OPINION OF ADVOCATE GENERAL

STIX-HACKL

delivered on 15 December 2005 1(1)

Case C-386/04

Centro di Musicologia Walter Stauffer

v

Finanzamt München für Körperschaften

(Reference for a preliminary ruling from the Bundesfinanzhof, Germany)

(Tax law – Corporation tax – Tax exemption for charitable foundations established under private law – Residence requirement)

I –  Introduction

1.        In this case the Court is essentially required to ascertain the extent to which a foreign foundation which satisfies national requirements governing charitable status may, on account of the location of its seat, be treated less favourably than a similar domestic foundation for the purposes of direct taxation in respect of the taxation of certain domestic income.

II –  Legal framework

A –    Provisions of Community law

2.        The provisions of Community law on which an interpretation is being sought are Articles 52, 58, 59, 66 and 73b of the EC Treaty.

B –    National law

3.        The relevant provisions of the German Körperschaftsteuergesetz (Law on Corporation Tax) (KStG) (2) read as follows:

‘Paragraph 2: Limited tax liability

The following shall be subject to limited liability to corporation tax:

1.      corporations, associations of persons and bodies of assets neither managed nor established in Germany, on their domestic income …

Paragraph 5: Exemptions

(1) The following shall be exempt from corporation tax:

…

9.      corporations, associations of persons and bodies of assets which, under their statutes, act of foundation or other constitution and under their de facto management, pursue exclusively and directly charitable, benevolent or religious objects (Paragraphs 51 to 68 of the Abgabenordnung (Tax Code)). If commercial activities are undertaken, tax exemption shall be excluded. The second sentence shall not apply to self-managed forestry activities;

…

(2) The exemptions under subparagraph 1 shall not apply to:

…

3.      persons with limited tax liability within the meaning of Paragraph 2(1).

Paragraph 8: Determination of income

(1)      The provisions of the Einkommensteuergesetz (Law on Income Tax) and of this Law shall determine what is to be regarded as income and the way in which income is to be determined … .’

4.        The relevant provisions of the German Einkommensteuergesetz (EStG) read as follows:

‘Paragraph 21: Rental

(1) The following shall be rental income:

1.      income from rental of immovable property, in particular land, buildings, parts of buildings, … .

Paragraph 49: Income subject to limited tax liability

(1) The following shall be domestic income for the purposes of limited income tax liability (Paragraph 1(4))

…

6.      rental income (Paragraph 21), where the immovable property, conglomerations of property or rights are located … in Germany … .’

III –  Facts and proceedings

5.        The applicant, the Centro di Musicologia Walter Stauffer (hereinafter referred to as ‘the foundation’) is a foundation established under Italian law which has its seat in Italy.

6.        The foundation owns commercial premises in Munich and receives rental income from those premises, on which the Finanzamt München (Munich Tax Office, hereinafter referred to as ‘the defendant tax office’) charged corporation tax for the 1997 tax year. The foundation does not have commercial premises of its own or a registered branch establishment in Germany. Nor does it not operate through a German subsidiary. The services in connection with the rental of the real property are provided by a German property management agent.

7.        Under its statutes in the version in force for the year at issue, 1997, the foundation pursues purposes exclusively in the fields of education and training by supporting instruction in the classical methods of production of stringed instruments, the history of music and musicology in general. The foundation may endow one or more scholarships to enable Swiss young people, preferably from the city of Berne, to reside in Cremona during the entire period of instruction.

8.        The reference for a preliminary ruling from the Bundesfinanzhof (Federal Finance Court, Germany) is based on the assumption that in the year at issue the foundation pursued charitable objects and satisfied the requirements with regard to company statutes for tax exemption under the first sentence of Paragraph 5(1)(9) of the KStG, whilst partial liability to tax on that income under the second and third sentences of Paragraph 5(1)(9) of the KStG did not arise, because the letting did not extend beyond property management and was not therefore a commercial activity.

9.        The Bundesfinanzhof points out in particular that the promotion of the interests of the general public within the meaning of Paragraph 52 of the German Abgabenordnung (AO 1977) does not require the promotion to be undertaken for the benefit of German residents or nationals.

