07.06.2024Lower tax court provides favorable decision for trade tax loss carry-forwards
In a decision dated 7 March 2024, which was published on 24 May 2024, Germany’s lower tax court of Duesseldorf ruled that, for trade tax (TT) purposes, a German corporation’s participation in a trading partnership should not preclude it from benefitting from an exception under the change-in-ownership rules, which require forfeiture of various tax attributes upon certain share transfers. The lower tax court explained that the determination of harmful structures (e.g., a loss corporation’s participation in a (deemed) trading partnership), which prevents the application of the “business continuation clause” exception to the change-in-ownership rules under the corporate income tax code (CITC), can apply differently for TT purposes. Since a partnership generally is considered a separate taxpayer for TT purposes, the lower tax court ruled that the corporation’s interest in the trading partnership should not qualify as being harmful.
Background
According to the change-in-ownership rules pursuant to section 8c CITC, current year losses, interest carryforwards, and net operating loss (NOL) carryforwards of a German company are generally forfeited if there is a direct or indirect transfer of more than 50% of the shares in the company to one new shareholder, related parties, or parties acting in concert. For TT purposes, the business continuation clause is applicable in an “analogous” way pursuant to section 10a sentence 11 of the TT code.
One of the exceptions to the change-in-ownership rules is the business continuation clause under section 8d CITC. Based on the business continuation clause, tax attributes continue to be available upon application provided that the company fulfills several criteria, including maintaining the same business operations since its formation or for at least three fiscal years before the change-in-ownership and in the future. Additionally, certain events must not occur within a three-year period before the ownership change and at any time thereafter until the carryforwards have been fully utilized. One of these harmful events is the participation of a loss corporation in a trading partnership.
Decision of the lower tax court
In the case decided by the lower tax court, a German corporation was the limited partner in a trading partnership during the three-year look-back period before the shares in the corporate partner were transferred to a new shareholder, which resulted in a change-in-ownership event. Based on the view of the tax authorities, the fact that the corporation held an interest in the partnership did not allow for the application of the exception from the general change-in-ownership rules under the business continuation clause.
In its decision, however, the lower tax court decided that, due to the fact that the business continuation clause is only applicable in an “analogous” way for TT purposes, the application in a specific scenario might differ for CIT and TT purposes. The lower tax court, furthermore, argued that the different treatment of a partnership for CIT and TT purposes should allow for a broader application of the business continuation clause for TT purposes in such a situation. As partnerships are opaque and separate taxpayers for TT purposes but transparent for CIT purposes, the rationale behind the business continuation clause requires a different application for CIT and TT purposes, based on the view of the lower tax court. The rationale behind the limitation of the application of the business continuation clause in partnership structures is to avoid the offset of current year profits of a partnership against NOL carryforwards that exist at the level of a corporate partner. The transparent character of a partnership for CIT purposes might be seen as a valid reason for not allowing the application of the business continuation clause for CIT purposes, as in this case profits of a partnership are offset against the NOL carryforwards at the level of the corporate partner. However, due to the opaque character of the partnership, there should be no risk for offsetting profits of a partnership with NOL carryforwards at the level of its corporate partner for TT purposes. Based on the fact that a partnership generally is a separate taxpayer for TT purposes, the lower tax court found that there is no room for abuse and the participation in a partnership should not prevent the application of the business continuation clause for TT purposes.
Comments
The decision by the lower tax court is one of the first decisions with regard to a different application of the business continuation clause for CIT and TT purposes. The business continuation clause was only introduced starting from 2016 in an attempt by the legislator to soften the consequences of the change-in-ownership rules and to allow for a utilization of NOL carryforwards after a change-in-ownership. However, due to the narrow conditions of the business continuation clause, the application of the rule can be challenging in practice. The decision by the lower tax court provides a welcome clarification that a different application of the business continuation clause can apply for CIT and TT purposes. The tax authorities have appealed the decision to the federal tax court.
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