Germany: 176. Final Version of Loss Utilisation Directive

The text of former § 10d (3) EStG is now found in § 10d (4) EStG (see also sec. 3.2 below).

In our article no. 148, the term "Zuführung neuen Betriebsvermögens" was translated as "provision of new business property". In keeping with our translation of the final directive, we have above used the slightly less literal, but clearer translation "injection of new business assets".

As a consequence of changes made in § 10d EStG, the basic loss carryback and carryforward provision of the German tax code, the code no longer refers to a "remaining [net] deductible loss" (verbleibender Verlustabzug – article no. 148, sec. 1.1). Instead, reference is now made (in § 10d (4) EStG) to a "remaining loss carryforward" (verbleibender Verlustvortrag). The final version of the directive nevertheless continues to use the old term (directive sec. 2, 15, 35 Examples 1 and 2, and Part B). No change in terminology has as yet been made in § 8 (4) or § 12 (3) UmwStG, which still refer to a remaining net deductible loss.

Like the draft version, the final version of the directive contains no exception from the strict rules respecting loss of economic identity for transactions between group companies. In other words, a 50 %+ shift in share ownership between two 100 % subsidiaries of the same parent followed by the injection of predominantly new business assets leads to a loss of economic identity and forfeiture of loss carryforward under the directive.

The draft version of the directive provided that loss forfeiture could occur as a result of a change in the indirect ownership of the loss corporation (draft directive sec. A(1)(b) par. 5). The final directive reiterates this position and expands upon it (directive sec. 28). It states that it makes no difference whether the indirect ownership is through other corporations or through partnerships and further provides that the conversion of an indirect shareholding into a direct shareholding can also constitute a damaging change in ownership for loss utilisation purposes. However, tax-neutral restructuring of indirect participations as different indirect participations under §§ 11 ff. and 20 ff. UmwStG (tax reorganisation act) are stated not to constitute a change in ownership for purposes of the statute.

This treatment of changes in indirect ownership is controversial (see article no. 148, sec. 3.2.1, last par.).

The final directive contains a new provision on the calculation of the percentage change in ownership in the event the loss corporation holds shares in itself (directive sec. 3). The new clause states that shares held by the corporation in itself are in effect treated as non-existent for purposes of the calculation.

Criticism that multiple changes in ownership of the same shares (e.g. triple transfer of a single 20 % stake) might constitute a material (50+ %) change in ownership have led to the insertion of a clause providing that "the multiple transfer of the same shares will be counted only once". The relevant question is whether an overall stake of more than 50 % has changed hands (directive sec. 5).

The draft directive provided that individual share transfers can only be added together if they occur in the same "overall context" (Gesamtzusammenhang). The final version instead refers to a necessary "connection in time" (zeitlicher Zusammenhang) between the transfers. The relevant time period remains five years. The same change in wording is used in connection with the five year period over which injections of new business assets will be added together to see if new business assets predominate (directive sec. 6, 12). The rigid five year time periods are controversial (see article no. 148, sec. 3.2.1 and 3.2.3 last par.).

The draft version of the directive provided for comparison of gross business assets held prior to the beginning of the injection of new assets with gross assets after the injection. The final directive, on the other hand, states that assets present at the time of the material change in ownership are to be compared with those after the injection of new assets.

Furthermore, the final directive provides that account is to be taken of immaterial assets not capitalised for tax accounting purposes in deciding whether the injection of new assets predominates. This reverses the position taken in the draft version, which rejected consideration of non-capitalised immaterial assets. This change can be quite significant for loss corporations with self-created intangibles.

The rehabilitation exception requires the loss business to be continued on a comparable scale for a period of five years. The draft directive provided that the scale on which the business operated at the outset of the loss phase was controlling. The final version instead looks to the average scale on which the business operated during the loss phase. Furthermore, the final directive provides that downsizing of the loss business during the five year period in which it must be continued is only damaging if the business declines in size by more than half compared with its average size during the loss phase (directive sec. 15).

The draft directive, on the other hand, had seemed to prohibit virtually any downsizing. These provisions may therefore be regarded as considerable improvements. As a practical economic matter, downsizing is often indispensable to the restructuring of loss businesses.

The suggested, non-exclusive measurement criteria remain the same (sales, order volume, business assets, workforce), except that the suggestion that workforce is not co-equal with the other criteria has been dropped.

No guidance is provided as to how to determine the average scale of the business during the loss phase.

With regard to a loss business which changes its trade (Branchenwechsel, translated in perhaps overly broad fashion as "change in line of business" in our article no. 148, sec. 3.2.4), language has been added providing that only the business existing after the change in trade can be a loss business for purposes of the rehabilitation exception (directive sec. 18). This would prevent the business existing prior to the change in trade from qualifying for the exception.

Language has also been added stating that a corporation which leases its business to another (Verpachtung) does not continue to operate this business. On the other hand, the division of a business into an asset-holding and an operative entity (Betriebsaufspaltung) does not cause the business to terminate (directive sec. 20). Once a business has been terminated, it can no longer qualify for the rehabilitation exception (directive sec. 18).

As in the draft version, the five year period during which the loss business must continue to operate is stated not to begin until both the change of ownership and the injection of new assets are complete. Language has been added stating that this applies as well when the change of ownership occurred prior to 1997 (directive sec. 21).

The provisions in this part of the directive are largely unchanged from the draft version, although. The text of directive sec. 26 and 27 was located elsewhere in the draft directive.

The language regarding transfers of indirect ownership interests (directive sec. 28) is new and has been addressed under sec. 3.4 above.

In the first sentence of directive sec. 29, the word "or" in the draft version has been replaced by the word "but" in the final version, probably to correct a perceived drafting error.

With regard to situations in which the injection of new business assets is damaging even if it occurs prior to the material change in ownership, the directive contains new language referring to "collusive cooperation" between seller and buyer (directive sec. 31).

New in the directive is mention of the situation in which the loss corporation's new owner injects new business assets into the loss corporation's subsidiaries, thus permitting them to earn profits which are offset at the level of the loss corporation by this entity's losses (directive sec. 32). Such structures are said to fall under the statute.

A significant – negative – change has occurred in this area. The draft directive provided that the event of loss of economic identity led to forfeiture of the losses accrued up to the time of the material change in ownership. The final directive provides for forfeiture of losses accrued up to the time of the loss of economic identity (directive sec. 33). This point in time is generally later, since it is not reached until 50+ % of the shares have changed hands and predominantly new business assets have been injected.

The examples under directive sec. 35 have been modified to take account of this shift in position.

The draft directive took positions regarding the entry into force of the statute which led to anomalous results (see article no. 148, sec. 3.2.7). The final directive makes no changes of substance in this area (directive sec. 35).

For a discussion of the issues involved, please see our previous article.