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Tax Exemption for Reorganization Gains

Not every de­ci­sion by the Fe­deral Fi­nance Court – Ger­many’s su­preme court for tax mat­ters – has at­trac­ted as much at­ten­tion as the court’s Grand Pa­nel de­ci­sion of No­vem­ber 28, 2016 (case GrS 1/15). The ope­ra­tive th­rust of the judg­ment: the Fe­deral Fi­nance Mi­nis­try’s re­struc­tu­ring ru­ling of March 27, 2003, which has ap­plied for years, vio­la­tes the law. Now both the le­gis­la­ture and the Fi­nance Mi­nis­try have re­spon­ded – but these re­spon­ses still fall short of crea­ting le­gal cer­tainty.

Nu­me­rous ex­perts im­me­dia­tely clai­med that the Grand Pa­nel’s de­ci­sion he­ral­ded the end of re­struc­tu­ring for com­pa­nies be­fore in­sol­vency is ap­plied for, or af­ter­wards th­rough court-su­per­vi­sed plans for com­po­si­tion with cre­di­tors. The re­aso­ning: if a com­pany rea­li­zes gains on claims wai­ved un­der such re­struc­tu­ring mea­su­res, those gains are ta­xable un­der the ru­les for de­ter­mi­ning pro­fit, un­less they can be fully off­set against los­ses car­ried for­ward.

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If cre­di­tors waive a part of their claims against a com­pany in need of re­struc­tu­ring, the wai­ved amount must be de­re­co­gnized in the in­come state­ment. The re­sult is in­come, un­der both the Com­mer­cial Code and the Tax Code. The ques­tion ari­ses whe­ther this gain – which is pu­rely a book pro­fit – can be sub­ject to per­so­nal or cor­po­rate in­come tax and trade tax, and whe­ther the tax sys­tem can thus bring in re­ve­nue from all the cre­di­tors’ contri­bu­tion toward a re­struc­tu­ring.It is cer­tainly true that los­ses may have been in­cur­red in the cur­rent fis­cal year, and of­ten in pre­vious ones as well. But as a rule, be­cause of mi­ni­mum ta­xa­tion and pos­si­bly also be­cause of a de­le­te­rious change of share­hol­ders, those los­ses can­not be ap­plied in full du­ring a re­or­ga­niza­tion. Un­der the Fi­nance Mi­nis­try’s re­or­ga­niza­tion ru­ling of March 27, 2003, tax on any re­struc­tu­ring gain that re­mains af­ter ex­haus­ting the loss-off­set­ting op­ti­ons for in­come tax pur­po­ses could in­iti­ally be de­fer­red, by re­quest, and ul­ti­mately wai­ved af­ter a fi­nal au­dit. Un­der the Grand Pa­nel de­ci­sion, this is no lon­ger pos­si­ble.

Howe­ver, on April 4 of this year the Bun­des­tag – the lo­wer house of par­lia­ment – quickly re­spon­ded to the court’s de­ci­sion, enac­ting a new Sec. 3a of the In­come Tax Act (EStG) to co­ver the tax ex­emp­tion of re­struc­tu­ring gains (see Bun­des­tag Prin­ted Pa­per 18/12128). At the same time, equi­va­lent pro­vi­si­ons were in­tro­du­ced into the Cor­po­rate In­come Tax Act (Körper­schaft­steu­er­ge­setz) and the Trade Tax Act (Ge­wer­be­steu­er­ge­setz). The pro­vi­si­ons are to ap­ply in those ca­ses where claims have been wai­ved af­ter Fe­bru­ary 8, 2017. Howe­ver, sub­ject to ra­ti­fi­ca­tion by the up­per house of par­lia­ment (the Bun­des­rat), the pro­vi­si­ons will not take ef­fect un­til the Eu­ro­pean Com­mis­sion de­ter­mi­nes that they do not con­sti­tute state aid, or if they do, that the aid is com­pa­ti­ble with the in­ter­nal mar­ket.