10.      In the view of the Bundesfinanzhof, the one point which is unclear from the background provided by the first instance court is whether the foundation also satisfies the requirements as to its de facto management, and in particular, whether it uses the resources it receives quickly for its statutory objects, which are eligible for tax relief. The Bundesfinanzhof is considering referring the matter back to the Finanzgericht in this respect.

11.      Since, because its seat and management are in Italy, the foundation receives the rental income against the background of its limited tax liability under Paragraph 49(1)(6) of the EStG in conjunction with Paragraph 21 of the EStG and Paragraphs 2(1) and 8(1) of the KStG, Paragraph 5(2)(3) of the KStG (now Paragraph 5(2)(2) of the KStG) applies, in the view of the Bundesfinanzhof; this provides that tax exemption does not apply to taxpayers with limited tax liability. The foundation would therefore be liable to pay tax on the domestic income from the rental of the commercial premises.

12.      The challenge brought by the foundation against the assessment for corporation tax was rejected by the Finanzgericht München (Finance Court, Munich). The foundation thereupon lodged an appeal on a point of law with the Bundesfinanzhof, which has doubts whether the exclusion of non-resident corporations from the tax exemption under Paragraph 5(2)(3) of the KStG complies with the requirements of Community law. The Bundesfinanzhof considers that there may be a breach of the principles of freedom of establishment, freedom to provide services and/or the free movement of capital.

13.      In particular, the Bundesfinanzhof takes the view that the applicability of the fundamental freedoms is not precluded in the present case by the fact that the second paragraph of Article 48 EC requires companies or firms to be ‘profit-making’. In its view, this means not only the intention to maximise profits, but also any economic activity that is carried on for the purposes of profit and in exchange for a consideration. From this perspective, the rental of real property, as in the present case, could also be seen as profit-making in this sense.

14.      The referring court also has doubts whether the difference in treatment between charitable foundations established in Germany and those established abroad can be justified under the cohesion principle. The cohesion principle states that tax exemption should be the correlate to the charitable objects. The charitable nature of a foreign foundation which pursues its objects abroad may not benefit Germany. However, the Bundesfinanzhof stresses that Paragraph 52(1) of the AO 1977 does not make the recognition of charitable status for tax purposes dependent on the promotion of the interests of the general public in Germany. From that point of view, the presumed correspondence between the crediting of an advantage and tax exemption in German tax law appears not to depend on charitable status, but on whether tax liability is limited or unlimited or whether the foundation in question has its seat in Germany or abroad, which is no longer cohesive.

15.      By order of 14 July 2004 the Bundesfinanzhof decided to stay the proceedings and made reference to the Court of Justice for a preliminary ruling on the following question:

‘Is it contrary to Article 52 EC, in conjunction with Article 58 EC, Article 59 EC, in conjunction with Articles 66 EC and 58 EC and Article 73b EC, for a charitable foundation established under private law in another Member State, with limited liability to tax on its rental income in Germany, unlike a charitable foundation established in Germany, with unlimited liability to tax and receiving similar income, not to be entitled to exemption from corporation tax?’

IV –  The question referred for a preliminary ruling

16.      First of all, it is necessary to consider the discussion regarding the basic applicability of the fundamental freedoms, which is controversial because of the charitable nature of the foundation in question (A). It should then be examined which fundamental freedom should be applied in respect of income obtained from the rental of a property in a Member State other than the one in which the foundation has its seat (B). After clarifying these preliminary questions, consideration should then be given to the issue of the restriction of any fundamental freedoms that might be relevant (C). Lastly, if it is found that there is a restriction of one or more fundamental freedoms which is relevant from the point of view of Community law, possible justifications should be examined (D).

A –    The basic applicability of the fundamental freedoms

1.      Main arguments of the parties

17.      The Federal German Government takes the view that the fundamental freedoms do not apply at all because the German tax rules on charitable institutions have a social normative content. The Court has held that such rules are applicable to foreign Community citizens only where there is a sufficiently close connection between the Community citizen and the Member State in question, which is not the case here.

