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1. Citation and structure of the final Directive
2. Positions taken in the Directive on selected issues
2.1 Denial of reorganisation loss and stepped up basis for trade tax purposes
2.2 Linkage of tax and commercial balance sheets
2.3 Definition of "branch of activity"
2.4 Relevant time for determining existence of a branch of activity
2.5 General anti-abuse provision (sec. 42 AO)
2.6 Specific anti-abuse provisions for divisive reorganisations
2.7 Retroactivity of a reorganisation for tax purposes
2.8 Thin capitalisation rules (sec. 8a KStG) and corporate mergers
2.9 Denial of protection of sec. 8b KStG
2.10 Blocking amounts under sec. 50c EStG
2.11 Retroactivity of 1996 amendment to sec. 5 (3) UmwStG
2.12 Downstream mergers
2.13 Corporate loss carryforwards in general
2.14 Loss carryforward of merged holding companies
2.15 Loss carryover under sec. 15a EStG
3. Concluding remarks
Final Directive on the Tax Reorganisation Act
For disclaimer and copyright see end of this article.
As reported briefly in article no. 131, the tax authorities have issued the final version of a voluminous comprehensive directive setting forth their positions on a wide variety of issues under the Tax Reorganisation Act (Federal Ministry of Finance directive of 25 March 1998, BStBl I 1998, 268). Previous articles have dealt at length with the Tax Reorganisation Act, which was completely rewritten with effect from 1 January 1995 (see in particular article no. 5 "New German Reorganisation Act" and article no. 28 "Share Deal Purchases under the Tax Reorganisation Act"). The preliminary draft version of the present directive was covered in detail in article no. 71.
The following article treats selected aspects of the directive with primary emphasis on the issues raised in our article on the preliminary draft version. Subjects omitted may nevertheless be of considerable importance to a specific reorganisation.
1. Citation and structure of the final Directive
The sections of the Tax Reorganisation Act are cited in this article using the abbreviation "sec." and "UmwStG" (Umwandlungssteuergesetz). Those of the final comprehensive directive are cited as "Directive" with section number. The numbering of the Directive by and large mirrors that of the statute. For example, Directive sec. 01.01 ff. relates to sec. 1 UmwStG, Directive sec. 02.01 ff. to sec. 2 UmwStG, and so forth. The Directive in addition contains an introductory part (sections 00.01 - 00.14) and three subparts on special topics with special numbering:
Org.01 - Org.27 concerning reorganisations involving members of consolidated tax groups (Organschaft),
GL.01 - GL.18 dealing with the effect of reorganisations on the equity baskets (Gliederung) into which the retained earnings of German resident corporations are subdivided for tax purposes, and
8a.01 - 8a.06 treating issues arising under the corporate thin capitalisation rules (sec. 8a KStG) in the reorganisation context.
These three subparts are situated in the middle of the Directive following the comments on sec. 18 UmwStG and preceding those on sec. 20 ff. UmwStG.
The Tax Reorganisation Act should not be confused with the Business Reorganisation Act (Umwandlungsgesetz) which defines the types of reorganisations permitted under company law (statutory reorganisations). Generally speaking, only statutory reorganisations under the Business Reorganisation Act can be accomplished tax free under the Tax Reorganisation Act.
2. Positions taken in the Directive on selected issues
2.1 Denial of reorganisation loss and stepped up basis for trade tax purposes
The final Directive adheres to the controversial position taken by the tax authorities in the draft directive with regard to conversion from corporate to partnership form and merger of a corporation into a partnership (Directive sec. 18.02). The Directive provides that any step-up in the value of the assets received by the partnership from the disappearing corporation (sec. 4 (6) UmwStG) will not apply for trade tax purposes. Instead, a separate calculation of taxable income based on the transfer values of the assets received is to take place for purposes of the trade tax on capital (repealed from 1998 onwards) and the trade tax on earnings. Furthermore, the Directive denies 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 under the general rules.
