A German partnership sold its shares in a Mexican subsidiary and realized a tax-exempt capital gain in an amount equal to the excess of the sales price of the shares and the tax book value of the shares at the time of the transfer. Five percent of the capital gain was treated as a nondeductible business expense and thus subject to corporate income tax and trade tax; in effect, the capital gain was 95% tax exempt.
Because the full sales price for the shares was not paid immediately, the German partnership capitalized a receivable. Approximately two years later when it was determined that the remaining purchase price receivable was irrecoverable, the partnership wrote off the receivable, taking the position that the write-off led to a tax deductible expense.
Both the Lower Tax Court and the Federal Tax Court (BFH) (I R 58/10) rejected this view and ruled that the write-off of a portion of the purchase price receivable must be considered an adjustment of the tax-exempt capital gain. The courts held that the impairment of the receivable had to be taken into account for the taxation of the “triggering one-time event,” i.e. the disposal of the shares in the Mexican subsidiary, and they confirmed that the adjustment was effective retroactively to the year in which the sale took place for German tax purposes. Consequently, the 5% nondeductible business expenses that had been deemed to arise on the capital gain had to be reduced.
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