Information only in English
 
06.02.2012

Official guidance issued on reorganizations under Reorganization Tax Act

Final guidance on the Reorganization Tax Act (RTA), published by the German tax authorities on 2 January 2012, addresses issues related to the taxation of cross-border as well as domestic reorganizations. The reform was aimed primarily at facilitating new possibilities for cross-border reorganizations (mergers, spin-offs, split-offs and hive-downs). The guidance comprises 170 pages and includes technical information on various topics. The authorities take a position on, inter alia, the following issues:

Valuation questions

Tax authorities’ view 

  • Reorganizations generally are possible under the RTA on a no gain/no loss basis if certain conditions are satisfied. The wording of the RTA allows for a tax neutral rollover even in situations in which assets are stepped up to fair market value (FMV) for German GAAP purposes. This view is now confirmed in the guidance. 
  • In contrast to previous practice, each asset in a contribution between book value and FMV will be stepped up on a pro rata basis based on its respective FMV. 
  • For contributions at FMV for tax purposes, even though the value of assets and liabilities can be stepped up to their FMV in the final balance sheet governing the reorganization for tax purposes, the general tax accounting rules should apply as from the next balance sheet date.

    As a result, any liabilities that may either not be recorded under regular tax balance sheet principles (e.g. accruals for impending losses) or not in the same amount (because their tax value is deemed to be lower) will have to be eliminated/reduced to their tax balance sheet value as of the next balance sheet date, thus potentially triggering a taxable profit.

Implications for taxpayers 

  • The position that a potential recording of liabilities at their FMV (irrespective of any tax balance sheet restrictions) should be reversed in the balance sheet in the year following the reorganization is a detrimental change for taxpayers if a reorganization at FMV is intended because this would lead to a taxable gain as of the next balance sheet date. Reorganizations at book value should not be affected. 
  • The tax authorities’ view also appears to be in contradiction to previous case law of the Federal Tax Court (BFH). Given the clear wording in the guidance, taxpayers taking a dissenting opinion will have to take their case to court.

Definition of branch of activity (as prerequisite for tax neutral reorganization)

Tax authorities’ view 

  • Spin-offs, split-offs and hive-downs are tax neutral only if the transferred assets at least have the quality of a “branch of activity.” The guidance generally uses the same definition of a branch of activity as the EU Merger Directive. 
  • As in the past, all business assets that are essential for the business division must be transferred with the business division. 
  • Any assets that are not essential for the business division will have to be reviewed in more detail. To the extent an economic relationship with the business division can be established, such assets have to follow the business division. Only non-essential assets that do not have any economic relationship with a business division can be allocated freely between various business divisions. 
  • A partnership interest or a 100% shareholding in a subsidiary will generally continue to constitute a per se business division. However, it will only be possible to allocate assets and liabilities with a direct economic relationship to such shareholding/partnership interest in the course of a reorganization at book value.
  • In line with previous guidance and jurisprudence (see Deloitte Tax-News), all assets that are necessary to continue the transferred business will have to be legally (or at least economically) owned by the entity to which the branch of activity is transferred in the reorganization. The “possibility” to use the assets is not considered sufficient (e.g. under rental agreements). 
  • In contrast to previous practice, the branch of activity must be in existence on the tax effective date; a branch of activity that is “under construction” is no longer sufficient. 
  • The guidance on the independent business division is likely to create additional uncertainty for taxpayers and will require careful review and planning of tax neutral reorganizations. Given that the rules on the allocation of non-essential assets are new but not very detailed, taxpayers should discuss the details of the reorganization and the allocation of the assets with the tax authorities in advance. 
  • The fact that the branch of activity will need to be in existence on the tax effective date may constitute an obstacle for tax neutral reorganizations with retroactive effect, especially where new business divisions are separated or the separation of existing business divisions has not been completed as of the tax effective date of the reorganization.

Downstream merger with nonresident shareholders

Tax authorities’ view 

  • Under the 2006 RTA, downstream mergers generally are possible on a no gain/no loss basis. Whether such a merger would be tax neutral if the parent company had nonresident shareholders has been controversial. The guidance states that in such cases, the shares in the German target entity cannot be transferred at book value to the foreign parent company of the transferring entity in the downstream merger (thus, a transfer at FMV will be deemed to take place, which will lead to a fully taxable or a 95% tax-exempt capital gain if the FMV of the shares in the subsidiary exceeds their book value). 
  • The tax authorities do not comment on the tax treatment of situations in which, after the merger, the liabilities exceed the receiving subsidiaries’ equity, which has also been a controversial issue for several years.

Implications for taxpayers

  • The tax authorities’ position on downstream mergers mainly will be important for taxpayers in cases in which the German holding company that is merged downstream into its subsidiary has held the shares for a certain period of time so that its shares have appreciated in value.

