Federal Ministry of Finance publishes draft of a new Reorganisation Tax Decree

On 11 November 2011, the currently applicable Reorganisation Tax Decree (“Umwandlungssteuererlass”, the “Reorganisation Tax Decree 2011”) was published, and had been urgently awaited by practitioners. It contains the tax authorities’ view of how to interpret the Reorganisation Tax Act (“Umwandlungssteuergesetz”) and thus has considerable practical importance in reorganisations. On 11 October 2023, the Federal Ministry of Finance has now published the draft of a fundamentally updated reorganisation tax decree (“Draft Reorganisation Tax Decree”). The draft takes into account significant changes in legislation and supreme court decisions that have been issued since the publication of the current version of 11 November 2011.

The new Reorganisation Tax Decree is intended to apply to all open cases and replaces the Reorganisation Tax Decree 2011 (sec. 00.04a). In individual cases, however, the Reorganisation Tax Decree 2011 remains applicable (e.g. sec. 34).

1 The main changes can be summarised as follows: Scope of application of the Reorganisation Tax Act

In the scope of application of the Reorganisation Tax Act, adjustments are made to legal changes, in particular with regard to the abolition of section 1(2) of the Reorganisation Tax Act, the introduction of the option model in section 1a of the Corporation Tax Act and the option introduced by the Act on the Modernisation of the Law on Partnerships (“Gesetz zur Modernisierung des Personengesellschaftsrechts – MoPeG”) for registered civil-law partnerships to act as legal entities suitable for reorganisation as of 1 January 2024. Updates are also planned in the substantive scope of application. For example, it is clarified (at sec. 01.15) that the non-proportional demerger also includes the scenario that a shareholder of the transferring company does not participate in the acquiring company at all (known as demerger at zero).

With regard to cross-border reorganisations, the necessary criteria for comparability with a domestic reorganisation are further specified. The Federal Ministry of Finance also follows the CJEU’s ruling in the case C-106/16 (Polbud) on cross-border outbound/inbound changes of legal form (sec. 01.38b). Insofar as an unlimited or limited domestic corporate income tax liability of the corporation continues to exist after an outbound change of legal form (e.g. reorganisation of a German limited liability company into a Luxembourg S.à r.l.), there will be no application of the Reorganisation Tax Act nor a disclosure of hidden reserves or a loss deduction limitation. Even in the case of an inbound change of legal form (e.g. reorganisation of a Luxembourg S.à r.l. into a German limited liability company), neither the transfer of the centre of management nor the transfer of the registered office will lead to a disclosure of the hidden reserves as there is no limitation of Germany’s right of taxation.

2 Prohibition on offsetting losses in the retroactive period (section 2(4) sentence 3 of the Reorganisation Tax Act)

With regard to the loss deduction limitation in the retroactive period pursuant to section 2(4) sentence 3 of the Reorganisation Tax Act, it is clarified that with regard to the losses that can be offset, the remaining loss carryforward, the negative income that has not been offset and the interest carryforward of the acquiring legal entity, there is no time restriction on the retroactive period (sec. 02.40a). In addition, the loss deduction limitation is applied irrespective of whether there is an intention to abuse the tax system as well as in the case of contributions and also applies to the determination of the trade tax assessment basis.

3 Allocation of permanent establishments in cross-border reorganisations

The Reorganisation Tax Decree 2011 was still based on the principles of the Federal Ministry of Finance’s letter of 24 December 1999 (Permanent Establishment - Administration Principles – “Betriebsstätten-Verwaltungsgrundsätze”). Therefore, in practice the question has increasingly arisen of whether the principal establishment’s central function claimed therein continues to be decisive in the context of the reorganisation. The Draft Reorganisation Tax Decree at sec. 03.20 now refers to the provisions under treaty law as well as section 1(5) of the Foreign Tax Act (“Außensteuergesetz”), the Regulation on the Allocation of Profits of Permanent Establishments (“Betriebsstättengewinnaufteilungsverordnung”) and the Administrative Principles on the Allocation of Profits of Permanent Establishments (“Verwaltungsgrundsätze Betriebsstättengewinnaufteilung”).

4 Merger of corporations into partnerships

In the case of mergers with partnerships, it is clarified that the fair market value is to be reduced for the acquiring legal entity on the tax transfer date if the fair market value of the shares in the transferring corporation is lower than its book value. If applicable, section 8b(3) of the Corporation Tax Act or section 3c(2) of the Income Tax Act is to be applied to the resulting loss (sec. 04.05).

In addition, foreign shareholders of corporations who become co-entrepreneur of the partnership due to the reorganisation are included in the separate and uniform determination pursuant to section 180 et seq. of the German Tax Code only to the extent that Germany had a right of taxation with respect to the capital gain of the shares in the corporation or the income within the meaning of section 7 of the Reorganisation Tax Act on the tax transfer date (sec. 04.23). The Federal Ministry of Finance clarifies that capital gains tax can then also be credited against the income pursuant to section 7 of the Reorganisation Tax Act as part of the assessment procedure. In our opinion, this clarification is only relevant for cases in which the fiction of contribution according to section 5(2) and (3) of the Reorganisation Tax Act does not apply. This is because in the cases of the contribution fiction, the capital gains tax is creditable for the takeover result irrespective of the existence of a German taxation right (cf. Stadler/Elser/Bindl, DB 2012, supplement no. 1 to Issue 2, 14 (24); Birkemeier, in Rödder/Herlinghaus/van Lishaut, Reorganisation Tax Act, 3rd ed. 2019, section 7 at para. 63).