In support of their position, the tax authorities rely on sec. 18 (2) UmwStG, which excludes gain realised by the receiving partnership from the trade tax base. The argument runs that the exclusion of gain for trade tax purposes excludes losses as well. Since the step-up is a result of a preliminary loss (loss before step-up), this is denied for trade tax purposes.
The tax authorities are, however, themselves not entirely convinced by their own argument and have therefore announced their intention to amend the law to "clarify" this point. Until such amendment takes effect, the taxpayer's chances of prevailing in court on this issue would appear to be promising.
Denial of the step-up on reorganisation in partnership form for trade tax purposes would weaken the incentive for such reorganisations following the purchase of the shares in a domestic corporation. Prior to 1995, when the new reorganisation law took effect, a share deal purchase was often followed by an "internal asset deal" in which the purchased corporation (target corporation) sold its assets to the domestic corporation which had purchased its shares, thus causing them to be revalued at fair market value on the books of the purchaser corporation. The gain resulting to the target corporation was then neutralised for purposes of the corporation tax on income by means of a dividend writedown (distribution of cash purchase proceeds by the target to its domestic parent followed by a writedown in the value of the shares held by the parent in the target corporation). However, the dividend writedown was not effective for trade tax purposes, meaning that trade tax on earnings had to be paid as the price of obtaining higher depreciation values on the assets of the target.
Reorganisation in partnership form will have an advantage even after the forthcoming amendment to the law has taken effect because, unlike an internal asset deal, it does not trigger immediate trade tax on earnings. Instead, the increase in trade tax is spread over several years in the form of denied higher depreciation values for trade tax purposes.
Article no. 28 on "Share Deal Purchases Under the Tax Reorganisation Act" contains more detail on the step-up procedure.
2.2 Linkage of tax and commercial balance sheets
It is a general principle of German tax accounting law that, unless otherwise provided, the commercial balance sheet controls for tax purposes as well (linkage of the tax balance sheet to the commercial balance sheet - Massgeblichkeitsprinzip). The draft directive had at various points contended that such linkage exists as well in reorganisation situations notwithstanding the apparent intent of the Tax Reorganisation Act to create exceptions in which the tax balance sheet need not follow the commercial balance sheet.
The final Directive retains by and large the positions of the draft version:
Directive sec. 03.01 essentially voids the option created by sec. 3 UmwStG for the transferring entity to value its assets on its closing tax balance sheet at book value, going concern value, or any intermediate value by requiring that the values on the closing tax balance sheet be identical to those on the closing commercial balance sheet. No option exists under general commercial law or under the Business Reorganisation Act for the transferring entity to revalue its assets upwards merely by virtue of the reorganisation. The only possibility for such upwards revaluation relates to assets as to which an extraordinary writedown was previously taken but which have in the interim recovered in value. Upwards valuation is thus restricted as to the assets which qualify. It is at any rate marginal because original cost less scheduled depreciation constitutes the upper revaluation limit.
Directive sec. 03.02 establishes a certain linkage between the commercial and tax balance sheets of the receiving entity despite the fact that sec. 4 (1) and 12 (1) UmwStG would appear to provide that the tax balance sheet of the receiving entity is controlled by the tax balance sheet of the transferring entity. The issue is of relevance above all because of a provision in the Business Reorganisation Act (sec. 24 UmwG) permitting the receiving entity either to carry over the bases of the transferring entity as shown in its closing balance sheet or to revalue these assets in accordance with their market values or at intermediate values. The Directive states that the election by the receiving entity of values in excess of transferring entity's book values for purposes of the receiving entity's commercial balance sheet will result in recapture of any extraordinary depreciation taken by the transferring entity with respect to the assets transferred. To the extent of such extraordinary depreciation and within the limits of the revaluation in its commercial balance sheet, the receiving entity must increase the values of its assets in its tax balance sheet as well and record the increase as taxable income.
