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German Federal Ministry of Finance (“GFMF”) publishes decree on the German Reorganisation Tax Act
In order to provide for possibilities to carry out tax neutral reorganisations, the German Reorganisation Tax Act ("GRTA") was introduced in 1994. However, significant amendments were made to the GRTA in 2006 (which are effective from 13 December 2006) to facilitate new possibilities for tax-neutral cross-border reorganisations (including mergers, spin-offs, split-offs and transfer of assets). Whilst a decree which is binding upon all German tax authorities was issued by the GFMF in 1998 to provide guidance on the interpretation and application of the GRTA, the decree has not been adapted to-date, leading to significant tax planning uncertainties for taxpayers.
In an attempt to resolve such uncertainties, the GFMF published an update of the decree in January 2012. Largely based on the decree issued in 1998, the new decree comments on the provisions which were introduced in 2006, issues relating to the taxation of cross-border reorganisations as well as cases that were common practice prior to the GRTA being amended in 2006. It also includes several ideas which have been developed in the past by tax literature and the fiscal courts. Unfortunately, most of the positions taken by the tax authorities in the decree follow a rather restrictive approach.
Taxand Germany discusses the amendments to the GRTA and the salient features of the new draft decree.
The new draft decree comprises a total of 172 pages and includes information, inter alia on the following topics:
1.1 Definition of a branch of activity
- Spin-offs, split-offs and transfers of assets (contribution in kind) are basically tax neutral only if the transferred assets as a whole qualify as a "branch of activity".
- Using largely the same definition for "branch of activity" as used in the European Merger Directive, a branch of activity consists of:
(i) all assets that are necessary to continue the transferred business; and
(ii) all assets which can be allocated to that branch of activity due to an economic connection
- In line with case law precedent set by the German fiscal courts, these assets will either have to be legally owned by the entity to which the branch of activity is transferred in the course of reorganisation or at least the economic ownership will have to be transferred. The mere right of use of the assets (e.g. on the basis of lease agreements) is not sufficient.
- Basically, the branch of activity now needs to be in existence on the tax effective date. As it is possible to carry out reorganisations with retroactive effect for tax purposes, making use of the retroactive effect implies that the requirements for a branch of activity must already be met on a tax effective date in the past. In this regard, the 1998 decree was less restrictive: even in cases of a retroactive tax effective date it was sufficient that the requirements for a branch of activity were met on the date the respective resolution to carry out the reorganization was passed.
1.2 Reorganisations at book value for tax purposes and at fair market value ("FMV") for GAAP purposes
- Under the GRTA, reorganisations are possible on a tax neutral basis if certain conditions are met, including scenarios under which assets are stepped up to FMV for German GAAP purposes. In the past, the German tax authorities have allowed such deviation of the tax balance sheet from the GAAP treatment only on a temporary basis, i.e until the next balance sheet date, which led to a taxable profit in the year following the year of the reorganisation.
- The decree now explicitly confirms that a reorganisation can be carried out on a tax neutral basis if the assets are stepped up to the FMV for GAAP purposes in the course of the reorganisation.
1.3 Blocking periods for shares received as consideration for tax neutral contribution in kind
- In case of a contribution in kind, the contributing party will receive shares in the target company as consideration for the contribution. If a branch of activity is contributed below FMV, a seven-year blocking period applies to these new shares received. Any transfer of the shares received during this blocking period should basically lead to a retroactive lapse of the tax privilege, i.e. the balance amount between FMV of the contributed branch of activity and its book value is basically subject to tax for the contributing party. However, the amount subject to tax is reduced by 1/7 for each full year passed between the contribution in kind and the transfer of the blocked shares. Whilst the wordings of the law do not provide for an exemption for "permitted transfers" of the blocked shares, e.g. by way of reorganisations at book value, the tax authorities have now included further guidance with respect to circumstances under which certain transactions regarding the blocked shares should not be harmful with a view to the tax privilege.
- According to the decree, upon application a reorganisation at book value which formally leads to a transfer of the blocked shares would not be seen as a harmful transfer of the blocked shares "in individual cases" if:
- the built-in gains of the contributed assets, in principle, continue to be subject to tax
- Germany's right to tax will not be restricted
- no built-in gains are shifted to the shares of a third party
- the taxpayer agrees that the new shares received in the course of this reorganization also will be subject to the same restrictions as the shares received in the first reorganisation.
- However, the phrase "in individual cases" implies that this exemption will be applied restrictively by the tax authorities.
1.4 Downstream merger in the case of non-resident shareholders
- Generally, so-called downstream mergers by which a parent company is merged into one of its subsidiaries are possible on a tax neutral basis. However, there has been uncertainty as to whether such tax neutral downstream mergers are possible where the parent company has non-resident shareholders (e.g. foreign acquirers use a German company as an acquisition vehicle that is subsequently merged downstream).
According to the decree, the German tax authorities take the stance that shares in the German target entity cannot be transferred at book value in the course of a downstream merger where the shareholders are being subject to tax in Germany.
Whilst the new decree provides further clarification on the interpretation of the GRTA, many questions remain unanswered. The restrictive approach of the tax authorities is likely to result in a large number of applications for binding rulings in the future. In view that the decree does not provide for grandfathering rules or a transition period, the tax authorities will apply the administrative guidance issued by the GFMF to all open cases.
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