Historically – meaning until the end of 2007 – the German corporate tax law provided for limitation rules on the use of tax-wise net operating loss carryovers of a corporation, where the "loss corporation," after a change in ownership occurred (i.e., transfer of more than half of the shares in the company), carried on its business with predominantly new business assets. The rules were based on the reasoning that the corporation economically was no longer identical to the corporation which incurred the loss. The corporate tax rules in that regard aimed at mimicking the corresponding trade tax rules on the discontinuance of tax-wise net operating loss carryovers.
With the introduction at the start of 2008 of the Corporate Income Tax Act (CITA), the law changed. Any reference to a change in the economic business was dropped. The rules henceforth only look at the change in ownership.
Therefore, upon share transfers, mergers and acquisitions, and even intra-group reorganizations, a tax-wise NOL carryover will be partially or entirely discontinued. A direct or indirect transfer of a more than 25 percent interest in the shares of a German corporation to any one shareholder within a five-year period will result in a pro rata forfeiture of the NOL carryover for German tax purposes. A complete forfeiture of all NOLs carryovers occurs if more than 50 percent of the shares are transferred directly or indirectly. Given that also indirect changes of ownership are harmful and all the more that related parties within a group of companies are treated as one shareholder, the rules apply to any reorganization within the chain of ownership above the German loss corporation. Therefore, any indirect change in ownership for reason of a group-internal restructuring 5 or 10 tiers above the German entity may well result in the German corporation losing all of its NOL carryovers.
By fall 2008, Parliament was already trying to ease the limitation rules on NOL forfeitures in cases where venture capital funds, as defined under German law, acquired loss corporations (section 8c (2) CITA). Given that the European Commission did not authorize these amendments, they never actually entered into force. In summer 2009, Parliament again tried to ease the limitation rules, this time by inserting a safe harbor in reorganizations for financial recovery to ward off insolvency or over-indebtedness (section 8c (1a) CITA). The European Commission again struck down the amendments by the German Parliament, deeming them illegal state aid that is incompatible with the internal market as described in Article 107 of the Treaty on the Functioning of the European Union. Germany sued the European Commission, but, in July 2014, the European Court of Justice ruled in favor of the European Commission (C‑102/13 P).
Parliament, however, didn't give up. Lawmakers recognized that the new rules constituted a significant impediment to group restructurings as the rules even applied in cases where there was a 100 percent direct and/or indirect identical shareholder. Group restructurings with a loss corporation de facto always resulted in the discontinuance of all NOL carryovers. From beginning of 2010, Parliament enacted two new safe harbors to the limitation on NOL carryover rules. One is an intra-group reorganizations privilege (section 8c (1) sentence 5 CITA); the other is an unrealized capital gain privilege (section 8c (1) sentence 6-9 CITA). The intra-group reorganization privilege intended to relieve restructurings within a group of companies. Parliament acknowledged that there are no reasons for a limitation of group-internal transactions without any transfer of tax losses to third parties.
Intra-group reorganization privilege
Under the intra-group exception, tax NOL carryovers can survive a share transfer in a German loss entity provided the company that is transferring the shares and the recipient/acquiring company are both wholly owned, directly or indirectly, by the same ultimate shareholder. The requirements for the application of this exception are, however, very narrow. For example, a transaction whereby shares are transferred or received by the ultimate shareholder should not obtain relief.
Draft of revised Revenue Ruling outdated before coming into effect
More than four years after the intra-group reorganization privilege entered into force, the Federal Ministry of Finance issued a draft for a revised Revenue Ruling covering, for the first time, the safe harbor of section 8c (1) sentence 5 of CITA. The draft disappointed expectations of a more liberal application of the group exception and applies a very literal reading of the statute: "first tier" ownership changes should not be covered by the exemption.
Here is more detail. A transfer of a loss corporation does not result in a forfeiture of tax losses if the transferor and the transferee of the shares in the loss corporation are 100 percent owned “by the same person.” Assume, for example, the publicly traded German AG owns subsidiaries T1 and T2. T1 owns German loss corporation T3. If T1 transfers T3 to T2 (Alternative 1), the group exception applies, since the transferee (T1) and the transferor (T2) are 100 percent owned by the same person, the AG. InAlternative 2, T1 is the loss corporation, and AG transfers T1 under T2; here the transferor AG is not owned by a single person, and thus the application of the group exception should be denied, if the term “same person” must be read as meaning only a “single” person and cannot include a group of “same persons.” However, such a literal reading may miss the intent of the statute, since a clear rationale as to why the second alternative should be treated differently from the first appears to be lacking. However, the tax administration insists that the safe harbor must be narrowly interpreted, and that “the same person” can only be a single corporation or a single individual, which then results in a tax loss forfeiture for all “first tier” transfers (e.g., a transfer according to Alternative 2).
The draft Revenue Ruling furthermore takes the view that a partnership cannot qualify as a "person" for purposes of the safe harbor. Assume, for example, partnership P, which is owned by A and B, owns subsidiaries T1 and T2. T1 owns loss corporation T3. T1 transfers T3 under T2. According to the view of the ministry, the safe harbor shall not apply, since P is not a “person” for purposes of the rule, which means, that the transferor T1 is considered not to be owned by a "single person" (since P has two partners A and B).
Note that under this interpretation, "first tier" transfers are also harmful if they are effected as indirect transfers in a foreign ownership chain above the German loss corporation, e.g., if a US publicly traded entity transfers its first tier US subsidiary, which owns directly or indirectly a German loss corporation.
As of today, no final version of the revised Revenue Ruling has yet been issued.
Recently published bill extends intra-group reorganization privilege
In February 2015, the Federal Ministry of Finance published a bill that intends to again amend the law to include various situations which, according to the above-outlined interpretation of the current law by the identical ministry, are yet not covered.
The law shall be amended in a manner which should better "express" Parliament's initial intension that intra-group restructurings shall not be affected by the limitation NOL carryover rules. To that effect, the bill proposes a completely new wording of section 8c (1) sentence 5 of CITA.
Particularly, the proposed new wording will now quite clearly also cover "first tier" ownership changes. Therefore, the ultimate group holding can be an acquirer or a transferor in a group restructuring falling under the safe harbor. Furthermore, also business partnerships explicitly would qualify as a "person" under the safe harbor. The amendments therefore should indeed relieve intra-group restructurings.
What, finally, appears striking is that the bill currently provides for a retroactive effect for the new wording of section 8c (1) sentence 5 of CITA to all transfers which occurred as from the beginning of 2010, i.e. when current section 8c (1) sentence 5 CITA entered into force. In other words, the German tax authorities may end up in tax court proceedings where they are challenging the applicability of the safe harbor under a provision of law that, because of that retroactive effect, may have never existed.