The above is an improvement over the position taken in the draft directive, which denied all protection of the Tax Reorganisation Act in the event the receiving entity did not elect a carryover basis in its commercial balance sheet. This more radical position became known as "diagonal linkage" of the tax balance sheet to the commercial balance sheet because the tax authorities provided that the tax balance sheet of the transferring entity must show all assets at full value (as opposed to book value or intermediate value) whenever the commercial balance sheet of the receiving entity did not carry over the book values from the commercial balance sheet of the transferring entity.
It is by no means clear that the positions taken by the tax authorities in the final Directive will be upheld in court. A persuasive case can be made that the tax authorities have misinterpreted the pertinent provisions of the Tax Reorganisation Act, the purpose of which is to break the general linkage between the tax and commercial balance sheets.
2.3 Definition of "branch of activity"
It is in various circumstances (drop-downs and divisive reorganisations) necessary that the assets being transferred and/or retained constitute a branch of activity. Assets and liabilities constitute a branch of activity (Betrieb or Teilbetrieb) if they have a certain degree of independence and are potentially capable of functioning as an independent business. Interests in commercial partnerships and 100 % stakes in corporations are deemed to constitute branches of activity (sec. 15 (1) sent. 3 UmwStG).
Despite criticism from practitioners respecting the draft version, the final Directive continues to apply a definition of "branch of activity" which was developed under the German income tax law to determine when an individual qualifies for a special capital gains tax rate (Directive sec. 15.02 and 20.08 - 20.11). This definition is stringent and, in reorganisation contexts, would in particular require not just that the assets being transferred be potentially capable of functioning independently, but also that all material assets forming part of the branch of activity as previously operated be part of the transfer.
For instance, the Directive states that a 100 % stake in a corporation will no longer be deemed to constitute a separate branch of activity if it constitutes a material asset of another existing branch of activity (Directive sec. 15.06). In the event of separation of the 100 % stake from the branch of activity in which it was previously integrated, neither the remaining assets of the original branch of activity nor the 100 % stake constitute independent branches of activity (Directive sec. 15.06).
In the event certain property constitutes a material asset for two or more parts of the enterprise (so-called "precluding assets"), division of these parts from each other is precluded even if, viewed in isolation, they would constitute branches of activity (Directive sec. 15.07, 15.10). The final Directive does not permit material assets used in several branches of activity to be assigned to the branch of activity of predominant use. In the case of real property, partition of the property among the various entities may, however, be possible. In response to comments received, the final Directive also allows joint ownership of real property proportionate to actual use, but only when partition would be "unduly burdensome" (Directive sec. 15.07). Property not constituting a material asset of any existing branch of activity may be freely assigned, at least among those branches of activity in which it is used. Furthermore, it may be possible to dispose of precluding assets in advance of the reorganisation.
The Directive does not provide for the free assignability of liabilities among branches of activity. However, since liabilities are never of material importance to a branch of activity, they would appear assignable in accordance with the same principles which apply to non-material assets. The Directive is silent on how to determine the branches of activity of a holding company when this is the subject of a divisive reorganisation.
KPMG believes that the position advocated by the tax authorities is too restrictive and not in accordance with the definition of "branch of activity" as used in the EU Merger Directive. In the reorganisation context, "branch of activity" should be interpreted functionally in light of the purpose of facilitating economically sensible reorganisations. This policy goal differs from that of deciding when a preferential income tax rate should be accorded to an individual under German income tax law. Different policy goals require different interpretations of the term "branch of activity." The fact that certain material assets previously used in a branch of activity are not transferred should not cause the transaction to forfeit tax protection as long as the assets which are transferred constitute a branch of activity in the functional sense even without the assets which are withheld.
2.4 Relevant time for determining existence of a branch of activity
The draft version provided that the branches of activity required in divisive reorganisations must be in existence (or in the process of formation) as of the effective date of the merger, which may be up to eight months prior to the date of filing with the Commercial Register. The final Directive states that the date of the reorganisation resolution is controlling (Directive sec. 15.10). Since the date of the reorganisation resolution can be several months later than the retroactive effective date, this change benefits the taxpayer. As before, a branch of activity in the process of formation is sufficient.