The Fe­deral Fi­nance Mi­nis­try made a par­al­lel an­noun­ce­ment on April 27, 2017, on the fur­ther tax tre­at­ment of re­or­ga­niza­tion gains:

In those ca­ses where wai­ver-of-claim pro­ces­ses were fi­nal and com­plete by Fe­bru­ary 8, 2017, the old re­or­ga­niza­tion ru­ling of May 27, 2003, will con­ti­nue to ap­ply, in or­der to pro­tect le­gi­ti­mate ex­pec­ta­ti­ons.

Bin­ding opi­ni­ons is­sued by a tax of­fice un­der the old re­or­ga­niza­tion ru­ling be­fore Fe­bru­ary 8, 2017, are to be re­vo­ked, whe­ther as wrongful ab in­itio or be­cause of the change of law, only if the as­so­cia­ted wai­ver-of-claim pro­ces­ses have not been lar­gely com­ple­ted al­re­ady, or if there are no other re­asons to pro­tect a le­gi­ti­mate in­te­rest.

Bin­ding opi­ni­ons is­sued un­der the old re­or­ga­niza­tion ru­ling af­ter Fe­bru­ary 8, 2017, are to be re­vo­ked if the wai­ver-of-claim pro­ces­ses have not been com­ple­ted yet.

In all other ca­ses – i.e., re­or­ga­niza­tion pro­ce­du­res in an early stage when no bin­ding opi­nion has been is­sued yet – the in­come tax payable on re­or­ga­niza­tion gains is to be de­fer­red, upon ap­pli­ca­tion, un­til the new le­gis­la­tive pro­vi­si­ons take ef­fect. If the new terms of law take ef­fect by De­cem­ber 31, 2018, the de­fer­ral is to be re­vo­ked, be­cause then of course the tax ex­emp­tion of re­or­ga­niza­tion gains will be co­vered fi­nally and re­troac­tively (the June 2017 is­sue of no­vus will deal in de­tail with the Fi­nance Mi­nis­try’s an­noun­ce­ment of April 27, 2017, and the new terms of the law).

The Fi­nance Mi­nis­try’s tran­si­tio­nal pro­vi­si­ons seem to pose pro­blems for prac­tice in se­veral dif­fe­rent re­gards, be­cause they es­ta­blish le­gal cer­tainty only to a de­gree.

First of all, there may well be dif­fe­ren­ces of opi­nion as to when “wai­ver-of-claim pro­ces­ses [have been] ent­irely or sub­stan­ti­ally com­ple­ted.” As we see it, this can mean only those re­or­ga­niza­tion pro­ce­du­res – par­ti­cu­larly court-su­per­vi­sed plans for com­po­si­tion with cre­di­tors – for which plans have been lar­gely com­ple­ted and a pro­tec­tion of le­gi­ti­mate in­te­rests in the is­sued bin­ding opi­nion is ne­cessary sim­ply be­cause of the ex­pen­ses in­cur­red and agree­ments re­ached in this re­gard bet­ween the in­sol­vency ad­mi­nis­tra­tor, the debtor in pos­ses­sion, the trus­tee, the cre­di­tors’ com­mit­tee and the mee­ting of cre­di­tors, as well as the court. But this will have to be squa­red once again with the Tax Ad­mi­nis­tra­tion.

Se­cond, the pro­vi­sion does not seem very prac­tica­ble for re­or­ga­niza­tion ca­ses that are only in their early sta­ges. De­fer­ring the in­come tax on a re­or­ga­niza­tion gain un­til the EU no­ti­fi­ca­tion pro­ce­dure has been com­ple­ted, which is the al­ter­na­tive pro­vi­ded in this case, will not help if the EU finds that it re­pres­ents state aid in­com­pa­ti­ble with the in­ter­nal mar­ket. It would seem un­rea­listic to carry out the re­or­ga­niza­tion of a com­pany in re­li­ance on the EU Com­mis­sion’s as­sess­ment of a law, where in case of doubt one would risk (pos­si­bly a re­turn to) in­sol­vency for the com­pany and – de­pen­ding on its le­gal form – for the share­hol­ders or part­ners as well, be­cause of the in­come tax that would then have to be paid.

In these ca­ses, then, there is still no le­gal cer­tainty wi­thout a de­ci­sion from the EU Com­mis­sion.

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