Growing globalisation means businesses increasingly have permanent establishments in multiple countries. Transferring assets from a domestic to a foreign permanent establishment can, however, trigger unwanted tax consequences in the form of deemed disposal taxation (Entstrickungsbesteuerung).
The deemed disposal of business assets occurs as a rule through the transfer of an asset from a German to a foreign permanent establishment of the same business. The statutory basis is § 4 para. 1 sentence 3 EStG, which provides that the exclusion or restriction of the right to tax the disposal gain on an asset is treated as a withdrawal for non-business purposes. This means that the transfer of the asset to another permanent establishment is treated as a withdrawal, and the hidden reserves (stillen Reserven) are disclosed and subjected to taxation. The hidden reserves represent the difference between the book value at the time of withdrawal and the fair market value - the amount a third party would be willing to pay for the asset.
Tax Consequences
The tax office taxes you on the transfer of the asset as though you had disposed of it at that point in time. Similarly to exit taxation, this results in the taxation of "dry income", as it is a notional transaction and no liquid funds are generated.
Example: You transfer a lorry from your German head office to a Dutch permanent establishment. The lorry has a book value of 50,000 euros and a fair market value of 110,000 euros. Since the double taxation agreement between Germany and the Netherlands allocates the right to tax the disposal gain on the lorry to the Netherlands, Germany's right to tax is restricted and deemed disposal taxation is triggered. Germany taxes the notional disposal gain of 60,000 euros at the time of transfer.
To mitigate the tax consequences of the notional disposal, the Income Tax Act provides in § 4g EStG the option to form an equalisation item (Ausgleichsposten). This offers the possibility of spreading the disposal gain evenly over a total of five years. This option is available - subject to the further conditions of § 4g EStG - only where the asset is transferred to a permanent establishment within the EU or the EEA. Where assets are transferred to third countries such as the USA or the United Kingdom, this is not possible.
In the above case, the option to form the equalisation item is available. This means that instead of the full 60,000 euros in the year in which the deemed disposal arises, only 12,000 euros per year need be taxed in the year of the deemed disposal and in each of the following four years.
In addition to the example shown, there are other situations that can trigger deemed disposal. Passive deemed disposal, in which the deemed disposal is triggered by a change to a double taxation agreement, remains contested and has not yet been definitively resolved by the courts.
We are happy to assess whether you face the risk of deemed disposal taxation, and to advise you on arrangements to avoid or reduce it.