Circular issued by the German Federal Ministry of Finance confirms that purchase of treasury shares is treated in the same way as a capital reduction.

I. Circular regarding the acquisition of treasury shares

In its circular dated 27 November 2013 (IV C 2 - S 2742/07/10009), the German Federal Ministry of Finance (“BMF”) took issue with the tax analysis of share buy-back transactions. The circular provided much needed certainty regarding the interpretation by the tax administration of share buy-back transactions. Previously, the tax administration according to a circular dated 2 December 1998, applied the financial accounting rules current before the update of the commercial code in 2009 (German Accounting Law Modernization Act, “BilMoG”) for tax purposes. Thus, the purchase of treasury shares was treated like any other asset purchase.

II. Summary

The 2013 circular provides for a thorough analysis of all tax aspects as they become relevant in the purchase of treasury shares by a company. The most important principle is that the tax analysis – as before – follows the commercial law analysis. As a result, the purchase of treasury shares is treated like a capital reduction in line with the new rules as provided in the updated commercial code. The shareholder is treated as having sold shares to the company and the company is not required to withhold taxes on the purchase price payable. There is no dividend.

III. Details

1. Level of the company

On the part of the company, the accounting for the acquisition of treasury shares is determined in accordance with revised German commercial law. Hence, the acquisition is not treated as a purchase by the company, but will be treated as a return of capital for accounting and tax purposes. This applies regardless of whether distributable profit, capital reserves or nominal capital will be used for the share buy-back. As the acquisition of treasury shares is treated as a sales transaction at the level of the shareholders (cf. below), the company is not obliged to withhold taxes – different from the distribution of dividends – even if distributable profits are used for the buy-back. This should apply not only in domestic but also in international buy-back cases.

Conversely, the future sale of acquired treasury shares by the company shall be treated as an increase of nominal capital in the amount of the nominal value of the treasury shares sold and as an addition to the capital reserve account to the extent that the sales proceeds exceed the nominal value.

The redemption of treasury shares already held by a company does not result in any tax consequences. In case of redemption without prior acquisition of the shares, the provisions for an acquisition stipulated in the circular apply mutatis mutandis, while the compensation payment is to be treated as a purchase price payment. The treatment is thus the same as if the company had first purchased the shares and, thereafter, redeemed them.

2. Level of the shareholder

At the level of the disposing shareholder, the share buy-back by a company shall be treated as a sale. Such a treatment leads in particular to a 95 percent tax exemption without requiring a specific threshold, whereas dividend distributions require a minimum participation for such tax exemption. The 95 percent tax exemption is also available for a non-treaty protected shareholder.

Withholding taxes would only become due if the acquired shares were held through an account maintained with a domestic bank or financial service provider, since the company itself is generally not obliged to withhold taxes on a share sale.

If the purchase price paid by the company exceeds the fair market value of the shares purchased, a constructive profit distribution by the company in favour of the selling shareholder would be assumed. This equally applies to the sale of such shares by the company if the purchase price agreed is below their fair market value.

The circular does not comment on a pro-rata buy-back equally from all shareholders. Further developments remain to be seen.

3. Application

These provisions shall apply to all domestic and foreign corporations to the extent subject to German financial and tax law.

The circular shall be applied to all open cases to the extent that business years are affected for which the new commercial balance sheet rules on the acquisition of treasury shares under the BilMoG (sec. 272 (1a) and (1b) of the German Commercial Code) are applicable, e.g., it will generally apply to business years commencing after 31 December 2009, or optionally for those commencing after 31 December 2008.

For prior years, to which the so-called half or partial income method (“Halb- bzw. Teileinkünfteverfahren”) was applied, the regulations of the previous circular dated 2 December 1998 shall continue to be effective.