1. Implications of the Accounting Law Reform Act on group taxation
The Federal Ministry of Finance recently issued a circular (dated 14 January 2010, file number IV C 2 – S 2770/09/10002) on the question whether the changes of accounting and corporate law provisions brought about by the Accounting Law Reform Act (Bilanzrechtsmodernisierungsgesetz – BilMoG) have implications on the requirements for group taxation for corporation and trade tax purposes (see also Tax Info no. 9).
In its circular, the Ministry of Finance clarifies that the amendments to Sec. 301 of the German Stock Corporation Act (SCA) by the BilMoG in principle have no implications on the requirements under which consolidated group taxation will apply. BilMoG introduced a limitation on distributions in respect of certain accounting entries (e.g. certain selfcreated intangible assets) in Sec. 268 para. 8 of the German Commercial Code (CC). At the same time, Sec. 301 sent. 1 SCA, which defines the maximum amount to be transferred to the group parent under a profit and loss pooling agreement, was amended to the effect that amounts barred from distribution under Sec. 268 para. 8 CC are also excluded from being transferred under profit and loss pooling agreements. In this context, it was not clear whether this amendment to the statutes needs to be reflected in existing or new profit and loss pooling agreements.
The clarification by the Ministry of Finance provides legal certainty for existing profit and loss pooling agreements, as they do not need to be amended according to the current wording of Sec. 301 sent. 1 SCA. However, the Ministry of Finance emphasizes that Sec. 301 sent. 1 SCA has to be taken into account in the practical application of profit and loss pooling agreements, i.e. amounts barred from distribution under Sec. 268 para. 8 CC must not be transferred under the profit and loss pooling agreement to the group parent. This should be strictly reflected in dealing with profit and loss pooling agreements.
While the circular seems to indicate that also in new profit transfer agreements references to Sec. 268 para. 8 CC are not necessary, such reference in the clause on the amounts to be transferred to the parent is in our view nevertheless advisable as a reminder.
The Ministry of Finance further clarifies its position in context of a transitional rule of BilMoG and its implications for group taxation. BilMoG abolished the possibility of provisions for expenses (Sec. 249 para. 1 sent. 3 and para. 2 CC). For the transition to accounting according to BilMoG, businesses are granted the option either to retain their current provisions for expenses or to reverse these provisions and to allocate the relevant amounts directly to the revenue reserves.
However, under Sec. 14 para. 1 sent. 1 no. 4 of the German Corporate Income Tax Act (CITA), a subsidiary that forms part of a consolidated group for tax purposes may only allocate amounts to the revenue reserves (other than mandatory statutory reserves) under limited circumstances. It was therefore unclear whether the allocation of amounts from the former provisions for expenses to the revenue reserves under the transitional provisions of BilMoG would compromise the consolidation for tax purposes. The Ministry of Finance now clarified that allocating amounts to the revenue reserves under the transitional provisions of BilMoG does not violate Sec. 14 para. 1 sent. 1 no. 4 CITA.
2. Strict requirements for profit and loss pooling agreements in context of Sec. 302 of the SCA
The regional tax offices (Oberfinanzdirektionen) Rhineland and Münster recently issued a circular (dated 12 August 2009, file numbers S 2770 – 1015 – St 131 (Rhld.)/S2770 – 249 – St 13 – 33 (Ms)), which is coordinated with the other state and federal tax authorities. In this circular, the tax administration further tightens the tax requirements for fiscal consolidation with limited liability companies (Gesellschaften mit beschränkter Haftung – GmbHs) as subsidiaries under Sec. 17 sent. 2 no. 2 CITA and Sec. 302 SCA.
