A tale of two rulings
There has been so much going on in the world of tax over the last few weeks that I have had a truly hard time choosing a hot topic for this week's column. After some glasses of Muga from Rioja, I decided that too much choice is certainly better than no choice at all but may still come short of qualifying as material for a good story. Although Tax Eye aspires to be informative and moderately entertaining, poor story-telling can discourage even those zealous readers who manage to get through the introduction. For this reason, I will tell you the tale of Dr. Danner.
Dr. Danner was a doctor of German and Finnish nationality who had lived and worked in Germany until 1977, when he moved to Finland. One year prior to leaving Germany, he began contributing to two German pension schemes. Once in Finland, he also began to pay contributions to a Finnish scheme.
Dr. Danner sought to deduct from his Finnish taxable income the pension insurance contributions he had paid to all three schemes. But the Finnish tax office disallowed the portion related to the German pension insurance on the basis that under Finnish law voluntary pension insurance taken out with a foreign rather than national insurance institution is not tax deductible.
The rationale behind this limitation was that the pension to be received in due course would in practice often be excluded from taxation in Finland either in case the person moves abroad and changes tax residency as a result, or because of the lack of information about the pension payments. This argument is often referred to as 'fiscal cohesion.' In other words, the tax regime regulating voluntary pension contributions should make a coherent whole, so that the deductibility of current contributions is matched with the subsequent taxation of the related pension payments.
The case was eventually brought before the European Court of Justice (ECJ). In October 2002, it ruled that the Finnish tax law provisions were contrary to Art. 59 (now, after amendment, Art. 49) of the EC Treaty, which entails the abolition of any discrimination against service providers on account of their nationality or the fact that they are established in a member state other than the one in which the service is rendered.
In the context of Dr Danner's case, disallowance of the German contributions from his Finnish taxable income was in violation of the fundamental EU freedom to provide services. It goes against the Treaty by restricting the tax deductibility of voluntary pension schemes paid to pension providers in other EU countries, i.e. Germany, while allowing such contributions to be deducted when they are paid to Finnish institutions. In order to comply with EU law, insurance premiums paid to foreign insurance companies should be allowed as a deduction in the same way as premiums paid to domestic insurance providers.
The Danner ruling (C-136/00) has far reaching consequences that are bound to hit Poland and dig deep down into the pockets of unsuspecting budget makers. It is up to Polish taxpayers to prove to the rest of the EU that they are willing to stand up to defend their fundamental rights and freedoms no less than the Dutch (who can't resist the temptation to litigate on every occasion).
Although Polish law does not impose the limitation in a straight forward way, it is accepted practice, dictated by formal guidelines issued by the ZUS (social security) authorities, that contributions to non-Polish social security schemes are not deductible for personal income tax purposes. Whereas the aforementioned Finnish provisions only refer to voluntary schemes, the Polish rules do not make a distinction in this respect and, therefore, apply to both compulsory as well as voluntary schemes.
Thus, in practice, expatriates working in Poland who continue to contribute to their home country's social security system on a compulsory or a voluntary basis are not allowed to deduct the amount of foreign-paid contributions from their Polish taxable income. No matter how you look at it, it seems unfair that contributions to the Polish ZUS should be treated as tax deductible whereas contributions paid to a non-Polish institution, for example, UK National Insurance, should be disallowed. So far, there have been limited legal means to deal with this issue, but EU accession has opened new doors of opportunity.
At this point, a worthy adversary in the tax advisory world might say: "Ha, gotcha! What about the Bachmann case?" Indeed, in the case of Bachmann (C-204/90), the ECJ accepted that restricting the deductibility of contributions paid to foreign institutions might be justified by the need to preserve the coherence of the Belgian tax system. However, under Belgian tax law, where the contributions were non-deductible, the resulting benefits were exempt from tax. In other words, there was a direct connection between deductibility of contributions and liability to tax.
The above 'fiscal cohesion' argument could not be used in the Danner case, as under the Finnish system, pensions payable by foreign institutions to Finnish residents were subject to tax irrespective of whether or not the insurance contributions paid were deducted from the taxable income of their recipients. The same applies in Poland. There is no clear- cut connection between the tax treatment of contributions and pension payouts.
