Cross-border Loss Utilization Concerning the Tax Treatment of a Taxpayer’s Own Losses Attributable to a Permanent Establishment in Relation to the Territoriality Principle –From an International and EU law Perspective

Abstract: The European Commission has acknowledged the lack of cross-border utilization of losses. Companies operating internationally want to have a possibility to offset losses against taxable profits at the same time or as soon as possible after the losses incurred. If no such possibility is at hand, a cash-flow disadvantage arises and also, it leads to segmentation of the internal market. The asymmetries occur while Member States enjoy sovereignty and a broad competence to levy taxes and determine the geographical extent of their tax jurisdiction. Member States are competent to apply a territorial taxation system and thereby limit the utilization of companies’ losses in cross-border situations. However, the meaning of territorial taxation differs depending on if it is seen from an international law or international tax law perspective. The European Court of Justice recognises a territorial taxation system from an international law perspective. This includes a right for the Member States to tax residents on their worldwide income and non-residents on their territorial income. Member States limit cross-border utilization of losses in order to preserve their tax bases. A territorial tax system can be achieved in two different ways. The first is by a definition of the tax base for income tax purposes, i.e. by limiting the tax base to locally sourced income and capital. The second is by exempting foreign-sourced income through unilateral, bilateral or multilateral conventions. The issue arises when Member States apply a double taxation convention with the exemption method. In that case, there is no possibility to utilize the losses in either the host State or the home State. However, the European Court of Justice may in certain situations require Member States to make it possible to utilize cross-border losses, whereas in other situations the European Court of Justice has recognised Member States sovereignty by stating that Member States do not need to utilize cross-border losses. In the latter situation, the European Court of Justice recognises Member States sovereignty and it may express an underlying principle, in terms of territoriality. The examination implies that the territoriality principle is more a consequence of Member States sovereignty than a self-supporting principle. Furthermore, the concept of territoriality falls into the background of other conceded concepts, such as the balanced allocation of taxing powers and symmetry. Yet, the concept of territoriality is still evolving within the European Union and will certainly be affected by the growing work on international level. When evolving the concept of territoriality, the European Union has to find a balance between the concept of an internal market and the Member States’ sovereignty. At the moment, the European Court of Justice recognises the Member States’ sovereignty even if it contradicts the concept of an internal market. Thus, cross-border losses attributable to permanent establishments are stranded when the Member States apply the exemption method in their double taxation conventions. In order for the territoriality principle to be a self-supporting principle it needs to get a clear definition and a consistent applicability.