During the past months, the German Federal Tax Court (Bundesfinanzhof ; BFH) had several occasions to comment on individual issues connected with the accounting of provisions in the context of asset transactions between companies. This relates to the fact that German law does not offer much flexibility to simply agree which party keeps or assumes pension or anniversary liabilities. Normally these just follow the business as far as active employees are concerned, whereas liabilities relating to retired employees remain with the seller of the assets. From the perspective of the transferring company, these rulings provide opportunities. Thus, tax effects may be planned and realized by means of transfers within a group, which enable the neutralization of nonrecurring income by nonrecurring expenses.
One set of cases dealt with the value of an assumed anniversary provision or a provision for contingent losses,
respectively, to be reported by a company purchaser on the balance sheet (BFH, judgment dated December 14, 2011 – I R 72 / 10; judgment dated December 16, 2009 – I R 102 / 08). Another set of cases related to the question of whether, after the assumption of an obligation to incur a pension liability by a third party, the originally obligated employer must continue to enter such pension commitment on the liabilities side (BFH, judgment dated April 26, 2012 – IV R 43 / 09).
Treatment at the Acquirer
The difficulty in the first set of cases was due to the fact that certain provisions, e.g., provisions for contingent losses, anniversary provisions, and pension provisions, were to be made according to commercial law; however, under tax law, such provisions were partly or totally irrelevant and/or were assessed lower than under commercial law. Finally, this resulted in a deferral of expenses; the profits were taxed earlier under tax law than they would have arisen under commercial law. The plaintiffs in those proceedings had assumed the respective obligation within the contractual scope of an asset deal. In the specific case of pension provisions, the obligations to former or retired employees would not have been transferred. Since the actual burden under commercial law exceeded the burden reported under tax law, the company purchaser acquired so-called hidden liabilities. The question was: What is the right value for tax purposes?
1. In the decisions regarding the accounting of provisions assumed by the company purchaser, the First Senate of the BFH held that the liabilities should be assessed with the consideration received for the assumption of the obligation, quasi as acquisition cost on the liabilities side. According to the First Senate, the general accounting principles took priority in this respect. The BFH thereby arrived at the conclusion that the provisions should be assessed with the proportionate acquisition costs within the scope of the entire transaction, i.e., not the tax values.
2. This led to the question of how these liability items were to be developed in the accounting period. The tax offices and the German Federal Ministry of Finance (Bundesministerium der Finanzen ; BMF) held the view that the tax law regulations on the assessment of provisions applied on the next balance-sheet date (BMF, circular dated June 24, 2011, Federal Tax Gazette (Bundessteuerblatt ; BStBl) I 2011, 627). This view meant that the company purchaser would have to release the provisions in whole or in part by the next balance-sheet date. The consequence would be a taxable income. The BFH did not support this view, as it held the opinion that this would result in the acquisition processes' finally affecting the net income, which contradicted the fundamental accounting principles. In addition, the acquired provisions were not to be recorded with the tax balance-sheet value on the next call date, i.e., the balance-sheet date following the acquisition, but were to be assessed with the continued "acquisition costs" until the tax balance-sheet value had been reached. This would not result in an immediate income at the level of the company purchaser.
Treatment at the Originally Obligated Company
In the second set of cases, the question of the accounting at the discharged company was disputed.
1. The tax office and the BMF held the view that the company had to report a pension provision as before, since an obligation to the employees continued to exist. They further stated that the consideration paid to the assumer of the obligations was to be capitalized as a receivable (BMF paper dated December 16, 2005, BStBl I 2005, 1052) and that the transaction therefore did not affect the income.
The Fourth Senate of the BFH in charge of the matter decided in favor of the taxpayer that the latter did not have to report any provisions for pension commitments to its employees if a third party, i.e., an acquirer, assumed the obligations by way of a collateral promise including an (internal) assumption of the obligations to perform. In this context, the BFH distinguished whether: (i) the acquirer promised the performance of the pension obligations only vis-à-vis the party obligated to pay the pension (i.e., the discharged company), although the employee could not demand them from the third party itself; or (ii) the third party also assumed the debt by way of a promise to the employees, and thus the employee could demand the pension directly from the third party itself. Only in the latter case was it not probable—in the opinion of the BFH—that claims were asserted against the originally obligated party. The BFH thereby applied fundamental accounting principles, according to which provisions would have to be made only in the event and to the extent that a future assertion of claims was probable.
The application of this principle also means that a discharged company has to examine whether the acceding third party will fulfill its obligations in the future. If there are any doubts in this respect, the originally discharged company has to make provisions once more. This may again result in differences between commercial and tax law.
2. The BFH also objected to a capitalization of the paid consideration as receivable from the acquirer and to a dissolution over the term of the pensions. Since tax pension provisions are reported at a lower amount than the actual burdens to be expected, the consideration to be paid to the third party exceeded the amount of the tax pension provision. The differential amount resulting therefrom is an immediate tax-deductible expense. For the discharged company, this resulted in the possibility of bringing forward the tax-effective expense for future pension payments.
Even though the court rulings are difficult to comprehend in detail due to their reasons, and even though they have aroused criticism in the literature (Bareis, FR 2012, p. 385; Siegel, FR 2012, p. 388; M. Prinz, FR 2012, p. 409), their results are to be welcomed. Taxable income in connection with the acquisition of a company is avoided. From the purchasers' perspective, asset deals become less risky in terms of tax.
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