Supranationality is a central legal principle within the European Union (EU). It means that the member states have transferred parts of their sovereignty to the EU, so that EU institutions can make overarching decisions in certain areas that are binding for all member states. This principle results in EU law taking precedence over national law. The principle of supranationality is supported by Article 1 of the Treaty on European Union (TEU) and Artikel 23 of the Grundgesetz (GG) (Basic Law) and forms the basis for EU law being applied uniformly across all member states.

Validity-preserving reduction (geltungserhaltende Reduktion) refers to the legal method of applying national laws in such a way that they are compatible with EU law. If a national norm conflicts with EU law, it is reduced through validity-preserving reduction to a scope that is consistent with EU law, rather than declaring it completely invalid. This principle was used, for example, in connection with the application of § 50d Abs. 3 Einkommensteuergesetz (EStG) (Income Tax Act). Here, the Cologne Tax Court decided that the anti-abuse provision of § 50d Abs. 3 EStG must be limited to artificial arrangements and thus interpreted in conformity with Union law. This is an example of the application of validity-preserving reduction to safeguard the primacy of Union law.

Here are some specific examples that illustrate the legal concepts of supranationality and validity-preserving reduction:

Supranationality

An example of supranationality in the EU is the EU's Common Commercial Policy. In this area, the member states have transferred their sovereignty to the EU, allowing the European Commission to negotiate and conclude trade agreements with third countries on behalf of the EU. These agreements are binding for all member states, even if individual countries might not have agreed to the deal if they had decided on it at a national level. This shows how member states have waived part of their sovereignty in the area of trade policy in favour of a common European policy.

National sovereignty describes the principle that a state has the highest authority over its internal affairs and is free from external control. This includes independence in legislation, jurisdiction, and the execution of state functions within its own territory.

In the European Union (EU), however, the principle of supranationality leads to member states transferring part of their national sovereignty to the EU. This is done to achieve common goals and closer integration within the Union. For example, legislation in certain areas, such as the internal market or trade policy, is subject to the supranational level, which means that EU law takes precedence over national law in these areas.

§ 50d Application of agreements for the avoidance of double taxation (national anti-abuse regulation)

(3) 1A corporation, association of persons or estate shall not be entitled to relief from capital gains tax and from tax deduction under § 50a on the basis of an agreement for the avoidance of double taxation to the extent that

1. persons hold an interest in it or are beneficiaries under the statutes, foundation deed or other constitution who would not be entitled to such relief if they generated the income directly, and
2. the source of income has no significant connection with an economic activity of this corporation, association of persons or estate; the generation of income, its forwarding to participating or beneficiary persons, as well as an activity to the extent that it is carried out with a business operation not appropriately set up for the business purpose, are not considered an economic activity. 2Sentence 1 shall not apply to the extent that the corporation, association of persons or estate proves that none of the main purposes of its intervention is the obtaining of a tax advantage, or if the main class of shares in it is subject to substantial and regular trading on a recognised stock exchange. 3§ 42 of the Abgabenordnung (Fiscal Code) remains unaffected.

Validity-preserving reduction

A well-known example of validity-preserving reduction is the application of § 50d Abs. 3 Einkommensteuergesetz (EStG) in Germany:

• Facts: § 50d Abs. 3 EStG regulates the restriction of exemption for dividends, interest, and royalties from third countries to prevent abuse. This provision was considered too far-reaching because, in its original version, it could also affect legitimate economic activities.
• CJEU Ruling: The Court of Justice of the European Union (CJEU) ruled that this regulation could violate the freedom of movement of capital, as it also excluded legitimate economic activities from tax exemption.
• Validity-preserving reduction: In order to apply the provision in conformity with Union law, German jurisprudence interpreted it such that it is only applied to cases of abuse or purely artificial arrangements, but not to legitimate business activities. Thus, the norm was preserved but reduced in its scope of application in a way that is compatible with EU law.

Validity-preserving reduction makes it possible to apply national legal norms so that they remain effective despite potential non-compliance with EU law, by simply adjusting or filtering out the parts of the norm that infringe upon EU law. In this way, the norm is preserved as a whole but adapted to the requirements of EU law.

Application to §§ 14 et seq. KStG (Corporation Tax Act)

In the context of the tax group (Organschaft) according to §§ 14 ff. KStG (Corporation Tax Act), validity-preserving reduction means that the norms are interpreted such that EU-foreign companies can also be recognised as controlled companies (Organgesellschaften) if they fulfil the other requirements.

§ 14 Stock corporation or partnership limited by shares as a controlled company

(1) 1If a European Company (SE), stock corporation (AG) or partnership limited by shares (KGaA) with its place of management in Germany and its registered office in a member state of the European Union or in a contracting state of the EEA Agreement (controlled company) undertakes by means of a profit and loss transfer agreement within the meaning of § 291 para. 1 of the Aktiengesetz (Stock Corporation Act) to transfer its entire profit to a single other commercial enterprise, the income of the controlled company shall be attributed to the head of the enterprise (parent company/Organträger), unless otherwise provided for in § 16, if the following requirements are met:

(...)

3.1The profit and loss transfer agreement must be concluded for at least five years and be performed throughout its entire duration. (...)

1. Expansion of the circle of controlled companies

• Normal application: According to traditional German regulations on §§ 14 ff. KStG, a tax group can only exist if the controlled company is a capital company resident in Germany. This means that, according to conventional interpretation, EU-foreign companies that have their management abroad would be excluded.
• Validity-preserving reduction: By applying validity-preserving reduction, EU-foreign companies that have their management in another EU country can also be recognised as controlled companies if they meet the requirements for economic integration and uniform management. The regulation is thus adapted so that it does not violate the fundamental EU freedoms, in particular the freedom of establishment under Art. 49 TFEU.

2. Loss absorption agreement

• Normal application: The regulation of the tax group requires a contractual agreement under which the controlled company transfers its profits and losses to the parent company. This agreement must exist for at least five years and be actually performed to be recognised for tax purposes.
• Validity-preserving reduction: Even if the controlled company has its registered office in another EU country, the loss absorption obligation could be recognised under German law as long as the actual performance of the agreement is ensured and the agreement complies with German requirements. This means that the requirement of loss absorption for five years and actual performance can also be applied to EU-foreign controlled companies without violating EU law.

By applying validity-preserving reduction, the provisions of §§ 14 ff. KStG can be adapted to be compliant with EU law. EU-foreign companies can be recognised as controlled companies if they meet the other requirements, in particular economic integration and the contractual loss absorption agreement. Thus, the norm remains effective, and only the components of the law that violate EU law are filtered out or adapted accordingly.

**
Note
**This article is for general information purposes and was carefully prepared by the Lexo.Tax editorial team. Personal tax advice can only be provided within the framework of membership with Lexo.Tax – and exclusively to the extent permitted by law according to § 4 Nr. 11 StBerG (Tax Consultancy Act).