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In general, a change in the shareholders of a German corporation (hereinafter referred to as a GmbH) affects neither the legal identity nor the tax status of the company. The purchase price is attributable fully to the shares acquired, which are not subject to scheduled depreciation, although they may be written down to their fair market value. Unlike the goodwill element in a payment for the assets of a business (including acquisition of a partnership interest), which can be depreciated for tax purposes over a period of 15 years, the goodwill element in a payment for shares may not be depreciated. Generally, the purchaser of a corporation is strongly interested in generating depreciation expense based on the full purchase price, not just on the historical book values of the GmbH's assets. Goodwill and other self-generated intangible assets not even appearing on the balance sheet of the GmbH are especially important.
The Tax Reorganisation Act which went into effect this year has created a major new possibility for reconciling the share deal with the purchaser's desire for full depreciation expense. The fundamental advantage of this step-up model over the old "internal asset deal" model heretofore employed is that the new step-up model produces full depreciation of the purchase price without triggering a substantial trade tax in the process.
The new model functions as follows:
a) X-GmbH purchases the shares in Target GmbH.
b) Target GmbH is converted into e.g. a limited partnership = Target GmbH & Co. KG. (A new general partner GmbH must be organised; X-GmbH becomes the sole limited partner of Target GmbH & Co. KG).
c) Target GmbH & Co. KG assumes most tax attributes of Target GmbH (but not e.g. its loss carryforwards).
d) The shares in Target GmbH are deemed contributed to the partnership with a book value equivalent to the price just paid for them by X-GmbH. As a result of the conversion, these shares disappear and are replaced by the book values of the assets of Target GmbH. Since these are much lower than the book value of the disappearing shares, the difference is applied pro rata to the reserves hidden in these assets. The remaining excess is applied to goodwill and other intangibles not previously capitalised by Target GmbH, making the step-up complete.
e) Any excess not attributable to an asset is a tax deductible loss. (This is not likely in transactions implemented shortly after acquisition of Target GmbH.)
By this means, a stepped up basis can be obtained at no income tax cost. This applies both to the corporate income tax and to the trade tax on earnings. Instead of converting Target GmbH into a limited partnership, it could also be merged into an existing partnership.
The above model is subject to certain limitations if any non-resident persons are involved. If the shares in target GmbH are purchased from non-resident persons, legal or natural, then no step-up is available. The same applies if there are any non-residents in the sellers' chain of title in the preceding 10 years. Furthermore, if the purchaser is a non-resident entity, the step-up can also fail under certain circumstances. A number of questions are still controversial in this connection. To side-step these issues, the example given above involves purchase through a domestic GmbH. The problems of non-resident purchasers can often, if not always, be solved by interposing a domestic GmbH as the purchase vehicle.
Legislation is pending which would also prevent the step-up if the shares in Target GmbH were purchased from German resident individuals each holding a stake of 25 % or less in Target GmbH (unless their stakes were "business property" in the German sense in their hands).
In spite of these restrictions, the new step-up model offers dramatic tax savings and is the subject of continuing lively discussion among tax professionals. Application of the model to a taxpayer's particular circumstances is a matter requiring expert advice and planning.
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. 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.