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09.04.2014
German Tax and Legal News

Federal Tax Court rules on justifications for terminating profit and loss transfer agreement

The Federal Tax Court ruled on 13 November 2013 that an intragroup transfer of the shares in a controlled company in a tax consolidated group does not constitute an “important reason” for the termination of a profit and loss transfer agreement (PLTA).

One of the requirements to establish an income tax consolidation between two German entities is that the parent entity and its subsidiary must enter into a PLTA for at least a five-year period, under which the subsidiary is legally required to transfer its entire local GAAP net income to the parent and the parent is required to compensate the subsidiary for a local GAAP net loss. Once a valid income tax consolidation is set up, the parent entity becomes the sole taxpayer of the income tax-consolidated entities and all taxable profits/losses of the subsidiaries are allocated to the parent.

A termination of the PLTA before the end of the five-year period generally results in a retroactive denial of the income tax consolidation; for example, if the PLTA is terminated after four years, the consolidation generally will be disallowed retroactively as from year one.

A retroactive denial of a PLTA can be avoided, however, if there is an “important reason” for the termination. Although this term is not defined in the law, the German tax authorities have issued guidance that states that the sale of the shares in the consolidated subsidiary by the parent entity is a sufficient reason for terminating a PLPA.

The present case involved a PLTA between a KG as a parent entity and a GmbH as a subsidiary; the PLPA was terminated in the second year during the course of an intragroup sale of the shares in the GmbH.

The PLTA initially was concluded between the KG and the GmbH to offset the GmbH’s operating income with NOL carryforwards at the level of the KG. The sale of the subsidiary’s shares and the termination of the PLTA were carried out once the NOL carryforwards of the KG were utilized.

The taxpayer referred to the tax authorities’ guidance, which does not distinguish between intragroup and third party sales, and argued that an intragroup sale of the shares in a subsidiary should be regarded as an important reason to justify allowing the income tax consolidation for years one and two.

The Federal Tax Court disagreed, holding that the intragroup sale of the GmbH shares does not qualify as an important reason for the termination of the PLTA and, as a result, the income tax consolidation between KG and GmbH was retroactively disallowed as from year one. The court emphasized, in particular, that the sole reason for the initial implementation of the PLTA in this case was the contemplated use of KG’s NOL carryforwards.

It is unclear whether all intragroup transfers of controlled entities in a tax group within the five-year period will result in a retroactive denial of the consolidation or whether some intragroup transfers will be permitted. Situations where neither the initial implementation of the PLTA nor a subsequent intragroup transfer are purely tax driven still may be possible without losing the benefits of income tax consolidation; to obtain certainty, however, prior consultation with the tax authorities (e.g. in the form of a binding ruling) is strongly recommended.

Contact

Norbert Miethe
Manager

nomiethe@deloitte.com
Tel.: +1 212 436 4625

Contact

Norbert Miethe
Manager

nomiethe@deloitte.com
Tel.: +1 212 436 4625

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