Federal Tax Court rules on requirements for tax group with partnership as head of tax group

The Federal Tax Court has ruled that where a partnership is the controlling entity of a German tax group (“Organschaft”), the partnership does not have to carry out its own genuine business activities as from the beginning of the first year of the Organschaft; it is sufficient if the partnership commences such activities during the first year in which the tax grouping is effective.

German tax law provides for the establishment of a tax group (Organschaft), under which participating companies can pool their profits and losses for corporate and trade tax purposes. One of the requirements to set up a tax group with a partnership as the head of the group (but not when a corporation is the head) is that the partnership must carry out its own genuine business activities. As a result, a partnership that is merely a holding/financing entity cannot act as the head of a group. Genuine business activities typically means that the partnership must earn income from engaging in a trade or business, such as by providing services to other affiliated entities. 

The Federal Tax Court (BFH) recently had to rule on whether a partnership that is the head of an Organschaft is required to carry out its own genuine business activities from the beginning of the first year for which the Organschaft is to be effective or whether the activities can begin during that first year. In the case, the taxpayer applied for Organschaft treatment as from 1 January 2006, even though the head of the group (a KG) did not commence its own business activities until 1 March 2006. The BHF ruled in favor of the taxpayer, holding that it is sufficient if the partnership starts its own genuine business activities during the first year of the Organschaft. 

The BFH decision may provide some relief in M&A transactions where the parties intend to set up a tax group between the acquisition vehicle (a partnership) and the target entities and the Organschaft treatment is to become effective on or shortly after the deal is closed. In such cases, it had been necessary for the acquisition vehicle to engage in genuine business activities between the time the deal was signed and the time it closed. The BFH decision should offer more flexibility from a timing perspective in these cases. 

The BFH also addressed another issue in the case, i.e. whether it is possible to cure a profit and loss pooling agreement (PLPA) which includes insufficient wording with respect to the mandatory loss compensation provision. A PLPA is another requirement to establish a tax group. The BFH confirmed a grandfathering provision in the corporate income tax code, under which taxpayers have until the end of FY14 to either amend or terminate an improperly worded loss compensation provision. By making this point, the BFH indirectly denied the applicability of a decree issued by the tax authorities that provides for a different approach to the need to amend an insufficiently worded PLPA.