Germany: Tax Pitfalls For Cross-Border Mergers

Last Updated: 13 May 2013
Article by Marcel Ruhlmann

Corporate restructurings across the European Union have long been on the top of the agenda to accomplish the EU single market. Some frequently used forms of restructurings are mergers by absorption, mergers by acquisitions, exchange of shares or split-offs (of business activities).

Due to the lack of harmonization of tax law at the EU level cross-border mergers still receive unfavourable tax treatment compared to national mergers. This can be seen in particular with regard to the rather conservative position on cross border mergers in Germany. In our view there are, however, a few areas where restrictive national rules may be challenged in view of more lenient EU legislation and case law.

I. Cross-border mergers in Germany

Germany, like other EU countries, has a special national tax regime to ensure that the above mentioned forms of restructurings are treated as "tax neutral". "Tax neutral" means that taxation of any built-in gains in assets and shares transferred as part of the restructuring is deferred until the transferred assets / shares are eventually sold at a later point in time.

II. Implementation of EU directives

Until 2006 this régime only applied to national reorganisations. In 2006 Germany transposed the cross-border mergers directive (2005/56/EC) into national law, amending, inter alia, the Tax on Reorganisations Act (Umwandlungssteuergesetz — UmwStG);five years later, in 2011, guidelines (Umwandlungssteuererlass) on interpreting the UmwStG were published. The implementation of the tax aspects of the EU directives thus took a rather long time: The first directive on cross border mergers at EU level dates back to as early as 1990, when the EU merger Directive (90/434/EEC) already stipulated that cross-border mergers within the EU should take place in a tax-neutral way, provided that certain conditions were satisfied.

Why, one may ask, did Germany take so long to transpose the tax aspects of the EU directives on cross border mergers and why did it take five more years to issue guidelines on it? Maybe the key reason is that in the aftermath of the first 1990 EU merger directive the transposition of the tax aspects of cross-border mergers has proven to be more difficult than the implementation of the legal aspects. Indeed, the challenge to ensure overall tax neutrality across all involved jurisdictions for the transaction is a formidable one.

The main technical problem is not so much, like with the legal issues involved in cross-border mergers, that each country concerned may apply its own reorganisation (tax) régime and that these régimes often differ from one another. This is not to say that this is not an important technical issue:

  • One only has to bear in mind that in a typical reorganisation there are potentially quite a few national tax régimes affected which need to be brought into line. The reorganisation must be viewed as tax neutral by all of the following jurisdictions, the jurisdiction:
    • where the involved companies are domiciled or managed
    • where the involved shareholders are resident
    • where assets of the companies are located (foreign PEs)
  • If only one of the jurisdictions does not view the restructuring as tax neutral pursuant to its own tax law the overall tax neutrality is lost. The thrust of the 2006 amendments is therefore aimed at linking the German reorganization tax régime with those of other countries. Accordingly the amendments ensure that Germany recognises foreign reorganisation tax deferral régimes if they are similar to the German one (which is determined by an equivalence test). Further, the scope of the application of the Tax on Reorganization Act has been extended to cover also foreign entities and even allows for foreign entities to be the sole participants of a merger under the Act, if the assets are located in Germany, e.g. in the PE (permanent establishment) of a foreign entity.

However, another technical problem has not been solved in a satisfactory manner, namely the inherent conflict of cross-border mergers with national exit taxation rules. Often, a jurisdiction loses its taxing right with respect to built-in gains in the transferred assets / shares as a result of a cross-border transaction. This is a result of the application of the relevant double tax treaties in place between the jurisdictions concerned.

The German taxing right is lost, where:

  • as a result of the merger assets are deemed to have been transferred to the foreign country and thus form part of a foreign permanent establishment or corporate entity (see Art. 7 OECD master agreement) or
  • the assets are still situated in Germany but Germany loses the right to tax the sale of any new shares issued to the shareholders in return for the transferred assets (or in return for the transferred shares in case of a share-for-share transfer) (see Art. 13 (5) OECD Master Agreement).

Hence Germany granting the deferment (the so called "tax neutrality") may be prevented from making use of its (deferred) taxation right when the deferment ends. This is viewed as being unacceptable by the German legislator and the German tax administration.

It is therefore no surprise that the German 2006 UmwStG denies tax neutrality in all situations where German taxing rights with regard to a later sale of the transferred assets / shares are being restricted as a result of the reorganization (so called "exit taxation").

  1. Examples for tax pitfalls

For this reason we now have a situation in Germany where EU cross border mergers are often legally feasible but still have many tax pitfalls. This can be illustrated by the following examples:

Example 1: a side-stream merger of a German company into an EU company (i.e. a company resident in another EU Member State).

Whether or not this is tax-neutral depends on the location of the intellectual property (IP). Theoretically it could remain in Germany as the merger results in EU Co having a PE in Germany. However, the 2011 guidelines tend to allocate the IP to EU Co's head office in the other EU state rather than to the remaining German PE, leading to the loss of Germany's taxing rights.

This exit taxation principle equally applies at the level of the shareholders with regard to the built-in gains in their participations.

Example 2: a German company (P-Co) owned by a foreign company (EU Co) enters into a downstream merger with its German subsidiary (S-Co).

Under the 2006 guidelines, since Germany loses the right to tax the participation in S-Co, there is a deemed dividend up to EU Co, 5% of which is subject to German tax.

III. Outlook and current possibilities to use EU law to override German law

It is worth noting that the role of exit taxation within cross-border reorganizations is now discussed in greater depth in Germany in the aftermath of the recent European Court of Justice (ECJ) ruling in the case National Grid Indus BV (of 29 November 2011, C-371/10). One conclusion from this case could be that going forward Germany may at least have to provide for an option to defer any exit taxation. German tax authorities are currently awaiting two other cases pending at the ECJ before proceeding with the implementation of this judgement. It is likely that the option of a deferment may ultimately only be available against interest and security which may deter business to make use of this option.

An alternative concept is to defer not the (exit) tax but rather the triggering point of taxation in a cross-border restructuring context: according to this approach an immediate exit tax would be replaced by the guarantee for Germany to tax the built-in gains when a later sale of the transferred assets / shares occurs. This concept would ensure the similar treatment of cross-border mergers and national mergers. The problem with this approach is that it runs counter to most of the double tax treaties (see above).

However, it is often overlooked that this concept already forms part of the 2005 EU merger directive, even though it is limited there to share-for-share transfers. Art 8 (6) provides that under certain circumstances the exit state waives the right to tax shareholders at the time of restructuring in return for a guaranteed right to tax at the time of later alienation of shares (thus promulgating a treaty override with respect to Art. 13 (5) OECD Master Agreement). Further support for this concept can be found in the reasoning of the German Federal Fiscal Court in itslandmark decision on exit tax for natural persons (BFH, 17 July 2008, I R 77/06).

While the discussion on how to take away the tax pitfalls for cross border mergers is still going on, there is nothing to prevent a business aiming to restructure its activities to invoke these options offered in the ECJ case law and in the EU directives in front of their respective tax authorities. Tax rulings from all jurisdictions affected by the transaction should be obtained to ensure that these options are viewed by all concerned tax authorities in a similar way.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions