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Decision regarding retroactive effect in tax law I: Extension of the speculation period in the case of transactions for the sale of land partly unconstitutional

Press Release No. 64/2010 of 19 August 2010

Order of 07 July 2010
2 BvL 14/02

Under the law applicable until 31 December 1998, gains from private transactions for the sale of land were liable to income tax if the period between acquisition and sale was shorter than two years ("speculative transactions"). After the change of government which took place in 1998, the period until sale was extended to ten years by the 1999/2000/2002 Tax Relief Act (Steuerentlastungsgesetz), promulgated on 31 March 1999 (§ 23.1 sentence 1 no. 1 of the Income Tax Act (Einkommensteuergesetz - EStG)). According to § 52.39 sentence 1 EStG, the new period applied for the first time from the 1999 assessment period onwards, but - retroactively - also covered land that had already been acquired where the contract on the sale was not concluded until 1999 (or later).

The plaintiffs of the three sets of initial proceedings sold their land which they had acquired in 1990 and 1991, respectively, in 1999, after the expiry of the old period until sale, but within the new one, the underlying contracts in some cases already having been concluded prior to the promulgation of the new law (on 26 February and 16 March 1999, respectively), but in another case not until afterwards (on 22 April 1999). The tax office applied the new period until sale in all cases and allocated the capital gains to the taxable income. The actions lodged led to the submissions made by Cologne Finance Court (Finanzgericht) and by the Federal Finance Court (Bundesfinanzhof), respectively, to the Federal Constitutional Court (Bundesverfassungsgericht).

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 ruled that § 23.1 sentence 1 no. 1EStG, in conjunction with § 52.39 sentence 1 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. By contrast, the extension of the period until sale to ten years as such is not constitutionally objectionable.

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 extended period until sale is not applied until from the assessment period still running at the time of the amendment, i.e. to capital gains accrued from 1 January 1999 onwards. However, an "unreal", de facto retroactive effect applies where the land had already been acquired at the time of the promulgation of the new provision on 31 March 1999 because the application of the extended period until sale 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. The retroactive extension of the period until sale is only partly compatible with this.

Where the previously applicable two-year speculation period had not yet expired at the time of the promulgation, its extension does not encounter any constitutional objections. The same applies where the old period had already expired, but only those value increases are liable for tax which did not occur until after the promulgation of the new provision. The decision to acquire a plot of land may be materially determined in an individual case by the expectation of being able to realise any capital gains free of tax after two years. The mere possibility of gains subsequently accruing free of tax however does not give rise to a position which is protected by law on grounds of legitimate expectations. It is not possible to expect value increases with certainty at the time of acquisition, so that the disappointment of the hope of future tax-free asset increases also cannot be regarded as an impairment of tangible assets.

The application of the extended speculation period, however, violates the constitutional principles of protection of legitimate expectations and is null and void insofar as a value increase which had already accrued at the time of the promulgation is made subject to tax, even though it had already been realised under the law previously applicable, or at least could have been realised free of tax until promulgation of the new law because the old speculation period had already expired. In this respect, a concrete established asset position had already arisen the value of which is subsequently reduced by virtue of the retroactive extension of the speculation period. This furthermore leads to unequal treatment which, from the point of view of equality of burdens, requires a more exacting justification if - as in the initial proceedings - the old period had already expired as per the end of 1998. For those taxpayers who sold their land no later than 1998, the value increases made until then are tax free.

There are no sufficiently weighty reasons suitable to justify the retroactive liability under the law on income tax of value increases which had already materialised and which were acquired free of tax. Where the new provision is generally reasoned by stating that it does better justice to the principle of taxation based on economic capacity, and hence also on the principle of fiscal equity, this is significant only for the fundamental decision to allot greater significance to private capital gains, and hence to value increases of private assets, than was previously the case when assessing financial power. This goal to "improve" the legal situation designates only the general interest in a legal amendment, but is not a specific reason which is amenable to legitimise, in particular, retroactive liability to tax of value increases which have already been acquired free of tax.

The same applies to the goal, stated by the legislature, to broaden the basis for assessment for financing to compensate for spending. As a matter of principle, the intention pure and simple to increase the state's income is per se not a public interest prevailing over the protection of legitimate expectations of the taxpayers affected. This would mean that the protection of legitimate expectations vis-à-vis retroactive tightening up of the tax law would practically be a toothless tiger. Also the need to fund tax relief granted in other places with additional revenue designates only a general need to change that justifies taxing value increases from the time of promulgation, but that particularly does not also legitimise the retroactive inclusion of asset increases that have already been acquired free of tax. Also, no such legitimation emerges from the difficulty and proneness to conflict attaching to ascertaining the market price at the time of the promulgation, given that this can only justify at best rough estimates to be made when ascertaining the value, but not waiving such ascertainment altogether.

The ten-year period until sale as such is, by contrast, not constitutionally objectionable. The differently effected income taxation of value increases in taxpayers' assets is compatible with Article 3.1 of the Basic Law (Grundgesetz - GG). It is the systematic and thus correct consequence of the historically developed dualism of types of income, and is hence within the latitude accruing to the legislature when seeking sources of taxation revenue. It furthermore does not breach the general principle of equality, namely that profits from the sale of land are not liable to the reduced scale that is applicable to extraordinary income according to § 34 EStG. The concept underlying the reduced scale for gains from the sale of an establishment, part establishment or joint share in a company is that the gainful activity is terminated and the hidden reserves accumulated in a whole economic life are realised once and for all. The sale of a plot of land, by contrast, only relates to one single asset and according to the new provision only includes those hidden reserves which have accrued over a maximum period of ten years. Finally, in the interest of the clarity and manageability of the law, as well as in light of monetary policy considerations, it is constitutionally unobjectionable, as the Federal Constitutional Court has already ruled, that income tax law is based on the nominal value principle, and that the devaluation of money which has taken place in the meantime is therefore not taken into consideration when calculating the capital gains.