Federal Constitutional Court - Press office -
Press release no. 58/2009 of 9 June 2009
Order of 12 May 2009 – 2 BvL 1/00 –
Provisions for long-service awards under the
Income Tax Act held constitutional
Before the Tax Reform Act (Steuerreformgesetz – StRefG) of 25 July 1988
went into effect, the question as to whether and how employers may
account for long-service awards and similar fringe benefits, and charge
them against income, before they are actually paid was determined
according to the rules that generally govern provisions. Since 1969, the
Federal Finance Court (Bundesfinanzhof) has rendered differing judgments
on the question as to the admissibility of provisions for long-service
awards. In a leading judgment in the year 1987, the Court decided –
unlike in the case of previous decisions and by way of deviation from
administrative practice which had not as a rule recognised such
provisions – that provisions for long-service awards not only may, but
must be, regularly established. The German Federal Ministry of Finance
(Bundesministerium der Finanzen – BMF) then decreed on 28 December 1987
that, in view of the possibility of a change in the law, there can be no
objection to failure to show, or fully show, provisions for long-service
awards in financial statements prepared for tax purposes despite the
current case-law of the Federal Finance Court unless a legally binding
commitment has been made in writing and the beneficiary is in any case
entitled to at least a proportionate part of the benefit in the event of
premature termination of employment. With the 1990 Tax Reform Act of 25
July 1988, the legislature then added two special provisions to the
Income Tax Act (Einkommensteuergesetz – EstG) that restricted the
establishment of provisions for long-service awards in terms of both
substantive content (§ 5.4 EStG) and timing (§ 52.6 EStG). According to
§ 52.6 EStG (old version), the establishment of provisions was not
allowed for the years 1988 to 1992 and provisions that had been
established previously had to be released and recognised as income
within three years. The essential reason for this provision, which was
submitted to the Federal Constitutional Court for review, was the fear
that a significant shortfall in tax revenues, possibly up to DM 5
billion, would result without the change due to the possibility of
establishing new provisions for commitments made in the past on the
basis of the new case-law.
In the initial proceedings, the plaintiffs, a married couple who file
joint income tax returns, sought recognition of a provision for a
long-service commitment that would have reduced income from commercial
activities for the year 1988. The plaintiff had made such a commitment
to the employees of his service enterprise in the year 1981 by posting
an announcement on the notice board of his enterprise. In the income tax
assessment notice for 1988, the Tax Office disallowed the increase in
the provision for the year ended 31 December 1988 and required the
release of one-third of the provisions established in previous years on
the basis of § 52.6 EStG of the 1990 version of the Tax Reform Act. The
Federal Finance Court dismissed the ensuing “leapfrog appeal” as
unfounded. In an appeal on points of law, the Tenth Senate of the
Federal Finance Court submitted the issue as to whether § 52.6 sentences
1 and 2 EStG of the 1990 version of the Tax Reform Act, which prohibit
provisions for the years 1988 to 1992 and require the release of
provisions for long-service awards established previously, is in
violation of Article 3.1 of the Basic Law (Grundgesetz – GG) to the
Federal Constitutional Court for review.
The Second Senate of the Federal Constitutional Court came to the
conclusion that § 52.6 sentences 1 and 2 of the 1990 version of the Tax
Reform Act of 25 July 1988 that was in effect up to and including 1998
was compatible with Basic Law and in particular with Article 3.1 GG. The
Senate reasoned that the statutory regulation deviates from the general
principle to the effect that the determination of taxable income is
subject to the principle of prudence that applies under commercial law,
but such deviation, in any case in respect of provisions for contingent
liabilities, is amenable only to restrained constitutional review as
regards the requirements ensuing from the prohibition of arbitrary
treatment. As far as substantive content is concerned, the statutory
regulation is not arbitrary and lies within the broad scope of
legislative operating latitude; there is also no evidence of unequal
treatment in violation of the Basic Law as regards timing.
In essence, the decision is based on the following considerations:
Deviation of tax law from the standard of the principle of prudence
called for under commercial law in connection with the determination of
taxable income is in violation of the requirement that follows from
Article 3.1 GG to the effect that the construction of decisions
pertaining to imposition under tax law must be consistent only if an
objective reason for such deviation is lacking and the “special
provision” under non-constitutional law is for that reason to be
considered arbitrary. The requirement of consistency that follows from
the legal principle of equality limits the authority of the (fiscal)
legislature to decide central issues regarding equitable distribution of
the tax burden with extensive freedom from constraint. Constitutional
law, and in particular the fundamental rights of taxpayers, constitutes
in this case only a general framework for the far-reaching operating
latitude of the legislature. In the construction of decisions in respect
of the distribution of the tax burden, the constitutional requirements
of consistency and proportionality do, however, bind the exercise of
legislative freedom to an adequate measure of rationality and balance.
