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A recent ruling by the regional tax office Frankfurt am Main (FR 1995, 82 - 26 October 1994) has clarified the requirements for forming a consolidated tax group under a managing holding company.
Tax consolidation (Organschaft) in general requires the financial, organizational and economic integration of a legal entity resident in Germany into another German resident company. The fulfilment of these factual requirements is sufficient to create a tax consolidated group for VAT and trade tax purposes. For corporation tax purposes a profit and loss pooling agreement between the parent company and the subsidiary is in addition required.
The tax advantages of a consolidated group arise from the fact that for the purposes of taxes on profit and for German trade tax on capital the tax basis for all companies belonging to the group is consolidated. Due to the fact that some members of the group usually are less profitable than others or even generate losses, the overall consolidated result leads to a reduced tax basis or in some case to zero taxes. German net worth tax is not affected by tax consolidation. The basic principle behind German tax consolidation is attribution of the tax base of members of the consolidated group to a single lead company, here called the "dominant company".
According to section 14 German Corporation Tax Act, the dominant company can be any inland resident entity engaging in a trade (e.g. corporations, partnerships, sole proprietors). Across the border tax consolidation is not possible for German tax purposes.
Inside a consolidated group, the taxation procedure varies depending on the kind of tax levied and the type of legal entity acting as the dominant company. For trade tax purposes (i.e. trade tax on income and trade tax on capital), the dominant company is liable. For corporation tax purposes the profit transferred will be subject to corporation tax on the level of the dominant company if it is also a corporate entity. In the case of a partnership, the profit will be allocated to the partners who are liable for the personal or corporate income tax thereon depending on their status. Tax consolidation does not affect the liability of each company for net worth tax.
Financial integration is given provided that the dominant company holds a majority of the subsidiary's shares.
Organizational integration is fulfilled if the parent company ensures that its instructions concerning the conduct of subsidiary's business are adhered to (exercise of strategic management control).
The dominant company has to conduct a business of its own by engaging in a trade or other active business. This requirement is, as a general rule, not met if the business purpose of the parent company is merely to hold shares in its subsidiaries. Economic integration of the subsidiary into the parent company requires that the parent company's business be supported or furthered by the subsidiary's business. Economic integration is as a rule the most difficult to meet of the three basic "integration" requirements.
For corporation tax purposes the fulfilment of certain formal requirements including a profit and loss pooling agreement is necessary in addition to the financial, organizational and economic integration. Such a profit and loss pooling agreement results in a legal obligation on the part of the member company to transfer profits and on the part of the dominant company to assume losses. If the profit and loss pooling agreement is not enforceable according to civil law, tax consolidation will not be recognized. Entry into a pooling agreement means that the dominant company must actually reimburse the losses of group member companies. This obligation is enforceable, e.g. in bankruptcy.
Managing holding companies
A managing holding company is a legal entity which holds participations in other companies and which exercises a controlling management influence on the business strategies of these companies.
If the requirement that the dominant company must conduct a business of its own (see economic integration) were strictly applied, it would seldom if ever be possible to construct a consolidated tax group under a pure holding company. By way of exception to the general rule, such a managing holding company is sufficient to implement tax consolidation if the following requirements are met:
the managing holding company must actively supervise the group members
the supervision must be recognizable by third parties
the managing holding company has to hold and control at least two active participations.
The ruling referred to at the outset of this article has now made clear that not all of the companies controlled by the holding need be included in a consolidated group for corporate tax purposes. Consolidation by a profit and loss pooling agreement could be accomplished, for instance, between the holding and its subsidiary no. 1, but not include its subsidiary no. 2.
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