2.5 General anti-abuse provision (sec. 42 AO)
The draft version of the Directive was criticised for providing that reorganisations conferring certain designated types of tax advantages "generally" or "as a rule" were abusive within the meaning of sec. 42 AO (tax procedure act) and therefore to be disregarded for tax purposes. The draft version failed to stress the need to consider whether, in a particular situation, a sound non-tax reason exists for the planned transaction. If this is the case, the fact that a particular structure yields tax advantages, in addition to achieving its business purpose, is not sufficient to bring the transaction under the anti-abuse provision.
The final Directive contains no material improvements in this respect (cf. Directive sec. 04.44 ff. and 12.22 ff.). Since the Tax Reorganisation Act allows the loss carryforward of a disappearing corporation to be transferred to a surviving corporation, one focus of attention is on corporate mergers involving corporations with large loss carryforwards. The 1997 amendment of sec. 12 (3) sent. 2 UmwStG has defused this issue considerably for reorganisations as to which the request for entry in the Commercial Register was filed after 6 August 1997 (see articles no. 80, 99 sec. 1, and 107; see also section 2.15 below).
The tax authorities also indicate willingness to challenge structures whereby a corporation is first converted into partnership form and then the partnership drops its branches of activity down into new corporations (Directive sec. 04.46).
2.6 Specific anti-abuse provisions for divisive reorganisations
Section 15 (3) sent. 1 UmwStG provides that tax will be triggered on divisive reorganisations involving partnership interests or 100 % stakes in corporations if the interest or stake was acquired or increased during the three preceding years by contribution of property which was not a branch of activity. It will be recalled that divisive reorganisations can only be accomplished free of tax if the assets transferred and retained constitute branches of activity. Partnership interests and 100 % stakes in corporations are deemed to constitute branches of activity however. Section 15 (3) sent. 1 UmwStG is intended to prevent the use of corporations or partnerships to circumvent the basic branch of activity requirement by contributing property not constituting a branch of activity to a partnership or a newly formed 100 % subsidiary and then spinning off the partnership interest or 100 % stake in lieu of the contributed property, which would not have qualified for a direct tax-free spin-off. Such contributions or drop-downs can often be accomplished tax free under the so-called Co-Entrepreneur Directive (Mitunternehmererlass - for contributions to partnerships) or under sec. 20 UmwStG (for drop-downs of majority stakes in corporations to a subsidiary).
The Directive (sec. 15.17) provides that any contribution of appreciated property to a partnership during the three preceding years will preclude a tax-free division. Since such contributions in nominal amounts are common and not always easy to determine after the fact, tax free division involving partnership interests will in many cases be frustrated. The tax authorities did not follow suggestions that they create a de minimis rule in this area.
Section 15 (3) UmwStG likewise denies the protection of the statute to transactions which are the economic equivalent of or in preparation for a sale of the interest in question to third persons. Directive sec. 15.24 states that this is the case in the event of a subsequent transfer in the context of a merger, division, or contribution, even though not all such transactions are ipso facto the economic equivalent of a third party sale. The tax authorities declined to word this section more narrowly in response to comments from practitioners. Restructuring between affiliated enterprises within the meaning of sec. 271 (2) HGB is permitted, however (Directive sec. 15.26).
2.7 Retroactivity of a reorganisation for tax purposes
The effective date of a reorganisation can generally be up to eight months before the date of its filing with the Commercial Register (sec. 17 (2) UmwG). This retroactivity, which is also accepted for tax purposes (sec. 2, 14 UmwStG), poses many questions, some of which are addressed in the Directive.
One such issue is whether the receiving entity in a merger must have been in legal existence at the effective date. While the draft version contended that this was the case, the final Directive reverses this position (Directive sec. 02.08). Accordingly, it is not necessary for the receiving corporation in a merger to have been in legal existence as of the effective date. Instead, the receiving corporation can be formed at any time prior to the merger resolution. Similarly, when changing from corporate to partnership form, a corporate partner of the partnership-to-be need not be in legal existence at the effective date, as long as it has been formed by the time of the reorganisation resolution (Directive sec. no. 14.06).
