Federal Constitutional Court - Press office -
Press release no. 66/2010 of 7 July 2010
Order of 19 August 2010 – 2 BvL 1/03, 2 BvL 57/06, 2 BvL 58/06 –
Decision regarding retroactive effect in tax law III:
Reduction of the relief for compensation of loss of income past
or present partly unconstitutional
The annual collection of income tax and the progression of the income
tax scale can lead to a distortion of progression if income accrues
which is combined in one year but constitutes economic yield from
several assessment periods. A considerable share of the income is then
taxed at a higher rate of tax than would have been the case were the
income to be spread over several assessment periods without the
financial capacity of the taxpayer being correspondingly assessed
higher. This problem of possible distortions of burdens is taken into
account by § 34 of the Income Tax Act (Einkommensteuergesetz – EStG)
through a tax reduction for “extraordinary” income, including amongst
other things compensation to substitute for loss of income past or
present (§ 24 no. 1 (a) EStG).
Until the end of 1998, a reduced tariff applied to extraordinary income
which was only half the average rate of the taxpayer’s tax. This was
particularly favourable for those on a high income for whom the income
would have been subject to the top rate of tax, even had it not accrued
in combination. After various amendment initiatives had initially been
unsuccessful, after the change of government which took place in 1998,
the half average rate of tax was replaced by the “fifths arrangement”
according to § 34.1 EStG in the version of the Tax Relief Act
1999/2000/2002, which was introduced to the Bundestag on 9 November 1998
and promulgated on 31 March 1999. Accordingly, extraordinary income is
taxed at the rate of tax which would have been applied with regard to
the progressive tariff if one-fifth of it had each accrued on a pro rata
basis in five assessment periods. According to § 52.47 EStG, the new
regulation applied from the 1999 assessment period onwards, but –
retroactively – also included compensation which had been agreed prior
to the promulgation of the new provision.
As employees, the plaintiffs of the three sets of initial proceedings
received settlements in the assessment period 1999 because of the
termination of their employment relationship which in each case were
disbursed in January and March 1999, respectively, and thus prior to the
promulgation of the new provision. Some of the underlying termination
agreements had already been concluded before the draft Bill was
introduced (in October 1996 and July 1998, respectively), but one not
until afterwards (in November 1998). In all cases, the tax office
applied the fifths arrangement in place of half the average rate of tax,
which resulted in an additional tax liability of roughly 5,000, 20,000
and 62,000 DM, respectively. The actions that were lodged each led to a
submission by the Federal Finance Court (Bundesfinanzhof).
In the proceedings on the constitutionality of a statute, which were
combined to form a joint ruling, the Second Senate of the Federal
Constitutional Court (Bundesverfassungsgericht) ruled that the
retroactive application of the fifths arrangement according to § 34.1 in
conjunction with § 52.47 EStG in the version of the Tax Relief Act
1999/2000/2002, is partly unconstitutional because of a violation of the
constitutional principles of the protection of legitimate expectations.
In essence, the decision is based on the following considerations:
A “real” retroactive effect, which is not permissible as a matter of
principle, in which the statutory legal consequences are to already
apply prior to the time of the promulgation to taxable events which have
already been completed (“retroactive impact of legal consequences” –
Rückbewirkung von Rechtsfolgen), does not apply. The fifths arrangement
is not applied until from the assessment period still running at the
time of the amendment, i.e. to compensation payments accrued from 1
January 1999 onwards. However, an “unreal”, de facto retroactive effect
applies where the underlying agreement had already been concluded at the
time of the promulgation of the new provision on 31 March 1999 because
the application of the fifths arrangement is attached to a past event in
this respect. This is not prohibited as a matter of principle, but is
only compatible with the principles, in terms of fundamental rights and
the rule of law, of the protection of legitimate expectations if the
retroactive attachment is suitable and necessary to promote the purpose
of the statute and if the bounds of reasonableness are not overstepped
in an overall weighing up between the import of the disappointed
expectation and the urgency of the grounds justifying the legal
amendment. This being the case, the application of the fifths
arrangement (in place of the half average rate of tax) violates the
constitutional principles of protection of legitimate expectations where
it also covers compensation which had been agreed in 1998, but prior to
the introduction of the new provision in the Bundestag or – if the
agreement is older or newer – had at least been disbursed prior to the
promulgation of the new provision.