18.      The defendant, the Finanzamt München, adds that the law governing foundations falls within the ambit of regional cultural policy, an area in which the European Union may not take harmonisation measures. The same also applies to education policy.

19.      The Chief State Solicitor of Ireland essentially argues that the provisions of the EC Treaty which protect and guarantee the four freedoms cannot have any bearing on the effect of recognition of charitable status for tax purposes in a Member State. In addition, the application of the fundamental freedoms requires an institution to carry on activities which serve economic profit-making purposes.

20.      On the other hand, the Commission stresses that the social policy motivation behind the tax rules at issue does not preclude the applicability of the EC Treaty. The foundation argues that the lack of harmonisation of charity or taxation law at Community level does not preclude the applicability of the fundamental freedoms. The Court has consistently held that the legislative powers retained by the Member States must also be exercised with due regard to the fundamental freedoms.

2.      Legal assessment

21.      The first point to be made is that, according to the Court’s settled case-law, although direct taxation does not as such fall within the purview of the Community, the powers retained by the Member States must nevertheless be exercised consistently with Community law. (3)

22.      The social policy objective of the national rules in question, which is underlined by the Federal German Government, cannot call into question the basic applicability of the fundamental freedoms either. The Commission stressed, correctly in my view, that the derogation under Paragraph 5(1)(9) of the KStG does not constitute a social advantage, but is a tax derogation introduced on social policy grounds.

23.      Even if, as the Federal German Government argues, the provision in question were to be classified as a social advantage – quod non – it should be borne in mind that the Court takes the view that Community law also applies in principle in that area. In the judgments in Cases C‑120/95 (4) and C‑158/96, (5) the Court held that ‘in the absence of harmonisation at Community level … it is therefore for the legislation of each Member State to determine, first, the conditions concerning the right or duty to be insured with a social security scheme … and, second, the conditions for entitlement to benefits’, but that ‘the Member States must nevertheless comply with Community law when exercising those powers’, with the result that the fact ‘that the national rules at issue in the main proceedings fall within the sphere of social security cannot exclude the application of Articles 59 and 60 of the Treaty’. I therefore stand by the view I took in my Opinion of 12 May 2005 in Case C‑512/03 Blanckaert, (6) according to which the categorisation of a rule as tax law or social security law does not affect the requirement to exercise powers in accordance with Community law principles.

24.      An institution’s contribution to the attainment of social policy objectives does not in principle preclude the applicability of Community law; the crucial factor is whether the institution carries on an economic activity. (7)

25.      It must now be examined which fundamental freedom is to be applied.

B –    The relevant fundamental freedoms

1.      Main arguments of the parties

26.      The foundation takes the view that the activity of the property management agent who manages the commercial property should be attributed to it as a permanent presence in Germany. The management of its building therefore falls within the scope of freedom of establishment. In the event that the Court does not share this view, its activity should be seen from the perspective of freedom to provide services, since it provides a cross-border service for a consideration. In any case, however, its economic activity is covered by the free movement of capital, since Annex I of Council Directive 88/361/EEC of 24 June 1988 for the implementation of Article 67 of the Treaty (repealed by the Treaty of Amsterdam) (8) sets out a nomenclature of capital movements and the realisation of income is classified as a capital movement within the meaning of Point II(A), which refers to investment in real estate on national territory by non-residents. In the explanatory notes for that nomenclature, such investments are defined as purchases of buildings and land by private persons for gain or personal use.

27.      The Commission, on the other hand, does not think that freedom to provide services is applicable. The foundation does provide a cross-border service for a consideration, but freedom to provide services is of subsidiary importance compared with the free movement of capital, which is relevant in the present case. Contrary to the view taken by the foundation, the Commission further argues that the present case does not fall within the scope ratione materiae of freedom of establishment, since the rental of the property in Germany does not extend beyond property management and is not therefore a commercial activity for the purposes of freedom of establishment.