Another issue relates to dividends, including constructive dividends, paid by the disappearing corporation in a merger in the period after the effective date and prior to the entry of the merger in the Commercial Register (so-called "retroactivity period"). Such dividends may include dividends paid prior to the merger resolution. The Directive attributes such dividends to the receiving entity except to the extent they are attributable to the shares of withdrawing shareholders (shareholders who exercise an option to surrender their shares in the disappearing corporation in return for a cash settlement instead of participating in the merger and taking interests in the receiving entity). Since the retroactivity fiction of sec. 2 UmwStG does not apply to such shareholders (Directive sec. 02.09 ff.), their pro rata share of dividends paid in the retroactivity period is to be attributed to the disappearing corporation. See Directive sec. 02.30, 02.31, 02.33 ff.
If the receiving entity is a partnership, distributions in the retroactivity period to continuing shareholders are regarded as sums withdrawn from the partnership (Directive sec. 02.29, 02.32). If the receiving entity is another corporation, distributions retain their character as (declared or constructive) dividends, but are treated as having been made by the receiving corporation.
The final Directive affirms the position of the draft version on this issue despite the complications it entails.
2.8 Thin capitalisation rules (sec. 8a KStG) and corporate mergers
For mergers of two corporations, the draft directive attributed the shareholder debt of the disappearing corporation to the surviving corporation as of the effective date. Since the safe haven ratio for thin capitalisation purposes is determined for the current fiscal year with respect to equity in the commercial balance sheet at the close of the preceding fiscal year (sec. 8a (2) KStG), serious problems can result wherever the effective date does not coincide with the close of a fiscal year (see Directive sec. 8a.01 ff.).
Example 1
A-GmbH is merged into preexisting B-GmbH (merger by absorption). The merger is effective on 1 March of Year 02. Immediately prior to this date, A-GmbH and B-GmbH both have conventional shareholder debt of 300. As of 31 December 01, each GmbH had equity of 100 in its commercial balance sheet. This equity applies for thin capitalisation purposes throughout Year 02. As a result of the merger, A-GmbH is dissolved without being liquidated effective 1 March 02. B-GmbH has shareholder debt of 600 and equity of 200 in its balance sheet as of the effective date of the merger. However, its equity for thin capitalisation purposes is determined by its closing balance sheet for the preceding year. As of the effective date, its debt-to-equity ratio is therefore 1-to-6 (100 to 600). This exceeds the thin capitalisation safe haven for conventional debt (debt-to-equity ratio of 3-to-1). Interest paid or accrued on the excessive portion of shareholder debt is therefore treated as a constructive dividend under sec. 8a KStG.
(Cf. Directive sec. 8a.04)
In effect, the position of the tax authorities means that neither entity can use the equity of A-GmbH for thin capitalisation purposes during the period from the effective date of the merger to the end of the fiscal year of the receiving corporation. The problem illustrated in Example 1 will occur in spin-offs as well.
Example 2
A-GmbH spins off one of its two branches of activity into newly formed B-GmbH. The shareholders of A-GmbH accordingly take shares in B-GmbH. The spin-off is effective on 1 March of Year 02. Immediately prior thereto, A-GmbH has conventional shareholder debt of 600. As of 31 December 01 and immediately prior to the spin-off, A-GmbH had equity of 200 in its commercial balance sheet. As a result of the spin-off, half of A-GmbH's equity and half of its shareholder debt pass to B-GmbH as of 1 March 02. B-GmbH thus has shareholder debt of 300 and equity of 100 in its balance sheet as of the effective date of the spin-off. Normally, B-GmbH's equity for thin capitalisation purposes would be determined by its closing balance sheet for the preceding year. Since Year 02 is its first year of existence, no such equity exists. As of the effective date, it therefore has no debt-to-equity ratio (debt 300, equity 0). Interest paid or accrued on all shareholder debt in Year 02 is therefore treated as a constructive dividend under sec. 8a KStG. The debt-to-equity ratio of A-GmbH as of the effective date is 3-to-2 (300 to 200), well under the permitted safe haven of 3-to-1. The Directive expressly refuses to permit the taxpayer to electively attribute an appropriate part of the equity of A-GmbH to the receiving corporation (Directive sec. 8a.03).