Confidence in the application of the half average rate of tax at the
time of the conclusion of the compensation agreement merits
constitutional protection as a matter of principle. The net amount
anticipated after tax is at least for the employee as a rule the basis
for entering into the termination agreement. As the initial cases show,
the transition to the fifths arrangement leads to a worsening of
considerable significance. The grounds put forward by the legislature
for the new provision do not justify evaluating this as acceptable. The
interest in broadening the basis for assessment for financing to
compensate for tax cuts made elsewhere does not have any sufficient
weight since this purpose does not go beyond a general need for finance,
and hence is unable to prevail over the protection of legitimate
expectations of the taxpayers affected. The goal of reducing
advantageous effects which overshoot the goal in breach of the purpose
of the half average rate of tax with those on a higher income is also
unable to justify refusing to provide protection of legitimate
expectations. This also refers only to a general interest in a legal
amendment, but not to grounds for retroactive inclusion, since the
favouring effects of the half average rate of tax were known to the
legislature and had been largely accepted by it in the past.
Insofar as, however, the compensation agreement was not concluded until
after the introduction of the new provision in the Bundestag on 9
November 1998, or already before 1998, the retroactive application of
the fifths arrangement is not objectionable as a matter of principle,
given that in such cases the import of the disappointed confidence is to
be assessed as being less significant. The introduction of the draft
Bill in the Bundestag already gave concrete expression to the legal
amendment, so that those concerned by a compensation agreement not
concluded until after this time were able to allow for it. It is not
unreasonable to expect the taxpayer to obtain information on ongoing
legislative proceedings. Particularly in connection with the conclusion
of specific agreements of some economic import, which includes
settlement payments, it is customary, expedient and as a rule can also
be expected to consult professional advice on their fiscal consequences.
Compensation agreements are also less eligible for protection which were
already concluded in 1997 or earlier, but which did not provide for
disbursement until 1999 or later. Where possible expectations with
regard to the continued application of the old law go beyond the year
after the agreement, i.e. two or more changes of assessment period lie
between agreement and disbursement, the taxpayer should have
independently considered the possibility of future legal amendments and
made allowance for this through contractual adjustment clauses. For this
reason, in these cases the legitimate interests of the legislature in
carrying out amendments suffice to justify a disappointment of the
confidence in the future continuation of the law at the time of
conclusion of the compensation agreements.
The situation is however different in these cases if the compensation
accrued to the taxpayer prior to the entry into force of the new
provision on 31 March 1999. In this constellation this constitutes
income still made under the application of the old law. Even if the
confidence exercised on conclusion of the compensation agreement was not
eligible for protection without restriction, taxpayers may when deciding
on savings, consumption or investment at any rate trust that the
legislature handing down tax legislation does not retroactively make
significant reductions to the net amount of the compensation which has
already accrued without a factual reason of adequate import. This was
also not changed by the legislative proceedings already pending at the
time of accrual. An ongoing legislative procedure does result in a
greater expectation being incumbent on the taxpayer to coordinate
dispositions with a future effect with the future law, but cannot from
the outset suspend the function of a guarantee accruing to the
applicable law until the promulgation of the new provision. Taxpayers
may also invoke this if the compensation with regard to the more
favourable older legal situation was deliberately disbursed as early as
March 1999, but the employment relationship was not terminated until
later. It does not constitute abuse as a matter of principle, but is
among the legitimate dispositions in the field of general (economic)
freedom of action protected by fundamental rights if taxpayers make
efforts to benefit from the advantages of the applicable law in view of
possible disadvantages of a future law. The retroactive application of
the new provision is in this respect also not justified by the interest
– justified as a matter of principle – to correct unwelcome
“competition” between the taxpayer and the legislature in view of
invoking the old law. Such a situation as may occur for instance in the
abolition of subsidies did not apply. The latter assumption is already
suggested by the fact that compensation according to § 24 no. 1 (a) EStG
is contingent on the agreement not having been brought about on a
party’s own initiative, but under considerable pressure, in particular
under that of immanent redundancy.
This press release is also available in the original german version.
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