12.08.2026Federal tax court refers German tax treatment of cross-border mergers to CJEU
CJEU must decide whether the EU merger directive allows for a 95% (instead of a 100%) participation exemption for a cross-border merger gain
In a decision dated 20 May 2026 that was published on 6 August 2026, the German federal tax court referred the question to the Court of Justice of the European Union (CJEU) of whether the addback of 5% deemed nondeductible business expenses in the case of a tax-exempt cross-border merger gain (resulting in an effective 95% participation exemption instead of a 100% participation exemption) is compatible with the EU merger directive (Directive 2009/133/EC). The referral brings a long-disputed issue in German reorganization tax law before the CJEU for further clarification.
Background
In the event of an upstream merger of a corporate subsidiary into its corporate parent company, any resulting merger gain (i.e., the difference between the basis in the shares of the subsidiary that is merged out of existence at the level of the surviving parent entity and the value of the assets that are transferred in the merger transaction) is generally exempt from tax under German law. This treatment is a result of the provision of article 7 (1) of the EU merger directive, which was implemented into German tax law in section 12 (2), sentence 1 of the Reorganization Tax Act (RTA). If the surviving entity holds shares in the transferring entity, section 12 (2), sentence 2 of the RTA provides that the German 95% participation exemption applies. The 95% participation exemption technically consists of a 100% participation exemption and an addback of 5% deemed nondeductible business expenses (as set forth in section 8b (3), sentence 1 of the corporate income tax code (CITC)). It is the application of the 5% addback rule that is now being scrutinized for compliance with the EU merger directive.
Facts of the case
In the case from 2010 pending at the German federal tax court, a German limited liability company (GmbH) was the sole shareholder of subsidiaries in France, Italy, Spain, Sweden, and the UK. The subsidiaries in Italy, Spain, Sweden, and the UK were merged into the GmbH in cross-border merger transactions. The French subsidiary was dissolved under French law (“transmission universelle de patrimoine”). The GmbH continued to operate the businesses in these jurisdictions as permanent establishments. For both German GAAP accounting and tax purposes, the mergers were conducted with a carryover basis. The merger transactions resulted in a merger gain at the level of the surviving GmbH; the German tax authorities applied the 95% participation exemption to the merger gain. The taxpayer appealed against the decision of the tax authorities and argued that the addback of 5% deemed nondeductible business expenses violated article 7 (1) of the merger directive. The main argument by the taxpayer was that the merger directive does not contain a clause allowing for the nondeductibility of expenses on a flat-rate basis. The lower tax court did not accept the arguments of the taxpayer and decided in favor of the tax authorities.
Decision of the federal tax court
In its reasoning for referring the underlying legal question to the CJEU, the federal tax court pointed out that there are strong arguments for regarding the German rules and the 95% participation exemption for merger gains as being in line with EU law. However, the court came to the conclusion that it could not reach a decision, as the question of compatibility with EU law has not yet been decided by the CJEU and as there is neither a clear and unambiguous answer nor existing CJEU case law in this regard. The court emphasized its position that the general tax exemption for a merger gain remains unaffected. In the view of the tax court, the 5% addback is unrelated to the tax exemption for the merger gain itself, but rather is a result of deemed nondeductible business expenses that were incurred during the holding period of the shareholding.
The federal tax court also referred to the reasoning of section 8b (3) of the CITC, which is economically related to the similar 5% flat-rate adjustment that applies for tax-exempt dividends (as set forth in section 8b (5) of the CITC). The tax court stated that, in its view, this is intended to prevent dividend income from being converted into tax-exempt capital gains or merger gains by leaving the earnings in the company and thereby avoiding the 5% addback. The court also stated that the connection between the merger directive and the EU parent-subsidiary directive (Directive 90/435/EEC at the time the case arose) seems to support an expansion of the 5% addback for deemed nondeductible business expenses in relation to shareholdings—which is specifically permitted under EU law for dividends—to comparable reorganization transactions.
The referral to the CJEU by the federal tax court also includes arguments that support the view of the taxpayer in the proceedings. According to the position of the taxpayer, the merger directive does not include a specific provision regarding the nondeductibility of expenses related to shareholdings, nor does it include an opening clause allowing for a flat-rate-like addback of such expenses. Unlike the parent-subsidiary directive, the merger directive provides only for a tax exemption for a merger gain. Based on this argument, which is consistent with the prevailing view in tax literature, a 5% addback of deemed nondeductible business expenses related to a merger gain is not in line with EU law.
In the view of the federal tax court, the question referred to the CJEU for a decision will be determinative of the outcome of the main proceedings before the federal tax court. If the merger directive does not preclude the German provision that provides for the 5% addback in the case of a tax-exempt merger gain, the decisions of the tax authorities and the lower tax court are correct, and the taxpayer’s appeal would have to be dismissed. Otherwise, the taxpayer’s appeal would succeed.
Deloitte Germany comments
The CJEU’s decision is likely to have significant practical implications for cross-border corporate restructurings. If the CJEU deems the 5% addback incompatible with the merger directive, tax-exempt merger gains could, in the future, be fully exempt from corporate income tax. Affected taxpayers should consider keeping tax assessments open and asking the tax authorities to wait to issue a decision until the pending proceedings in front of the CJEU and federal tax court have been decided.
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