As a general matter, the position of the tax authorities can lead to a mismatch between equity and shareholder debt of the sort illustrated in the above example whenever the transferring corporation continues to exist after the reorganisation and/or when the receiving corporation was in existence prior to the reorganisation.
However, when the transferring corporation disappears and the receiving corporation first comes into existence on the effective date of the reorganisation, the above problem does not occur.
Example 3
A-GmbH is consolidated with B-GmbH to form new C-GmbH. The merger is effective on 1 March of Year 02. As of this date, A-GmbH and B-GmbH each have conventional shareholder debt of 300. As of 31 December Year 01 and 1 March Year 02, each GmbH has equity of 100 in its commercial balance sheet. As a result of the merger, A-GmbH and B-GmbH are dissolved without being liquidated effective 1 March 02. C-GmbH prepares an opening balance sheet as of this date. Since C-GmbH's first year of existence is 02, it is impossible to base the thin capitalisation calculation on its equity at the close of the preceding fiscal year. Section 29 of he thin capitalisation directive of 15 December 1994 provides that the equity of newly formed corporations shall be determined with reference to their opening balance sheet. The tax authorities adopt this solution for consolidation of corporations (merger by creation of new entity - Directive sec. 8a.03). C-GmbH has shareholder debt of 600 and equity of 200 in its opening balance sheet. It is therefore within the thin capitalisation safe haven for conventional debt (debt-to-equity ratio of 3-to-1) as of this date.
The same approach would apparently apply for a split-up of A-GmbH into two or more newly formed corporations.
The tax authorities rejected proposals from practitioners which would have relieved the obvious inequity of the above literal interpretation of the law by allowing the taxpayer to elect to make the thin capitalisation calculation without regard to the retroactivity fiction or by calculating the thin capitalisation debt-to-equity ratio with respect to equity at the effective date of the merger or at the end of the fiscal year in which the reorganisation takes place, instead of at the close of the preceding fiscal year.
It is not clear that the tax authorities' interpretation is the correct one. It may be possible to argue that there is a gap in the terms of the statute with respect to its interrelationship with the retroactivity provisions of the Tax Reorganisation Act and that this gap should be filled in a way which makes economic sense.
In view of the uncertainty created by the new Directive, a prudent approach to the problem would be to leave shareholder debt in the entity which can make use of the corresponding equity for thin capitalisation purposes. However, this will not always make economic sense.
2.9 Denial of protection of sec. 8b KStG
Section 8b of the German corporation tax act provides a tax exemption inter alia for gains realised by German corporations on the disposition of shares in foreign corporations. The Directive states (sec. 03.11) that any gain from upward valuation of such shares by the transferring corporation on its closing balance sheet shall not benefit from the tax exemption because such revaluation does not constitute a disposition.
2.10 Blocking amounts under sec. 50c EStG
Section 50c of the German income tax law (EStG) is a complex provision which operates, generally speaking, when the shares in a German corporation which has retained earnings are purchased by a domestic buyer from a foreign seller. Absent sec. 50c EStG, the buyer could obtain a refund of the corporation tax paid by the purchased corporation on its retained earnings by distributing these earnings after the purchase and then neutralising the resulting dividend income by means of a dividend-based write-down in the value of the shares. The provision is needed to close an otherwise existing loophole because foreign sellers will typically be shielded from German tax liability on their capital gain under the terms of a tax treaty. Under sec. 50c EStG, shares are tainted by a "blocking amount" (equal to the excess of the purchase price of the shares over their par value) when a taxpayer entitled to the corporation tax credit purchases shares in a domestic corporation from a person not entitled to this credit. There are a variety of related circumstances in which a blocking amount also arises.
