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In April 1997, the Federal Ministry of Finance issued in draft form a highly detailed directive setting forth the position of the German tax authorities on numerous issues associated with the new tax reorganisation act which took effect on 1 January 1995. The draft directive is 179 pages in length and the subject of comments which KPMG Germany submitted to the Institute of German Accountants (IDW) at the end of May 1997. The Institute issued its own comments in early June.
The most controversial position taken by the tax authorities in the draft directive is that, when a corporation is merged into or otherwise reorganised as a partnership, any step-up in the value of the assets received by the partnership from the disappearing corporation will not apply for trade tax purposes. Instead, the draft directive states that a separate calculation of taxable income based on the transfer values of the assets received is to take place for the trade tax.
Furthermore, the draft directive would deny recognition for trade tax purposes to any reorganisation loss realised by the receiving partnership on the reorganisation. In situations where a step-up would otherwise occur, in particular where the reorganisation follows closely after purchase of the corporation at a premium, the denial of the step-up would typically lead to a reorganisation loss if, under the general rules, the shares in the transferring corporation belong, or are deemed to belong, to the receiving partnership. In such situations, the assets received replace these shares on the partnership's balance sheet, resulting in a negative difference where the book value of the assets transferred is under the book value of the shares and the assets cannot be stepped up.
KPMG considers that there is no basis in law for either of the above positions. Were the positions of the tax authorities correct, this would seriously diminish the tax advantages obtainable on share deal purchases of German corporations through conversion of the target company to partnership form following the purchase.
A selective, and of course highly condensed, list of other positions taken in the draft directive which are of potential interest to foreign investors is as follows:
The draft directive will doubtless be the subject of much debate in the coming months.
- In several instances, the draft directive argues that the general principal of linkage between the commercial and tax balance sheets operates to frustrate options present in the tax law but not in commercial law or to cause the exercise of commercial law options at variance with tax law options to trigger tax on an otherwise non-taxable reorganisation.
- A strict definition of "branch of activity" is applied which would raise the requirements for and restrict the options available in divisive reorganisations. Assets and liabilities constitute a branch of activity (Betrieb or Teilbetrieb) if they are potentially capable of functioning as an independent business. Under the draft directive, retention of any material assets belonging to a branch of activity would be damaging even if the assets transferred possessed the required degree of independence.
- Little guidance is given in divisive reorganisations on allocation of assets not needed for any branch of activity or used in more than one branch of activity.
- There are indications that the tax authorities wish to attack many reorganisations under the general anti-abuse rule contained in the German tax procedure act (sec. 42 AO). It is questionable, however, whether the tax authorities have correctly interpreted the statute on which they rely.
- The positions taken on the specific anti-abuse provisions for divisive reorganisations are overly strict.
- Various issues involving the retroactivity of a tax-free reorganisation are resolved in questionable manner. These include an important issue under Germany's thin capitalisation rules. For mergers and consolidations of two corporations, the draft directive proposes to attribute the shareholder debt of both the surviving and the disappearing corporation to the surviving corporation as of the retroactive effective date of the reorganisation. Since the safe haven ratio for thin capitalisation purposes is determined with respect to equity in the commercial balance sheet at the start of each fiscal year, this can easily lead to serious problems wherever the effective date is not simultaneously the start of a fiscal year.
- It is argued that the protection of sec. 8b KStG (exempting gain on the sale of shares in foreign corporations located in tax treaty countries from corporation tax) will not apply to the gain which results when a transferring corporation chooses to value its participations in foreign corporations above book value on its closing balance sheet.
- The blocking amount provisions under sec. 50c EStG and sec. 4 par. 5 UmwStG are interpreted in overly broad fashion.
- On a positive note, it is recognised that a holding company carries on a business and hence that a tax loss carryover which it possesses may potentially be transferred when it is merged into another corporation.
- Furthermore, downstream mergers are recognised as possible in principle.
A more detailed version of this article is available as article no. 71.
Disclaimer and Copyright
This article treats the subjects covered in condensed form. It is intended to provide a general guide to the subject matter and should not be relied on as a basis for business decisions. Specialist advice must be sought with respect to your individual circumstances. We in particular insist that the tax law and other sources on which the article is based be consulted in the original, whether or not such sources are named in the article. Please note as well that later versions of this article or other articles on related topics may have since appeared on this database or elsewhere and should also be searched for and consulted. While our articles are carefully reviewed, we can accept no responsibility in the event of any inaccuracy or omission. Please note the date of each article and that subsequent related developments are not necessarily reported on in later articles. Any claims nevertheless raised on the basis of this article are subject to German substantive law and, to the extent permissible thereunder, to the exclusive jurisdiction of the courts in Frankfurt am Main, Germany. This article is the intellectual property of KPMG Deutsche Treuhand-Gesellschaft AG (KPMG Germany). Distribution to third persons is prohibited without our express written consent in advance.