26.11.2014Local tax authorities broaden concept of “harmful divesture” following tax-neutral spinoff
The Ministry of Finance (MOF) of the State of Brandenburg has issued its interpretation on when a divesture of shares following a tax-neutral spinoff results in retroactive taxation of the spinoff. The MOF’s announcement considerably broadens the interpretation of a “harmful divesture” compared to guidance previously issued by the Federal MOF.
Under the Reorganization Tax Act, a corporation (e.g. GmbH) can spin off business into a sister corporation in a tax-neutral transaction if, inter alia, the following requirements are met:
- The transferred business qualifies as a “separate business line” (the transfer of individual assets will not quality);
- The assets that remain at the transferring entity qualify as a separate business line; and
- New shares in the receiving entity are issued to the shareholders of the transferring entity.
A tax-neutral transfer will be disallowed, however, if the spin-off is used to implement a (tax efficient) divestment structure. This will be deemed to be the case if shares in the transferring or receiving entity that represent more than 20% of the value of all shares in the transferring entity before the spinoff are sold within five years after the spinoff (“harmful divesture”).
For example, assume A-GmbH spins off a separate business line that represents 21% (Alternative A) or 19% (Alternative B) of A-GmbH’s entire value into a newly founded sister corporation, NewCo. All shares in NewCo are sold within five years.
The sale of the shares in NewCo generally benefits from the participation exemption (i.e. preferred taxation compared to the sale of assets). The sale of shares in Alternative A, however, will be considered a harmful divesture and, therefore, will result in a retroactive denial of the tax-neutral spinoff treatment and, correspondingly, full taxation of built-in gains in the transferred assets at the time of the spinoff at the ordinary German income tax rate of approximately 30%. No harmful divesture will be presumed in Alternative B since the value of the shares sold represent less than 20% of A-GmbH’s pre-spinoff value.
The MOF in Brandenburg has expanded the interpretation of harmful divestures for cases where the value of the shares falls below the 20% threshold. According to the new interpretation, a harmful divesture will also be presumed where there are indications that the sale of shares was intended at the time of the spinoff even if the 20% threshold is not exceeded.
The new interpretation considerably restricts the applicability of the tax-neutral spinoff regime. It is unclear whether the tax authorities in other states and/or the Federal MOF will adopt this interpretation.
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