Section 4 (5) UmwStG provides that a blocking amount which exists with respect to the shares of a corporation which is merged into (or otherwise reorganised as) a partnership must be treated as income by the receiving partnership. Otherwise, an effect similar to that of a dividend writedown could be obtained by reorganising the target corporation as a partnership subsequent to the purchase.
Directive sec. 04.21 - 04.27 interpret sec. 4 (5) UmwStG and sec. 50c EStG in ways which would give rise to such reorganisation income in a variety of questionable circumstances.
2.11 Retroactivity of 1996 amendment to sec. 5 (3) UmwStG
The cited statute, which applies to mergers and conversions of corporations into partnerships, was amended in December 1996. The amendment relates to the value at which shares in the disappearing corporation held by a partner of the receiving partnership in his or her domestic permanent establishment are deemed contributed to the partnership. The tax authorities have always claimed that the amendment only clarified what the statute meant all along. Directive sec. 05.15 therefore states that the amendment is effective retroactive to 1 January 1995 (date of entry into force of the new Tax Reorganisation Act). This is subject to considerable doubt.
2.12 Downstream mergers
The Directive permits the merger of a parent into its subsidiary, but does so only "for equitable reasons" (sec. 11.24 ff.) and only pursuant to a formal request by all parties to the merger. Arguably, the permissibility of such transactions follows from the statute itself and is not subject to special conditions. Downstream mergers are problematic because they may cause the surviving corporation (subsidiary) to acquire the shares in itself previously held by the disappearing corporation (parent).
2.13 Corporate loss carryforwards in general
Under the Tax Reorganisation Act as originally legislated, the surviving corporation in a corporate merger assumed the loss carryforward of a disappearing corporation provided the disappearing corporation had not yet ceased doing business at the time of entry of the merger in the Commercial Register (sec. 12 (3) sent. 2 UmwStG). If this requirement was met, use of the loss carryforward by the surviving corporation was still subject to the conditions of sec. 8 (4) KStG (see Directive sec. 12.21).
The tax reform act passed in the summer of 1997 made changes to both sec. 12 (3) sent. 2 UmwStG and sec. 8 (4) KStG (see articles nos. 80, 99, and 107) Under the new version of sec. 12 (3) sent. 2 UmwStG, the loss carryforward of the disappearing corporation may only be transferred to the surviving corporation provided the business or branch of activity which produced the losses is continued on a comparable scale for five years following the effective date of the merger. The new provision applies to mergers for which the request for entry in the Commercial Register is filed after 5 August 1997.
2.14 Loss carryforward of merged holding companies
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 (Directive sec. 12.18). The principal activity of a holding company is defined as holding participations in other corporations. Language in the draft version to the effect that the requirements for a managing holding company need not be met has, however, been deleted from the final Directive. A cross-reference to sec. 271 (1) HGB regarding the meaning of the term "participation" has also been deleted. The Directive does state that it is sufficient to hold a participation in a single corporation in order to qualify as a holding company.
2.15 Loss carryover under sec. 15a EStG
Generally speaking, sec. 15a of the income tax act (EStG) restricts utilisation by limited partners of their distributive share of partnership losses to the capital they have actually committed to the partnership. Losses which cause their capital accounts to become negative can, however, be carried forward. The Directive provides that such loss carryforwards will not be transferred to the surviving entity when a corporate limited partner is merged into a partnership (Directive sec. 04.38 ff.).
3. Concluding remarks
It is again stressed that the above is a highly selective treatment of issues posed under the new comprehensive Directive on the Tax Reorganisation Act. Despite its length, the Directive by no means addresses all open issues. Nor does it possess the force of law as to the matters on which it does provide guidance. The controversial positions taken in the Directive on certain issues and its silence on others leave little doubt but that final resolution of many questions will be up to the tax courts.
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.
