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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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