Federal Tax Court rules against tax authorities on tax effects of intra-group assumption of accruals

The Federal Tax Court has issued a decision on whether pension accruals must be released from the balance sheet for tax purposes if the underlying obligation is assumed by a group company.

In a recently published decision (case reference: IV R 43/09), the Federal Tax Court (BFH) ruled on whether pension accruals must be released from the balance sheet for tax purposes if the underlying obligation is assumed by a group company. In the case, a German taxpayer (a partnership) granted pensions to its employees and booked a corresponding accrual in the GAAP and tax balance sheets. Based on German tax balance sheet requirements, pension provisions typically are accrued with a special value, which is usually lower than the accounting (e.g. IFRS) value.

The partnership entered into an agreement with a group company, under which the group company agreed to assume all current and future payment obligations in connection with the accrued pension provisions (with a tax value of approx. 230,000 Euro) in exchange for a single payment (approx. 310,000 Euro, which was equal to the net present value of the obligations). From a legal perspective, the primary liability for the pension obligations remained with the employing partnership; under the internal agreement between the partnership and the group company, the partnership had recourse against the group company.

As a result of the agreement, the partnership released the pension accrual for GAAP and tax purposes. The one-time payment made as consideration for the assumption of the pension obligations, was booked as business expenses. The tax authorities disagreed with this approach and held that the pension accrual could not be released because the partnership still had the primary obligation under the pension agreements. Moreover, the partnership would need to record an asset to show a compensation claim with respect to the group company that assumed the liability. The value of the asset would be equal to the consideration paid (310,000 Euro), according to the authorities.

The BFH rejected the approach of the tax authorities for the following reasons:

• Under German GAAP, an accrual must be released from the balance sheet once it is expected that the accrual will not actually materialize. Based on the contractual assumption of debt by the group company, the group company would pay the pensions going forward, either directly to the persons entitled to the pension or it would compensate the partnership for any expenses paid. Based on this agreement, it was no longer likely that the partnership would be affected by the pension obligation, so the obligation could no longer be recorded. 
• Since GAAP accounting is decisive for the tax balance sheet, the release of the provision also must be accepted for tax purposes. Going forward, only the group company that assumed the liability can recognize the pension accrual in the balance sheet. 
• The initial payment made by the partnership as consideration for the assumption of the debt by the group company does not have to be capitalized. Such a receivable could not be capitalized because the pension obligation is uncertain going forward and would depend on the group of pensioners. It should, therefore, be treated as an expense equal to the consideration paid.

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