If a corporation other than a stock corporation, a partnership limited by shares (Kommanditgesellschaft auf Aktien – KGaA) or a European stock corporation (SE) enters into a profit and loss pooling agreement, Sec. 17 sent 2 no. 2 CITA requires that the group parent undertakes to assume the subsidiary’s losses in accordance with Sec. 302 SCA. Although it is settled law that Sec. 302 SCA is to be fully applied by analogy to corporations other than stock corporations, the BFH and the tax administration require for tax purposes that profit and loss pooling agreements with such entities explicitly refer to Sec. 302 SCA in its entirety or that the profit and loss pooling agreement lays down rules on the assumption of losses that are equivalent to all paragraphs of Sec. 302 SCA.
The circular addresses the specific wording from a profit and loss pooling agreement, in which first reference is made generally to Sec. 302 SCA, but then the clause continues as a nearly literal quotation of the first paragraph of Sec. 302 SCA. According to the tax authorities, this kind of clause in a profit and loss pooling agreement does not satisfy the requirements under Sec. 17 sent. 2 no. 2 CITA. The tax authorities claim that repeating the provisions of Sec. 302 para. 1 SCA invalidates or limits the general reference to Sec. 302 SCA in the introductory part of this clause. As a consequence, this clause of the profit and loss pooling agreement does not sufficiently lay down provisions on the waiver or settlement of the subsidiary’s right to an assumption of losses by the parent (Sec. 302 para. 3 SCA) and on the limitation of time of such right (Sec. 302 para. 4 SCA).
Taxpayers and their advisers should verify that existing profit and loss pooling agreements comply with the strict requirements set by the tax administration in context of the group parent’s loss assumption obligation according to Sec. 302 SCA. In new profit and loss pooling agreements with limited liability companies as subsidiaries, a separate clause should be included to the effect that the group parent shall assume the losses of the subsidiary in accordance with the provisions of Sec. 302 SCA in its entirety and as amended from time to time.
3. Highlights of the new circular letter regarding withholding tax
The Business Tax Reform Act 2008 introduced a final withholding tax on capital income as of 1 January 2009. In recent history, the German tax authorities have answered questions of the Top Organizations of the Credit Industry regarding the application of the new regime with several circular letters. The Federal Ministry of Finance has now answered some open questions regarding the final withholding tax in its circular letter issued 22 December 2009 – IV C 1 – S 2252/08/10004 (Withholding Tax Circular Letter).
The extensive circular letter starts out by using examples describing the different kinds of income deriving from capital and their tax treatment, in terms of both current earnings and capital gains, which are now also deemed income deriving from capital. The tax treatment of forward contracts is dealt with in detail, maintaining the terminology used in previous circular letters. However, to some extent, the tax authorities deviate from their previous views regarding the tax treatment.
Furthermore, for the first time, the circular letter comments on questions of interpretation regarding the exceptions of the separate rate for income deriving from capital (Sec. 32d para. 2 of the German Income Tax Act (ITA)). The Withholding Tax Circular Letter also describes in detail the deduction of the withholding tax, its assessment and its payment, the cases when not to deduct and its reimbursement in certain cases.
However, even though the Withholding Tax Circular Letter provides answers to many open questions, doubts remain for affected banks, companies and investors. The circular letter therefore does not simplify the application of the complex rules, especially regarding the deduction of the withholding tax, and thus, more questions may be expected in the future, which then may have to be settled in court if necessary.
Below, we would like to outline a few chosen aspects of the scope of the Withholding Tax Circular Letter:
Typical Silent Partnerships: Losses deriving from typical silent partnerships shall be deductible under the application of Sec. 15a and 15b ITA, despite the general disallowance to deduct expenses in connection with the final withholding tax. If the silent partner is allocated a balance in the course of the dissociation, shares in the profits and losses that have increased or decreased the dissociation balance shall be included in the assessment of the respective profits.
Forward exchange transactions: The Withholding Tax Circular Letter did not adopt the criteria of previous circular letters for the differentiation between the delivery transaction and the settlement. The Federal Ministry of Finance rather holds that a forward exchange transaction that is aimed at a settlement may also be presumed in case of an opening transaction followed by a counter transaction.