In the case of a change of legal form from a corporation to a partnership, the Federal Ministry of Finance applies the Federal Fiscal Court ruling of 11 April 2019 (IV R 1/17). According to this ruling, the taxation of the corporation’s open reserves under section 7 sentence 1 of the Reorganisation Tax Act in the case of shares fictitiously treated as contributed in section 5(2) of the Reorganisation Tax Act are treated as the profit of the joint ownership and not as the designated profit of the previous shareholder (sec. 05.07a).

5 Asset transfer costs (sec. 04.34)

The allocation of expenses to “asset transfer costs” is based on the principle of causation. In implementing the Federal Fiscal Court ruling of 23 November 2022 (I R 25/20), the “triggering momentum” for the occurrence of the expenses and their greater proximity to the sale or the current profit must be taken into account.

6 Merger of corporations

In the case of a downward merger, applying the Federal Fiscal Court ruling of 30 May 2018 (I R 31/16), the shareholding of the transferring company in the acquiring company that is transferred directly to the shareholder of the transferring company also belongs to the transferred assets within the meaning of section 11 para. 1 sentence 1 Reorganisation Tax Act (sec. 11.06). According to sec. 11.09a of the Draft Reorganisation Tax Decree, the downward merger of a parent company with shareholders resident abroad into its subsidiary can also be completed tax-neutrally at book values if the taxation of the hidden reserves of the parent company is ensured. Since the shareholding in the subsidiary is transferred to the shareholder of the parent company in the course of the downward merger, it is important for the recognition at carrying amount whether the hidden reserves in the shareholding continue to be subject to German taxation for this shareholder.

7 Demergers of corporations

Furthermore, the Draft Reorganisation Tax Decree now provides an answer to a question that is often critical in practice in the case of demergers of branches of activity. According to this, assets that can be allocated according to economic connections, which are used by several branches of activity and are not split up, are to be uniformly allocated to the branches of activity in which they are predominantly used (sec. 15.08).

The Draft Reorganisation Tax Decree now expressly stipulates that a takeover gain or loss within the meaning of section 12(2) sentence 1 in conjunction with section 15(1) sentence 1 of the Reorganisation Tax Act must be determined not only in the case of an upward demerger but also in the case of a downward and lateral demerger, in which the acquiring corporation did not previously hold an interest in the transferring corporation. Accordingly, in line with the Federal Fiscal Court’s ruling of 9 January 2013 (I R 24/12), the cost of the asset transfer is not deductible as a business expense in those cases either (sec. 15.14a).

The Draft Reorganisation Tax Decree contains hardly any changes or clarifications regarding the misuse avoidance provisions of section 15(2) of the Reorganisation Tax Act, which are controversial in practice.

8 Change of legal form (section 25 Reorganisation Tax Act) and contribution of a co-entrepreneur share (section 20 Reorganisation Tax Act)

In a change of legal form from a partnership to a corporation (section 25 of the Reorganisation Tax Act), it is clarified that the object of the contribution is in each case the co-entrepreneur shares in the partnership which is changing its legal form. In these cases there is also a uniform transaction that can fall under section 20 of the Reorganisation Tax Act as a whole if the transfer of the joint ownership and the special business assets takes place in a temporal and economic context (sec. 20.05). In the case of contributions of only part of a co-entrepreneur share, for the application of section 20 Reorganisation Tax Act the associated functionally essential asset of the special business assets must be transferred proportionately, i.e. at least in the same ratio of the transferred part of the share in the joint ownership in relation to the entire share in the overall assets (sec. 20.11).

9 Contributions for which other consideration is also granted

Extensive changes with examples are also made in the Draft Reorganisation Tax Decree for contributions in which other consideration is granted in addition to corporate rights. This applies both to contributions under section 20 of the Reorganisation Tax Act (sec. 20.19a) and section 24 of the Reorganisation Tax Act (sec. 24.07) and to the exchange of shares under section 21 of the Reorganisation Tax Act (sec. 21.10).

In addition, the Draft Reorganisation Tax Decree clarifies that the transferring entity cannot oppose the valuation at the acquiring corporation within the scope of its own taxation procedure. However, in implementation of the Federal Fiscal Court rulings of 8 June 2011 (I R 79/10) and 15 June 2016 (I R 69/15), the transferring party, as a third party, is entitled to a third party right of appeal for the relevant tax assessment of the acquiring corporation (sec. 20.25).

10 Contribution profit

The contribution profit 1 is not subject to trade tax if the contribution at fair market value would not have been subject to trade tax. This also applies if not all shares received are sold in one transaction (sec. 22.07). The same applies to the contribution profit 2, which is also not subject to trade tax if the contribution at fair market value would also not have been subject to trade tax pursuant to section 7 sentence 2 of the Trade Tax Act (sec. 22.13).

The Draft Reorganisation Tax Decree makes an addition for cases in which the transferring party has already sold all or part of the shares received before the time of the retroactive taxation of the contribution profits. In principle, there is no retroactive taxation of the contribution profit in this case (section 22(2) sentence 5 of the Reorganisation Tax Act). However, according to the meaning and purpose of the provision, this only applies if the previous sale of the shares received by the transferor resulted in the complete disclosure of the hidden reserves (sec. 22.17).

11 Reorganisations and consolidated tax groups

In sec. Org.12 the Draft Reorganisation Tax Decree contains a stricter stance on the termination of a consolidated tax group within the five-year minimum term to the effect that a reorganisation-induced termination of a profit and loss transfer agreement “may” be an important reason within the meaning of section 14(1) sentence 1 no. 3 sentence 2 of the Corporation Tax Act (wording in the Reorganisation Tax Decree 2011: “is an important reason”). Furthermore, a change of legal form of a corporation into another corporation does not constitute an important reason (sec. Org.26).

In addition, the Draft Reorganisation Tax Decree also makes further statements in connection with reorganisations of consolidated tax groups, which, among other things, also concern the transition from the adjustment item method to the contribution-/contribution repayment method.