Germany: 176. Final Version of Loss Utilisation Directive

Last Updated: 29 July 1999
KPMG Germany Webpage
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1. Introductory

A major part of article no. 148 dealt with the draft version of a directive on loss utilisation released by the Federal Ministry of Finance in the summer of 1998. As reported briefly in article no. 171, the final version of this directive was issued by the tax authorities in April 1999 (directive IV C 6 - S 2745 - 12/99 dated 16 April 1999, hereinafter "the directive").

Large parts of the final version of the directive are identical to the draft version. However, there are also a number of significant changes. This article attempts to identify and comment on the major differences between the draft and final versions of the directive. It is emphasised that the directive represents the position of the tax authorities. It does not possess the force of law and may be challenged in court. Even where this article does not expressly identify a position taken in the directive as controversial, one should not assume it to be uncontested.

KPMG Germany has prepared an English language translation of the final version of the directive. Persons desiring to obtain a copy of the translation should contact Ulrich Löwenstein, tax partner with KPMG Frankfurt, at one of the following numbers:

Telephone: +49-69-9587-2174

Telefax: +49-69-9587-2176

2. Structure of the directive

The basic structure of the directive is unchanged compared with its draft version:

A. Loss of economic identity (§ 8 (4) EStG)

1. Substantive application

a. Primary loss forfeiture situation

b. Transfer of more than half of the shares in a corporation and equivalent situations

c. Injection of predominantly new business assets

d. Rehabilitation (corporate recovery) situations

e. Application to other corporate entities and to other instances of loss of economic identity

f. Extent of forfeiture of loss utilisation

g. Consequences for the equity accounts

2. Entry into force

B. Carryover of the remaining net deductible loss under § 12 (3) sent. 2 UmwStG

1. Substantive application

a. Business or sub-business which caused the loss

b. Loss deduction for sub-businesses

c Continued operation on a comparable scale in the following five years in light of the overall economic circumstances

d. Transfer of parts of the loss business or sub-businesses

e. Continued operation in situations involving divisive reorganisations

2. Entry into force

C. Relationship of § 12 (3) sent. 2 UmwStG to § 8 (4) KStG

The only new subpart is B(1)(b). However, in some cases text in the draft version has been rearranged and appears at a new location in the final directive. Furthermore, text has been deleted, added, and reworded in some cases. Some of the changes simply provide greater clarity or address an aspect not dealt with in the draft version. Others make major substantive changes in the positions taken by the draft directive. The following comments do not necessarily address all such changes.

The final version of the directive also has consecutive marginal section numbers in addition to the above structure. These consecutive section numbers are used to cite the directive in this article.

3. Loss of economic identity under the corporation tax act

3.1 Old and new text of § 8 (4) KStG

The directive interprets the version of the statute enacted in 1997. The following is our translation of the old and new wording of the statute. Changes are underlined in the new version:

Old version (1990)

Amended version (1997)

1Loss deduction under § 10d of the Income Tax Act on the part of a corporate entity is contingent upon its being not just legally, but also economically identical to the corporate entity which suffered the loss. 2Economic identity is not present in particular when more than three fourths of the shares in a corporation are transferred and the corporation thereafter recommences its business (Geschäftsbetrieb) with predominantly new business assets (Betriebsvermögen). 3The same shall apply mutatis mutandis with respect to the offsetting of loss [incurred] from the beginning of the fiscal year to the time of share transfer.

1Loss deduction under § 10d of the Income Tax Act on the part of a corporate entity is contingent upon its being not just legally, but also economically identical to the corporate entity which suffered the loss. 2Economic identity is not present in particular when more than half of the shares in a corporation are transferred and the corporation continues or recommences its business (Geschäftsbetrieb) with predominantly new business assets (Betriebsvermögen). 3The injection (Zuführung) of new business assets is not damaging if the sole purpose served thereby is the rehabilitation (Sanierung) of the business which caused the remaining deductible loss within the meaning of § 10d (3) sentence 2 of the Income Tax Act and the corporate entity continues to operate the business on a comparable scale, in light of the overall economic circumstances, during the following five years. 4The same shall apply mutatis mutandis with respect to the offsetting of loss [incurred] from the beginning of the fiscal year to the time of share transfer.

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".

3.2 Remaining loss carryforward

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.

3.3 No intra-group transaction clause

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.

3.4 Changes in indirect ownership

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.).

3.5 Corporation holding shares in itself

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.

3.6 Multiple transfer of the same shares

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).

3.7 Connection in time

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.).

3.8 Injection of predominantly new business assets

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.

3.9 Rehabilitation (corporate recovery) exception

Scale of continued operation

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.

Change in trade; lease; division of an operative business

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).

Beginning of five year continuation period

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).

3.10 Operation of the statute outside the primary loss forfeiture situation

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.

3.11 Extent of forfeiture of loss utilisation

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.

3.12 Entry into force: 1997 or 1998?

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.

