On 7 April 2010, the Federal Tax Court (BFH) overruled a decision of the local tax court of Saxony (see GTLN 2/2009) and confirmed long-standing principles, while defining the concept of an “independent business division,” which represents one of the prerequisites to qualify for a tax neutral demerger of a business under the German Reorganization Tax Act and for certain other tax neutral reorganizations. The court held that an independent business division can be presumed only if all operating assets that are necessary to continue the transferred business are legally owned by the demerged entity (case reference I R 96/08, BStBl II 2011, p. 467).
The case involved a German GmbH that carried out two different businesses that used the same premises for their business activities. One of the businesses was transferred to a newly founded NewCo (a GmbH) held by the same shareholder in a demerger. However, the production site and the office buildings were not part of the transferred business, but remained in the GmbH and were rented out to NewCo after the demerger.
To carry out a tax neutral demerger, the Reorganization Tax Act requires that both the transferred business and the remaining business qualify as independent business divisions, i.e. an organizationally autonomous part of a business with a certain degree of independence. In related guidance, the German tax authorities have stated that a qualifying independent business division must comprise all operational assets necessary for the continuation of the business, and that a tax neutral demerger may not be possible if there are operational assets that are necessary for the remaining business, as well as for the business that is transferred. According to this view, real estate that is used by both businesses generally must be legally separated in advance and the part relevant for the transferred business must be transferred to the receiving entity.
Contrary to the decision of the local tax court, the BFH ruled that the retention of the premises is detrimental to the tax neutrality of the transaction. The BFH did not agree with the local tax court’s position, under which the possibility to use the real estate based on a lease agreement and to continue the business on this basis is sufficient to fulfill the requirements for a tax neutral demerger. The BFH further rejected the argument that the built-in gains of the real estate remained taxable in the hands of the original GmbH.
In its decision, the BFH also commented on the conditions for the retroactive effect of a demerger for tax purposes. Under the Reorganization Tax Act, a demerger generally may have retroactive tax effect for up to eight months. The BFH held that the retroactive tax effect is also available in a situation in which a non-tax neutral demerger is effected, confirming the prevailing view in tax literature and the view of the tax authorities. However, the BFH stated that the retroactive effect applies only to the companies involved in the demerger transaction and not to the shareholders of the companies. Any tax effects as a result of a taxable demerger transaction at the level of the shareholders of the companies involved are triggered at the time the demerger becomes legally (and not for tax purposes) effective.
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