Holding periods for shares received in tax neutral contribution of branch of activity

Tax authorities’ view

  • A seven-year holding period generally applies for new shares received in a contribution of a branch of activity or a partnership interest at below FMV. Any sale of the shares received should lead to the retroactive taxation of the capital gain deferred upon contribution, with the taxable gain being reduced by 1/7 each year. Because the RTA does not mention certain types of reorganizations as permitted transfers, even if made at book value, the tax authorities have included further guidance as to which reorganizations can trigger a harmful retroactive taxation of built-in gains and which transactions should not be harmful. 
  • According to the guidance, a reorganization at book value will not be harmful for the parties involved if
    - The capital gains derived from the contribution, in principle, remain subject to tax;
    - No built-in gains are shifted to the shares of a third party;
    - Germany’s right to tax will not be restricted; and
    - All affected taxpayers agree that the new shares also will be subject to the same restrictions as the shares received in the first reorganization. 
  • The following transactions always will be considered harmful and will lead to retroactive taxation of capital gains:
    - A merger of the receiving company back into the parent company that made the contribution (because the shares received will be eliminated); and
    - A reorganization into a partnership or a contribution into a partnership. 
  • Under these rules, a distribution that is sourced out of the capital contribution account for tax purposes will be considered a harmful event and will trigger a retroactively taxable capital gain of the original contribution. According to the guidance, it will not be decisive whether the capital contribution account was created in the reorganization or whether it previously existed. A retroactively taxable capital gain will be presumed to the extent the distribution out of the capital contribution account exceeds the tax book value of the shares received in the reorganization at the time of the contribution.

Implications for taxpayers

  • The fact that certain reorganization measures should – upon application – not be harmful for previous tax neutral reorganizations is generally positive for taxpayers. Reorganizations following tax neutral contributions, however, will have to be examined carefully to determine whether they meet the tax authorities’ requirements so that no retroactively taxable capital gain is triggered. 
  • The fact that distributions out of the capital contribution account for tax purposes can trigger a retroactively taxable capital gain in certain situations has caused some uncertainty in the past. The final guidance addresses these uncertainties. As in the past, taxpayers should take potential future distributions into consideration when structuring the contributions. In particular, the future effects of certain “deemed distributions” that arise in a tax group situation for technical reasons and that may be sourced out of the capital contribution account for tax purposes will be important to analyze in the course of the contribution.

Tax groups and reorganizations

Tax authorities’ view 

  • One of the requirements to establish a German tax group is that the parent company holds the majority of the voting rights in the subsidiary (“financial integration”) from the beginning of the subsidiary’s fiscal year. In cases where shares were transferred in reorganizations, it has been unclear whether and in what cases a tax group could be continued without interruption.  
     
  • Reorganizations involving the parent in a tax group:
    According to the guidance, the tax group can be continued without interruption/newly established only if the subsidiary in the group was financially integrated into the transferring entity before the reorganization and (under the retroactivity principle for tax purposes) the shares in the subsidiary are deemed to be owned by the receiving entity (i.e. the new parent) from the beginning of the subsidiary’s fiscal year.

    A tax group cannot be formed from the (retroactive) tax effective date of the reorganization where the financial integration is made possible only by the reorganization (even if the reorganization has retroactive effect to the beginning of the subsidiary’s fiscal year).

    Given that share-for-share exchanges generally are no longer possible with retroactive effect under the 2006 rules, a retroactive formation of a tax group will not be possible in these situations.  
     
  • Reorganizations involving the controlled entity in a tax group:
    The guidance describes the tax consequences where a controlled entity is the receiving entity in a reorganization. According to the tax authorities, a “deemed dividend” (which results in a 26.375% refundable dividend withholding tax and a 5% inclusion at the level of the parent of the tax group) will be triggered if the reorganization is made at FMV for German GAAP purposes, while for tax purposes the reorganization takes place at the (lower) tax book value.

    A similar treatment as a distribution (or contribution) will apply to any existing book/tax differences existing at the time of the transfer at the level of the transferring entity or their subsequent reversal at the level of the receiving entity.

    If an entity that is a subsidiary in a tax group ceases to exist because of the reorganization (i.e. in a merger or a split-up), any potential gain resulting from the transfer will be subject to tax at the level of the tax grouped subsidiary. If the subsidiary continues to exist (e.g. in cases of a spin-off or a hive down), a potential gain resulting from the reorganization will be subject to tax at the level of the parent of the tax group.

Implications for taxpayers 

  • The detailed rules on the timing aspects of tax groups generally are beneficial for taxpayers and in line with previous decisions of the BFH. The most important exception from this general assessment is the tax authorities’ position on share-for-share exchanges. Although it can be argued, based on the BFH decisions, that even though retroactive share-for-share exchanges are no longer possible, it still should be possible to form a tax group with retroactive effect under the concept of universal succession, the tax authorities do not share this view. Taxpayers that wish to take a different position will have to take their cases to court given the clear wording of the guidance. 
  • The BMF’s comments on the tax treatment of book/tax differences in the case of a reorganization with a controlled company in a tax group as the receiving entity raise concerns from a tax perspective, because the tax consequences can be significant. Taxpayers will need to carefully review existing book/tax differences of the transferring entity, as well as potential book/tax differences created by the reorganization, before reorganizations are implemented to fully assess the tax consequences and potentially amend transaction structures as needed.

Transition rules

The new guidance generally applies to all open cases, although some transition rules apply for reorganizations where the resolution on the reorganization was taken on or before 31 December 2011.

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