Insofar as it is also necessary to develop “convincing” dogmatic
structures through systematically consistent and practicable
construction of fact, this is left to the discretion of the legislature
and the competent courts. It is not the task of the Federal
Constitutional Court to review and guarantee the “correctness” of
solutions to complex dogmatic issues of dispute such as may be, and are
in any case in the area of provisions, typical of many areas of
legislation governing accounting for tax purposes.
The individual provisions of law involved in the construction of fiscal
fact that are not necessarily relevant as regards constitutional law
include decisions of the fiscal legislature concerning restriction of
the principle of congruency and the establishment of provisions for
contingent liabilities in keeping with the principle of prudence
pursuant to commercial law.
The temporary retention of the application of the law as practiced under
the guidance of the highest fiscal court for many years prior to the
change in the case-law effected by the judgment of the Federal Finance
Court of 5 February 1987 – IV R 81/84 (Collection of the decisions of
the Federal Finance Court (Sammlung der Entscheidungen des
Bundesfinanzhofs – BFHE 149, 55) – was not arbitrary either in terms of
substantive content or timing. By disallowing the establishment of
provisions for long-service awards in the years 1988 to 1992 and
requiring the release of provisions previously established over the
period of three years from 1988 to 1990, the legislature extended for a
further five years the administrative practice based on the case-law of
the highest fiscal court that had been in place for decades.
Independently of whether the more recent case-law of the Federal Finance
Court is to be welcomed as a significant gain in systematic clarity and
consistency, especially because of the judgment in the year 1987, it
cannot be assumed that the reasons advanced in the previous case-law for
disallowing provisions for long-service awards were arbitrary within the
meaning of the Basic Law.
In view of the way the law was applied in practice for many years,
without arbitrariness and on grounds provided by the highest fiscal
court, the reaction of the legislature to the shift in the case-law of
the highest fiscal court to recognition of provisions for long-service
awards in the year 1987, which was expected to result in a significant
revenue shortfall, did not exceed its broad operating latitude. Not
least of all to protect fiscal interests, the legislature had the right
to maintain, for the time being – up to the entry into force of a basic
statutory reform of the legal situation –, the old legal practice in
force through temporary disallowance of provisions and the simultaneous
gradual release of existing provisions.
The progressive legislative reaction to the change in the case-law of
the highest fiscal court also does not result in a violation of the
general equality provision of Article 3.1 GG as regards its timing. The
same reasons that preclude inference of an arbitrary substantive
conflict from the timing of the progressive reaction of the legislature
to the decision of the Federal Finance Court also preclude the
presumption of a violation of Article 3.1 GG in respect of timing. The
commencement of the disallowance of provisions and the requirement that
they be released in the year 1988 was the direct reaction to the
decision of the Federal Finance Court in the year 1987, and the end of
the disallowance when the reform started to be applied as of the year
1993 reflected the interest in handling the legal situation in a manner
that would spare the budget. This fiscal interest in retaining an “old”
legal situation that was not arbitrary for a limited period of time in
conjunction with the goal of creating a uniform initial situation for
the reform that would be conducive to equality delivers adequate
objective grounds for the concomitant unequal treatment as regards
timing.
The regime pursuant to § 52.6 sentences 1 and 2 EStG (old version)
submitted for review contained no constitutionally prohibited
retroactive effect that violates the principle of legitimate expectation
under the rule of law that follows from Article 2.1 in conjunction with
Article 20.3 GG. A legitimate expectation could result neither from the
initially inconsistent case-law of the Federal Finance Court nor from
the fact that a change in the case-law due to significant changes in the
factual or legal situation was obviously required and to be expected.
The time that elapsed between publication of the judgment of the Federal
Finance Court of 5 February 1987 and the 1990 Tax Reform Act that was
enacted on 25 July 1988 and went into effect on 3 August 1988 also
provided no grounds for the existence of a legitimate expectation since
an objective observer could not have anticipated that the legal
situation that has since been clarified by the Federal Court of Finance
would remain as it was.
This press release is also available in the original german version.
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