4. Carryover of loss carryforward under the tax reorganisation act

4.1 Old and new text of § 12 (3) sent. 2 UmwStG

Old version (1995)

Amended version (1997/1999)

1[Sentence 1 provides that, upon merger of two corporations, the receiving corporation assumes certain tax attributes of the disappearing corporation.]

2This applies as well for any remaining net deductible loss within the meaning of § 10d (3) sentence 2 of the Income Tax Act, provided the disappearing corporation has not yet discontinued its business (Geschäftsbetrieb) at the time of entry of the transfer of property in the Commercial Register.

1[Sentence 1 provides that, upon merger of two corporations, the receiving corporation assumes certain tax attributes of the disappearing corporation.]

2This applies as well for any remaining net deductible loss within the meaning of § 10d (4) sentence 2 of the Income Tax Act, provided the business (Betrieb) or sub-business (Betriebsteil) which caused the loss continues to operate on a comparable scale, in light of the overall economic circumstances, during the five years following the effective date of the merger.

The only 1999 change in the statute relates to the citation of § 10d (4) EStG (previously § 10d (3) EStG. See also sec. 3.2 above.

4.2 Business or sub-business which caused the loss

Scale of continued operation

With respect to the scale of continued operation of a loss business assumed by the surviving corporation, the final directive refers to the provisions regarding scale of continued operation under the rehabilitation exception of § 8 (4) KStG (directive sec. 38). Hence, the improvements made in this area with respect to the purchase of loss corporations apply as well when a loss corporation is merged into another corporation (see sec. 3.9 above).

Language has also been added making clear that lease of production facilities to third persons is regarded as a form of downsizing (directive sec. 38). Clarifying language has been added regarding the scale of the business of corporations which are lead companies in tax consolidated groups and or partners in commercial partnerships (directive sec. 39).


An entire subsection has been added on the subject of sub-businesses (directive sec. 40). If the requirements regarding continued operation of the business cannot be met as to the business as a whole, the possibility exists to show that the losses in question are properly allocable to a sub-business, as to which the requirements for continued operation are met.

According to the directive, taxpayers seeking to rely on this provision must – convincingly – allocate profits as well as losses to the various sub-businesses. The loss deductible for a particular sub-business may not exceed the net loss incurred by the sub-business (total sub-business loss reduced by total sub-business profits). The deductible loss for all sub-businesses is further limited to the overall loss carryforward of the corporation as a whole.

With respect to what constitutes a sub-business, the directive now states that individual assets or mere cost centres such as the research department of a chemicals company do not rise to the level of sub-businesses (directive sec. 37).

5. Relation of loss utilisation provisions under corporate tax law and reorganisation tax law

Like the draft version, the final directive states that § 8 (4) KStG and § 12 (3) UmwStG are cumulatively applicable. Hence, the merger of B-Corp. into A-Corp., both with loss carryforwards, can conceivably destroy the loss carryforwards of both corporations. If the former shareholders of B-Corp. now hold more than half of the shares in A-Corp., this constitutes a material change in ownership. If predominantly new business assets are also injected (which presumably means, injected from outside – see next example discussed below), then A-Corp. forfeits its loss carryforward under § 8 (4) KStG. If the requirements of § 12 (3) UmwStG are not met (continuation of the loss business or sub-business of B-Corp. by A-Corp.), then the B-Corp. loss carryforward also disappears.

A new second example with commentary has also been added (directive sec. 49). It relates to the merger of a loss corporation into a profitable corporation followed by the injection of predominantly new business property from outside sources. The shareholders of the disappearing corporation (T-Corp.) take less than half of the shares in M-Corp. as a result of the merger. Hence, the shareholders of M-Corp. remain in control.

The merger is treated as equivalent to a material change in ownership in T-Corp. (the disappearing corporation). The directive says that if predominantly new business assets are injected into M-Corp. from outside, the transaction falls under § 8 (4) KStG. Hence, even if M-Corp. meets the requirements of § 12 (3) UmwStG by continuing the loss business of T-Corp., the losses of T-Corp. will still be forfeited. The example makes clear that the business assets of M-Corp. will not in themselves be regarded as "predominantly new business assets."

One may doubt whether the merger is in fact the economic equivalent of a purchase of a majority share in T-Corp. by M-Corp. It is furthermore unclear whether the injection of predominantly new business assets is properly determined with respect only to the business assets of T-Corp., which are owned by M-Corp. after the merger, or with respect to the joint assets of the two entities.

6. Concluding remarks

The positions taken by the final directive are controversial in numerous respects. However, in planning future transactions, they must be given due consideration.

For further information, please send a fax stating your inquiry to KPMG Frankfurt, attn. Christian Looks +49-(0)69-9587-2262 or an e-mail using the button appearing below. Please state your name and organisation in all inquiries.

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. Distribution to third persons is prohibited without our express written consent in advance.

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