Imagine that a company is in a difficult economic situation. The annual result is deep in the negative and creditors are demanding their money back. The shareholders, who also have money invested into the company, are now considering waiving part of the (interest) liabilities of the company. That sounds like a good idea. But what would be the tax consequences of this decision?
What are the requirements for tax-free restructuring profits and how can the affected companies make the correct choices?
TAX EXEMPTIONS ON RESTRUCTURING GAINS
The partial waiver of (interest) liabilities: What sounds like a good idea, however, is risky. By waiving part of the liability, the company generates income. If this income is greater than the losses accumulated up until the waiver, this leads to a positive annual result. If there is no tax loss to carry forward from previous years or if it is less than the income, then notional income must be taxed. In the same way, the already tight liquidity of the company is further reduced.
THE CONDITIONS
This can be prevented under certain conditions, as explained by the tax authorities in the Federal Tax Gazette issued by the Federal Ministry of Finance in the March 2003 edition under Section IV, Passage A 6, of 2003 I, on page 2,140, namely by not taxing these restructuring profits. However, the Federal Fiscal Court (BFH) had judged this procedure – according to the BFH decision of 28.11.2016 – GrS 1/15 and BFH ruling of 23.08.2017 I R52/14 – to be contrary to European law. The legislation therefore introduced a new regulation with effect from the 9th of February 2017 in Sections 3a of the German Income Tax Code (EStG), 7b of the German Trade Tax Code (GewStG), and 8c of the German Corporate Tax Code (KStG).
According to this, restructuring profits are tax-free in the year of the decree and in the following year, provided:
- the company is in need of restructuring and
- is also capable of being restructured;
- the debt relief is suitable for reorganization; and
- the creditors intend to reorganize with the remission.
All four points must be demonstrated by the company to be restructured.
SIGNIFICANCE OF THE NEW REGULATION
Furthermore, the application of the new regulations sets the prerequisite that the tax losses accumulated to date have been used up. If these still exist, they must first be exhausted. Costs that are directly related to the remediation are not tax-exempt income when waived. For past cases, in which debts were waived before February 9, 2017, the new regulation also applies when an application is made in accordance with Section 52 (4a) sentence 3 (EStG).
However, the decisive question for the consultant now is whether this settles the dispute between the BFH and the tax authorities and thus provides legal certainty with regard to the tax exemption of the restructuring profits.
The EU Commission has commented on this stating that this type of aid for companies in need of restructuring is to be classified as “existing aid,” i.e. aid that can no longer be approved on a case-by-case basis. It remains to be seen whether the Federal Court of Finance and thus the European Court of Justice (ECJ) will agree with this legal view.
SALE OF SHARES AS RESTRUCTURING MEASURE
A further measure taken by the shareholders for restructuring purposes may be to sell shares in the company or the entire company. What is to be considered here?
Section 8c (1) of the German Corporation Tax Act (KStG) contains a provision that, in principle, leads to the complete loss of the company in the event of a sale of more than 50 percent of the shares.
Let us assume that a GmbH has a tax loss of 1 million euros. The old shareholders are considering taking on a new shareholder. To this end, they want to offer them the majority of the shares for sale and either use the money received to grant another shareholder loan or – in the context of the capital increase – use the premium on the new issue of shares to further finance the company.
However, the new shareholder will only pay a price for the shares if they can assume that their investment will generate an advantageous capital value for them. If they are convinced that the GmbH will quickly return to profits, it is advantageous if no taxes need to be paid on these profits at company level, as there is a loss to carry forward.
Until now, however, it was considered that in such cases the accumulated losses were completely lost. But in the context of restructuring, the sale of shares must be treated differently due to 8c (1a) KStG. Accordingly, Section 8c (1) does not apply if the conditions of Section 8c (1a) KStG are fulfilled.
This means that for share transfers in the context of restructuring after December 31, 2007, the losses from previous years will not be lost from the 2008 assessment year onwards – and thus retroactively. They are therefore preserved for a potential investor and they can take them into account when determining their advantageous capital value of the investment. The continued losses reduce the tax burden and increase the dividend payments of the company to the investor-
THE CURRENT LEGAL REGULATION
This regulation, after the EU Commission had considered it to be classified as illegal aid in 2011, was later approved on June 28, 2018 – and also by the ECJ. Thus it is legally secure.
This gives companies, such as the GmbH shown as an example above, the legally sound option of selling shares in the context of significant share disposals under the conditions of Section 8c (1a) KStG – restructuring to prevent or eliminate over-indebtedness or insolvency while at the same time maintaining the main operating structures.
Companies are advised to contact their tax advisors for an intensive examination of this topic.
