Capital gains liability triggered due to disproportionate merger

The German Federal Tax Court (BFH) recently ruled that a disproportionate merger can lead to taxable capital gains (case reference: IX R 24/09). In the case, an individual directly owned shares in one German corporation (Company X) and indirectly held shares in another (Company Y) via a wholly owned Dutch BV. 

Upon the merger of Company Y (transferring entity) into Company X (surviving entity), Company X increased its capital and issued new shares to (amongst others) the Dutch BV (as the former direct shareholder of the transferring entity). For each nominal share in Company Y as the transferring entity, the Dutch BV received one share in Company X as the surviving entity. The fact that each share in Company X had significantly higher fair market value than a share in Company Y was not taken into account. Therefore, the effect of the share exchange was that the Dutch BV received shares with a significantly higher fair market value than the shares it previously owned (or rather its share in Company X was significantly larger than it would have been had the share exchange been conducted based on the fair market value of the relevant shares).

Since the individual was the shareholder of both the Dutch BV and Company X as the surviving entity following the merger, the disproportionate allocation of shares in the course of the merger was considered to constitute a deemed contribution of the shares in Company X into the Dutch BV. The BFH ruled that third parties would have agreed on an adequate arm’s length capital increase, and held that the transaction led to a taxable capital gain which was assessed vis-à-vis the individual.

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