28.      The defendant tax office, the Government of the United Kingdom and – in the alternative – the Federal German Government and the Chief State Solicitor of Ireland claim that Article 58 of the EC Treaty (now Article 48 EC) is to be interpreted as excluding from the scope of Articles 52 and 59 of the EC Treaty (now Article 49 EC) all legal entities whose statutes specify that they are non-profit-making, irrespective of whether or not they carry on economic activities. The Government of the United Kingdom believes that its view is confirmed by the judgment in Case C‑174/00 (9) and adds that the Court distanced itself from the diverging proposal made by Advocate General Cosmas in his Opinion of 28 January 1999 in Case C‑172/98. (10)

29.      The defendant tax office submits in this connection that the term ‘profit-making’ within the meaning of Article 58(2) of the EC Treaty is to be interpreted as going further than merely acting as an ‘operator on the market’, since it relates to the internal structure of the organisation in question. The crucial factor is whether, according to its objects and its statutes, the foundation is also geared to realising positive income. Article 58(2) of the EC Treaty allows Member States to prevent distortions of competition which might arise where non-profit-making associations compete with undertakings.

30.      In the view of the Government of the United Kingdom, the facts of the case as described by the national court do not indicate that the free movement of capital under Article 73b of the EC Treaty is affected.

31.      The Italian Government, on the other hand, takes the view that this case falls directly within the scope of the provisions of the EC Treaty on freedom of establishment and freedom to provide services. The contested German rules are also contrary to the principle of the free movement of capital, because legal persons not established in Germany could be deterred from investing there.

2.      Legal assessment

a)      Introductory remarks

32.      In its question, the German Bundesfinanzhof refers to the provisions of the Treaty concerning freedom of establishment, freedom to provide services and the free movement of capital. Since freedom to provide services is subsidiary to the other two fundamental freedoms under Article 60(1) of the EEC Treaty (now Article 50(1)EC), it is to be examined only if neither freedom of establishment nor free movement of capital is applicable in the present case.

33.      With regard to freedom of establishment, it should be noted, first of all, that the parties have made detailed submissions on the interpretation of the second paragraph of Article 58 of the EC Treaty (now the second paragraph of Article 48(2) EC) in so far as that provision excludes persons governed by private law which are non-profit-making from the scope ratione personae of freedom of establishment, and in conjunction with Article 66 of the EC Treaty (now Article 55 EC), of freedom to provide services. It is possible, however, to clarify whether and to what extent a charitable foundation is profit-making only if the foundation’s contested rental activity falls within the scope ratione materiae of freedom of establishment.

34.      The question which must first be clarified is therefore whether the national rules at issue are to be assessed with reference to freedom of establishment and/or the free movement of capital. If the activity carried on by the foundation in Germany falls within the scope ratione materiae of one or both of these freedoms, it would lastly have to be considered whether the foundation belongs to the group of persons covered by the freedom in question.

b)      Differentiation between freedom of establishment and the free movement of capital

35.      There is a close connection between the provisions governing freedom of establishment and those governing the free movement of capital, as can be seen from the reciprocal reservations contained in Article 48(2) of the EC Treaty (now Article 58(2) EC) and the second paragraph of Article 52 of the EC Treaty (now Article 43(2) EC).

36.      The Court has addressed the differentiation between the two fundamental freedoms in a number of decisions. In its existing case-law it has taken the view that freedom of establishment and the free movement of capital apply in parallel. That case-law is based on the premise that the provisions governing the movement of capital exclude the parallel application of other fundamental freedoms only in cases where measures specifically regulate capital flows. If, however, capital flows are affected indirectly because the exercise of an economic activity in another Member State is made more difficult, the fundamental freedom applicable to the activity in question also applies in any case. (11)

37.      The free movement of capital and freedom of establishment overlap in particular where national legislation concerns direct investment, for example in the form of participations, (12) or the acquisition of property with a view to carrying on a cross-border profit-making activity. (13)

38.      It follows from Article 54(2)(e) of the EC Treaty (now Article 44(2)(e) EC), first of all, that freedom of establishment also covers the acquisition of commercially-used real property required for that purpose. Secondly, investment in real property constitutes a capital movement within the meaning of the nomenclature of capital movements in Annex I to Directive 88/361 and since that nomenclature still has indicative value in the Court’s case-law for the purposes of defining the notion of capital movements under Article 776 et seq. of the EC Treaty (now Article 56 et seq. EC), (14) an investment in real property also falls within the scope of the free movement of capital.

