European Commission finds German rule on loss carryforwards by ailing companies unlawful state aid

Under normal German corporate tax rules, tax losses may be carried forward indefinitely and offset against future income (within certain limits per year). Loss carryforwards will expire, however, if more than 50 % of the shares in a company with unused loss carryforwards are transferred to a single recipient (with certain exceptions for intragroup restructurings and a safe haven for losses not exceeding hidden reserves applying as from 1 January 2010). The financial restructuring exception, introduced in July 2009 and applicable retroactively from 1 January 2008, grants ailing companies that have the potential for a turnaround a possibility to carry forward tax losses despite a significant change in the shareholding.

The European Commission opened an ex-officio case on the tax measure in question in July 2009, when it became aware of the measure through articles in the press. In February 2010, the Commission opened an in-depth investigation after a preliminary assessment into the financial restructuring exception on the grounds that the measure may constitute state aid. On 26 January 2011, the Commission announced its final decision in a press release (the full text of the decision is not yet available), concluding that the financial restructuring exception grants a selective advantage to ailing companies because it differentiates between ailing companies and healthy companies. Even though both companies could be loss-making, only ailing companies are able to retain their loss carryforwards under the financial restructuring exception. Given that the ability to offset future profits with loss carryforwards has to be considered a tax advantage, the Commission ruled that the financial restructuring exception constitutes state aid. Since Germany did not notify the Commission of its intention to introduce this scheme, the financial restructuring exception is unlawful state aid and any aid granted since its introduction (1 January 2008) has to be recovered. In principle, the recovery of aid will be effected in accordance with the procedures under the national law of the Member State concerned, provided they allow the immediate and effective execution of the Commission's decision. According to established case law, procedural difficulties may not prevent recovery.

Any German companies that have relied on the financial restructuring exception to retain loss carryforwards, despite significant changes in their shareholding, will no longer be able to make use of these loss carryforwards. According to established case law of the European Court of Justice (ECJ) and the EU Court of First Instance, the Commission’s decision may not be challenged in domestic legal proceedings, but any company that has made use of the financial restructuring exception could be in a position to file a lawsuit (action for annulment of the Commission’s decision) at the EU Court of First Instance. The possibilities and the likelihood of success of such legal action would have to be analyzed on a case-by-case basis.

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