Lower tax court of Munich rules on deduction of business expenses for reinstating liability under return to good fortune clause

The lower tax court of Munich recently issued a decision in a case in which the shares in an inactive company were transferred (case reference: 6 K 1451/08). The company had negative equity and a liability on a loan granted by the transferring shareholder. Before the share transfer, the shareholder waived its loan receivable on the condition that the loan would be reinstated if the company became profitable in the future (“return to good fortune” clause). Since the loan waiver resulted in a profit at the level of the inactive company, the company used the profits derived from the waiver to offset its tax losses. Thus, when the shares were transferred, no losses were subject to the German change-in-ownership rules.

When selling the shares in the inactive company for 1 Euro, the seller also sold the latent receivable on the waived loan to the purchaser of the shares. The new shareholder subsequently merged another active company into the acquired inactive company. The new active business generated profits that led to a reinstatement of the liability under the return to good fortune clause. This reinstatement created business expenses that the company sought to deduct. The tax authorities disallowed the deduction.

The lower tax court agreed with the tax authorities. According to the court, the expense generated under the return to good fortune clause should either be considered a deemed dividend or – if not qualified as a deemed dividend – should be nondeductible under the general anti-abuse rule (section 42 of the General Tax Code). The court believed that the only purpose for the steps taken in the case was to safeguard losses that otherwise would have been impacted by the change-in-ownership rules.

While the case relates to tax years before 2003, and should not be covered by the official tax authority guidance that disallows the use of losses created by making use of the good fortune clause in change-in-ownership cases (under a transition rule, only waivers taking place after 18 December 2003 are covered by the guidance), the fact that it was brought to court demonstrates that pre-2003 cases are equally under scrutiny.

If you have any questions, please contact the authors of the article at gtln@deloitte.de or your regular Deloitte contact.