Bearer bonds: Contrary to the opinion of the issuers, the sale or redemption of bearer bonds which securitize delivery claims for gold or another commodity and are not physically settled shall constitute income according to Sec. 20 para. 2 sent. 1 no. 7 ITA. The same shall apply to securitized claims that constitute marketable shares, accordingly, even if the delivery claim is physically settled or if, instead of delivery of the commodity, settlement by cash payment is allowed.
The term “disposal”: The assignment for security, the loss of receivables and the waiver of receivables shall not constitute a disposal. In this respect, acquisition costs and additional expenses of acquisition of the receivables are irrelevant for income tax purposes. Also, the liquidation of a company shall not constitute a disposal of the shares in the corporation. A conversion of preference shares into ordinary shares as well as from common shares into registered shares and vice versa as well as conversions that are performed solely for technical reasons shall not constitute an exchange and therefore no disposal. The same applies to the reclassification of Depository Receipts into the represented shares.
Determination of profits: The circular letter once more clarifies in connection with the determination of profits according to Sec. 20 para. 4 ITA, among other things, that distributions from the special account may result in a reduction of the acquisition costs or in negative acquisition costs, respectively.
Deposit fees or investment management fees are no deductible expenses anymore. However, expenses of acquisition and disposal are deductible. Special rules shall apply to the transaction costs part of the all-in-fee.
Full-risk certificates: According to Sec. 20 para. 4a sent. 3 ITA, the exchange of receivables is tax neutral, if at the due date shares are delivered instead of a nominal payment. Until now, the Federal Ministry of Finance held that full-risk certificates were not covered by this provision. The circular letter now contains the opposite view in anticipation of the amendment of the law.
Subscription rights: In contrast to the Federal Ministry of Finance’s previous opinion, exercising a subscription right shall not constitute a disposal; the value of the subscription right shall be set as acquisition costs of the new shares with €0. If the subscription rights are disposed of, the acquisition costs shall also be set to €0; according to the circular letter, this shall also apply if the shares were acquired before 1 January 2009.
Bonus shares: If bonus shares are acquired, it shall be deemed impossible to determine the amount of the shareholder‘s capital income in foreign cases, resulting in the income deriving from their acquisition and acquisition costs to be assessed with €0. However, in domestic cases, the circular letter argues that the profits can be determined on the basis of information provided by the issuer and therefore can be used as a basis for tax purposes. The case of a corporation transferring shares it owns in another corporation to its shareholders without a capital decrease or additional consideration shall be treated accordingly.
Depository Receipts: Losses deriving from the redemption of Depository Receipts (ADRs and GDRs) shall be subject to the limited loss off-setting rules. Since the reclassification of Depository Receipts into the represented shares shall also be tax neutral (see above), it can be assumed that the tax authorities have now given up on their view stated in previous circular letters and now consider Depositary Receipts to be treated the same as the represented shares for tax purposes.
Tax rate rules for income deriving from capital: Sec. 32d para. 2 no. 1 lit. a) (related parties) and b) (capital commitment by shareholder) ITA shall only apply if the respective loan interest payments can be deducted as business or tax allowable expenses. The exceptions of Sec. 32d para. 2 no. 1 lit. a) and b) ITA shall therefore not apply to interest payments on a loan granted by a related party, which the party uses for private purposes. Furthermore, the Withholding Tax Circular Letter provides for a very broad definition of the term “related party”.
For the occupational activity for the relevant corporation required by Sec. 32d para. 2 no. 3 lit. b) ITA any self-employed or employed activity shall suffice, as long as it is not insignificant.
Withholding Tax: In connection with the deduction of withholding taxes from nonresidents, the Withholding Tax Circular Letter stipulates that there is no obligation to withhold taxes if a non-resident disposes of shares in a corporation, even if the shares are stored in a German custody account. This shall also apply if the non-resident owns at least 1% of the corporation’s shares.