• Service: Tax, Mergers & Acquisitions, Global Compliance Management Services, International Tax
  • Type: Regulatory update
  • Date: 6/3/2014

Germany - Loss carryforwards in mergers; earnings stripping rules 

June 3: Germany’s federal tax court (BFH) issued decisions in cases concerning:

  • The tax authority’s treatment of a loss carryforward in the merger of a profit corporation into a loss corporation
  • Requalification of interest in light of an income tax treaty’s “equal treatment article”

Loss carryforwards in mergers

In one case, the court held that, for 2013 (the year under dispute), a loss carryforward was not forfeited when a profit corporation merged into a sister corporation that had the loss carryforwards.

The position of the tax authorities was that loss carryforwards could not be recognized under a then-applicable anti-abuse rule prohibiting structuring possibilities, given that the reason for the merger was to reduce tax by offsetting the profits of the transferring entity with the existing loss carryforwards of the receiving entity.

The BFH, however, concluded that the merger of the profit corporation into the loss corporation must be recognized and that the general abuse rules were not applicable, because of special provisions governing the merger of a profit corporation into a loss corporation.

Thin capitalization and earning stripping rules

Current rules may limit the deduction of interest as a business expense (i.e., the earnings stripping rules). Previously, taxpayers had to consider the "thin cap rules" when determining the interest deduction at the level of the corporations. When criteria for the thin cap rules were met, interest payments were “re-qualified” as constructive dividend and, as such, were added to the taxpayer’s income.

The federal tax court (BFH) held that application of these “requalification rules” violate the principle of equal treatment under the Germany-United States income tax treaty (1989). The case concerned a U.S. LLC that held controlling interests in Irish and German limited liability companies (GmbH) and a loan made to a German “sister GmbH” and the treatment of the interest paid on the loan. The German sister GmbH had claimed the interest payments as a business expense, but the German tax authorities re-qualified the interest payment as constructive dividends instead, by applying the former “thin cap rules“.

The BFH found that a loan granted by a foreign parent company to a domestic subsidiary could not be requalified as constructive dividend if the company were not entitled to corporate income tax crediting.

Read a June 2014 report [PDF 1.66 MB] prepared by the KPMG member firm in Germany: German Tax Monthly

The KPMG report also discusses the following topics:

  • The constitutionality of non-deductibility of trade tax
  • A decision of the lower tax court of Münster concerning amendments of incorrect statements in the declaration of the tax-specific capital contribution account
  • KPMG’s 2014 German Tax Card
  • The determination of extended trade income reduction for real property
  • Status of a bill for tax simplification

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