This article was first published in International Tax Review June 2002, p. 58.
For editorial cut-off date, disclaimer, and notice of copyright see end of this article.
Cross-border reorganizations rank among the most complex tax planning transactions. Two recent changes in German tax law open up new possibilities for accomplishing certain cross-border reorganisations without realisation of gain.
New sec. 12 (2) KStG (corporation tax law) permits the assets of the German permanent establishment of a non-resident corporation to be transferred en bloc to a new entity pursuant to a merger that takes place in a foreign jurisdiction at book value and does not qualify for tax preferred treatment under the German Tax Reorganisation Act. The transaction must be comparable to a merger under sec. 2 UmwG (German Business Reorganisation Law). Furthermore, Germany's right of taxation must be preserved. Like the previous version of § 12 (2) KStG, the new version is without prejudice to the provisions of the Tax Reorganisation Act, which permit certain cross-border transfers tax free between EU entities.
New sec. 12 (2) KStG is limited by its terms to mergers, that is, the transfer of the German permanent establishment to the receiving entity must occur as a result of the merger of the former owner of the permanent establishment into another corporation pursuant to the laws of a foreign jurisdiction. The failure to extend the new law to split-ups, spin-offs, and contributions (drop-downs) is criticized in the literature. The new provision applies to transactions taking place on or after 1 January 2002.
Wider in scope, but limited in application to German-Canadian transactions, is Article 13 (5) of the new tax treaty between Canada and Germany:
Where a resident of a Contracting State alienates property in the course of an organization, reorganization, amalgamation, division or similar transaction and profit, gain or income with respect to such alienation is not recognized for the purpose of taxation in that State, if requested to do so by the person who acquires the property, the competent authority of the other Contracting State may agree, subject to terms and conditions satisfactory to such competent authority, to defer recognition of the profit, gain or income with respect to such property for the purpose of taxation in that other State.
The new provision applies to cross-border transactions permitted to take place tax free under the reorganization laws of the state of residence of the transferring (alienating) entity and authorizes the source state to grant tax-free treatment to that part of the transaction that transpires within its tax sphere, if requested to do so by the acquiring entity. The provision might, for instance, be invoked to permit a Canadian corporation to transfer its German permanent establishment to another corporation free of German tax, or to permit Canadian persons to effect transfers of shares in German real estate companies or interests in real estate partnerships that are taxable in Germany under Article 13 (4) of the tax treaty.
Since, inside the European Union, certain of the above transactions could be accomplished tax-free under sec. 23 UmwStG (Tax Reorganization Act), the German tax authorities may be expected to condition their consent to tax free treatment under Article 13 (5) of the German-Canadian tax treaty on observance of a 7 year holding period for shares taken in the receiving entity (application by analogy of sec. 26 UmwStG). An entity receiving property in the German tax sphere would also have to agree to take a carryover basis.
While the opportunities remain fragmentary for accomplishing a tax-free cross-border reorganization under German tax law, the provisions on EU reorganizations, the new wording of sec. 12 (2) KStG, and Article 13 (5) in the new German-Canadian tax treaty mark a clear trend towards liberalizing the tax treatment of cross-border reorganizations in keeping with the economic demands of a global economy.
Editorial cut-off date: 16 May 2002
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