In conclusion, I turn to taxpayers who make contributions to their home country social security schemes: if you have already received your May salary, you will probably have to report it and pay tax on it next month. Before you order the tax payment, think back to Dr. Danner. If you are tax equalized, you will probably care much less than you would like to admit to your employer. If you are a non-EU national, you may congratulate yourself on reading through to the end of an interesting story that will not be of much practical use to you.
Dr. Danner was a doctor of German and Finnish nationality who had lived and worked in Germany until 1977, when he moved to Finland. One year prior to leaving Germany, he began contributing to two German pension schemes. Once in Finland, he also began to pay contributions to a Finnish scheme.
Dr. Danner sought to deduct from his Finnish taxable income the pension insurance contributions he had paid to all three schemes. But the Finnish tax office disallowed the portion related to the German pension insurance on the basis that under Finnish law voluntary pension insurance taken out with a foreign rather than national insurance institution is not tax deductible.
The rationale behind this limitation was that the pension to be received in due course would in practice often be excluded from taxation in Finland either in case the person moves abroad and changes tax residency as a result, or because of the lack of information about the pension payments. This argument is often referred to as 'fiscal cohesion.' In other words, the tax regime regulating voluntary pension contributions should make a coherent whole, so that the deductibility of current contributions is matched with the subsequent taxation of the related pension payments.
The case was eventually brought before the European Court of Justice (ECJ). In October 2002, it ruled that the Finnish tax law provisions were contrary to Art. 59 (now, after amendment, Art. 49) of the EC Treaty, which entails the abolition of any discrimination against service providers on account of their nationality or the fact that they are established in a member state other than the one in which the service is rendered.
In the context of Dr Danner's case, disallowance of the German contributions from his Finnish taxable income was in violation of the fundamental EU freedom to provide services. It goes against the Treaty by restricting the tax deductibility of voluntary pension schemes paid to pension providers in other EU countries, i.e. Germany, while allowing such contributions to be deducted when they are paid to Finnish institutions. In order to comply with EU law, insurance premiums paid to foreign insurance companies should be allowed as a deduction in the same way as premiums paid to domestic insurance providers.
The Danner ruling (C-136/00) has far reaching consequences that are bound to hit Poland and dig deep down into the pockets of unsuspecting budget makers. It is up to Polish taxpayers to prove to the rest of the EU that they are willing to stand up to defend their fundamental rights and freedoms no less than the Dutch (who can't resist the temptation to litigate on every occasion).
Although Polish law does not impose the limitation in a straight forward way, it is accepted practice, dictated by formal guidelines issued by the ZUS (social security) authorities, that contributions to non-Polish social security schemes are not deductible for personal income tax purposes. Whereas the aforementioned Finnish provisions only refer to voluntary schemes, the Polish rules do not make a distinction in this respect and, therefore, apply to both compulsory as well as voluntary schemes.
Thus, in practice, expatriates working in Poland who continue to contribute to their home country's social security system on a compulsory or a voluntary basis are not allowed to deduct the amount of foreign-paid contributions from their Polish taxable income. No matter how you look at it, it seems unfair that contributions to the Polish ZUS should be treated as tax deductible whereas contributions paid to a non-Polish institution, for example, UK National Insurance, should be disallowed. So far, there have been limited legal means to deal with this issue, but EU accession has opened new doors of opportunity.
At this point, a worthy adversary in the tax advisory world might say: "Ha, gotcha! What about the Bachmann case?" Indeed, in the case of Bachmann (C-204/90), the ECJ accepted that restricting the deductibility of contributions paid to foreign institutions might be justified by the need to preserve the coherence of the Belgian tax system. However, under Belgian tax law, where the contributions were non-deductible, the resulting benefits were exempt from tax. In other words, there was a direct connection between deductibility of contributions and liability to tax.
The above 'fiscal cohesion' argument could not be used in the Danner case, as under the Finnish system, pensions payable by foreign institutions to Finnish residents were subject to tax irrespective of whether or not the insurance contributions paid were deducted from the taxable income of their recipients. The same applies in Poland. There is no clear- cut connection between the tax treatment of contributions and pension payouts.
In conclusion, I turn to taxpayers who make contributions to their home country social security schemes: if you have already received your May salary, you will probably have to report it and pay tax on it next month. Before you order the tax payment, think back to Dr. Danner. If you are tax equalized, you will probably care much less than you would like to admit to your employer. If you are a non-EU national, you may congratulate yourself on reading through to the end of an interesting story that will not be of much practical use to you.
