriate to achieve the legitimate goal. In the Centro di Musicologia Walter Stauffer case, the BFH found that the discrimination was not proportionate, as the tax disparity went beyond what was necessary to achieve the coherence of the tax system.

The BFH ruled that the provision in § 5 Abs. 2 Nr. 2 KStG, which excludes foreign non-profit entities from the tax exemption, violates the free movement of capital and cannot be justified. Thus, the national regulation was not compliant with EU law.

Key Points of the BFH Decision:

1. Freedom of Establishment: The BFH determined that through the ownership and active management of a property, the foundation had a "permanent presence" in the state of establishment (Germany) and thus the freedom of establishment under Art. 49 TFEU was applicable.
2. Free Movement of Capital: Additionally, the free movement of capital according to Art. 63 TFEU became relevant, as the rental and active management of the property constituted a movement of capital (subsidiary to the freedom to provide services). The BFH emphasised that restrictions on these freedoms can only be justified by overriding reasons of public interest, which was not the case here.
3. Discrimination: The different treatment of the Italian foundation compared to domestic foundations was deemed discriminatory as it lacked an objective justification. The mere fact that a foundation is resident in another Member State does not justify different tax treatment.

In the BFH judgment in the Centro di Musicologia Walter Stauffer (C-386/04) case, explicit reference was made to the Mutual Assistance Directive (Directive 77/799/EEC, amended by Directive 2004/106/EC).

The BFH stated that national tax authorities have the possibility to request information from the authorities of other Member States to ensure that the tax requirements, such as non-profit status, are also met by foreign foundations. The BFH ruled that the wholesale refusal to grant foreign foundations the same tax exemption as domestic ones is not justified, particularly because the Mutual Assistance Directive provides Member States with the necessary means to carry out the required checks.

Effectiveness of fiscal supervision: The BFH recognised the effectiveness of fiscal supervision as a legitimate ground for justification but clarified that mere administrative disadvantages arising from the audit of a foreign foundation are not sufficient to justify unequal tax treatment.

Use of the Mutual Assistance Directive: The Court emphasised that Member States have the option to rely on the Mutual Assistance Directive to obtain the necessary information to verify non-profit status. This would allow national tax authorities to ensure that foreign foundations also meet the requirements for tax exemption without being disadvantaged due to their foreign seat.

Following the ruling of the European Court of Justice (BFH) in the Centro di Musicologia Walter Stauffer (C-386/04) case, Germany had to adapt its tax regulations to meet the requirements of EU law and eliminate discrimination based on the seat of non-profit organisations in other EU Member States. The adjustments primarily affected the Körperschaftsteuergesetz (KStG) (Corporate Income Tax Act) and associated tax law regulations.

§ 5 KStG – Tax Exemptions

(2) The exemptions under paragraph 1 and under laws other than the Corporate Income Tax Act do not apply (...)

2. for persons subject to limited tax liability within the meaning of § 2 No. 1, unless they are taxpayers within the meaning of paragraph 1 No. 9 who are companies within the meaning of Article 54 of the Treaty on the Functioning of the European Union or Article 34 of the Agreement on the European Economic Area formed under the laws of a Member State of the European Union or the laws of a state to which the Agreement on the European Economic Area of 3 January 1994 (OJ EC No L 1 p. 3), last amended by Decision of the EEA Joint Committee No 91/2007 of 6 July 2007 (OJ EU No L 328 p. 40), in the respective version applies, whose seat and place of management are located within the territory of one of these states, and an administrative assistance agreement exists with these states.

Before the ruling, the tax exemption for non-profit entities paying corporate income tax on their income in Germany was limited to entities resident in Germany. After the BFH ruling, § 5 Abs. 2 Nr. 2 KStG was adjusted so that foreign entities having their seat in another EU Member State or a state of the European Economic Area (EEA) and recognised there as non-profit can be exempt from German corporate income tax under certain conditions.

§ 2 KStG – Unlimited and Limited Tax Liability

Section § 2 KStG, which regulates unlimited and limited tax liability, was also clarified to state that foreign non-profit entities generating income in Germany can fall under the tax exemption if they meet the relevant requirements. In particular, it was established that non-profit entities with limited tax liability resident in another EU Member State and enjoying tax benefits there must not be disadvantaged in Germany.

Substance Proof and Administrative Regulations

Following the ruling, administrative practice also had to be adapted, particularly regarding the proof of non-profit status and the recognition of foreign non-profit status.

Administrative Instructions and Substance Evidence

The tax authorities issued guidelines and administrative instructions to ensure that the non-profit status of a foreign foundation can be verified. These instructions clarified which documents and evidence a foreign organisation must submit to be recognised as non-profit in Germany and to benefit from the tax exemption. This includes, for example, the submission of certificates from foreign tax authorities and evidence of the actual performance of charitable activities.

§ 51 ff. Abgabenordnung (AO) (Fiscal Code)

The regulations on non-profit status in the Fiscal Code (§ 51 ff. AO) were also adapted and substantiated. These regulations establish the criteria by which an organisation is recognised as non-profit. Adjustments were made here as well to ensure that the criteria for recognising a foreign organisation as non-profit are in line with EU law.

Relevance and Impact:

This ruling meant that the German legislator had to adjust the regulations. Since then, foreign non-profit foundations can also claim a tax exemption in Germany under certain conditions. This strengthens the freedom of establishment and the free movement of capital within the EU and ensures that institutions operating in one Member State are not unjustifiably disadvantaged.

3. Further Implementation by the German Legislator

The German legislator has implemented this BFH case law through various regulations in tax law:

• § 50d Abs. 3 EStG (Income Tax Act): This provision regulates the evidence of actual economic activity in connection with the tax exemption of dividends and other income from foreign sources. It requires the taxpayer to prove that actual economic activity exists to avoid abuse.
• § 8 Abs. 2-4 AStG (Foreign Tax Act): Following the Cadbury Schweppes ruling, § 8 AStG regulates the controlled foreign company (CFC) taxation of foreign subsidiaries. The legislator introduced substance criteria to ensure that only such income is added back that originates from a purely artificial arrangement without actual economic activity.

Conclusion

The concept of "establishment" in European law is closely linked to the fundamental freedoms of the EU, in particular the freedom of establishment. BFH case law has established clear criteria to ensure that this freedom is not abused, and the German legislator has implemented these requirements into national law to ensure application compliant with Union law.

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Note
**This article serves for general information and was carefully created by the editorial team of Lexo.Tax. Personal tax advice can only be provided within the framework of membership with Lexo.Tax – and exclusively within the legally permissible scope according to § 4 Nr. 11 StBerG (Tax Consultancy Act).