39.      As far as any competition between the free movement of capital and freedom of establishment is concerned, the criteria of differentiation developed by the Court may be summarised as follows:

(1) The cross-border acquisition of real property is essentially always an investment of capital, which is therefore protected under the rules governing movement of capital, irrespective of the purpose of acquisition. (15)

(2) Where the acquisition of property is necessary in order to exercise a permanent profit-making activity in another Member State, such acquisition is also protected by freedom of establishment. (16) (17)

40.      Against this background, it must be examined whether the acquisition of property by a non-resident at issue in the main proceedings – on the basis of the criteria of differentiation previously set out – falls within the scope ratione materiae of the free movement of capital and/or freedom of establishment.

i)      Scope ratione materiae of the free movement of capital

41.      The present case falls within the scope ratione materiae of the free movement of capital because the foundation, which is established in Italy, acquired a property in Germany and the purchase of real estate on national territory by non-residents constitutes a capital movement within the meaning of Article 1 of Directive 88/361 and the nomenclature of capital movements contained in that directive. (18)

ii)    Scope ratione materiae of freedom of establishment

42.      For freedom of establishment to apply materially in addition to the free movement of capital, the property in Germany would have to be used by the foundation as a fixed establishment in order to carry on a profit-making activity. (19)

43.      It should first be stated in this connection that the real property acquired in Germany is rented out by the foundation and does not constitute an addition to an existing establishment, but is the foundation’s main activity in Germany. (20)

–       A permanent, autonomous profit-making activity?

44.      It must first be considered whether renting out a property as in the main proceedings actually constitutes a profit-making activity.

45.      In its observations, the Commission stated that this is not the case because renting out a property extended no further than property management under German law and thus does not constitute an autonomous commercial activity.

46.      That view cannot be shared. Renting out properties under Paragraph 14 of the AO 1977 is actually only property management and not a commercial activity. However, the interpretation of a concept of Community law cannot essentially be based on national rules. The fact that the spirit and purpose of that national provision has no connection with freedom of establishment, which is to be interpreted in the present case, also suggests that the German tax rules are not relevant.

47.      Paragraph 14 of AO 1977 evidently seeks to accord tax advantages to revenue from property rental, which is generally modest compared with revenue from a commercial activity. On the other hand, freedom of establishment seeks to protect any economic operator in the Common Market against discrimination and the scale of the economic activity in question is irrelevant unless it is a completely trivial and subsidiary activity. The broader the interpretation of the notion of profit-making activity in Community law, the larger the group of persons covered, with the result that the Court’s broad interpretation of the concept of profit-making activity is not surprising against this background. (21)

48.      Legal persons which, as in the present case, do not seek to maximise their profits, may also therefore carry on a profit-making activity. (22) Even though, as a charitable foundation, the foundation may not seek to maximise its profits in renting out the property, its rental activity is an activity for a consideration and thus constitutes participation in economic life, which is not completely insignificant. As a result, renting out the property in Munich is an autonomous profit-making activity for the purposes of freedom of establishment.

49.      The criterion of permanence is thus also satisfied.

–       Existence of a fixed establishment?

50.      The foundation does not have commercial premises of its own, or therefore a fixed establishment, in Germany. The services in connection with the rental of the property are, according to the documents before the Court, provided by a German property management agent. The question therefore arises whether the activity of the property management agent may be attributed to the foundation as a permanent presence.

51.      In the ‘insurance case’ (23) the Court held that that an undertaking is to be regarded as established even if its presence in another Member State consists merely of an office managed by a person who is independent but authorised to act on a permanent basis for the undertaking, as would be the case with an agency.

52.      However, in such cases there must be an exclusive or predominant link