Until the end of 2004 the so-called trust model was an often used structuring tool in the context of reorganizations and leveraged transactions. The reasoning was that, inter alia, such a model provided for the possibility of achieving consolidation for trade tax as well as corporate income tax purposes. In addition, the trust model could be used in order to implement certain reorganization schemes in a taxneutral manner irrespective of the rules of the Income Tax and the Reorganization Tax Act. Finally, in a transactional context, tax efficient debt push-down and recapitalization measures could be implemented under the trust model.
What Is This About?
Typically, the trust model was based on the following structure: assets were transferred to a newly established company in the legal form of a German limited liability partnership (GmbH & Co. KG/NewCo), the general partner of which was the transferring company. The only limited partnership interest (with a minimum participation in NewCo only) was held by a wholly owned corporate subsidiary of the transferring company which held the partnership interest on trust for its parent. While under such a structure NewCo was recognized as a separate partnership from a civil law perspective, it was ignored for tax purposes pursuant to the prevailing view. From a tax perspective the transfer of the assets was thus viewed as not existent, i.e., the transfer did neither have any trade tax nor corporate income tax implications.
The Treatment by the Tax Authorities
The tax authorities initially also shared such view. However, at the end of 2004 the tax authorities changed their mind and shut down the trust model. In a decree rendered by the Superior Tax Office of Münster on 16 March 2005, the tax authorities take the view that the partnership to which the assets are transferred qualifies as a separate trade or business within the meaning of the Trade Tax Act. While the tax authorities point out that irrespective of the fact that the partnership shall qualify as a separate trade or business within the meaning of the Trade Tax Act the transfer of the assets does not result in a disclosure of hidden reserves, the partnership is required to set up a balance sheet for trade tax purposes in order to determine the relevant trade tax base.
Based on such a view, the tax authorities require a separate profit determination for trade tax purposes on the one hand and for income tax purposes on the other hand which does not only prevent taxation on a consolidated basis, but which further entails various open and unsolved questions. With respect to those questions, in practice, the trust model could only be used in exceptional cases and based on a respective binding ruling of the tax authorities.
However, it has to be taken into account that the trust model entails certain issues which will still be relevant (although under different circumstances). For example, this is true with respect to the GAAP treatment of the trust model which provides for a viable option to achieve a step-up in basis only if upon the transfer of the assets the hidden reserves are disclosed for purposes of the GAAP balance sheet of the transferring company. In this respect, a close cooperation with the company’s auditors will be necessary. In addition, the new accounting rules, which have only recently come into force and which introduced a new concept for the accounting treatment of deferred taxes will be particularly relevant because deferred taxes will typically decrease the step-up capacity.
In addition to those aspects, the taxation on a consolidated basis resulting from the trust model provides for an alternative to the implementation of a fiscal unity which is subject to certain requirements and thus — under certain circumstances — may not offer the necessary flexibility. Also, the trust model should again be increasingly taken into account when it comes to reorganizations where the requirements of the Reorganization Tax Act may be hard to fulfill.
However, there is just one minor flaw: So far there is no statement of the tax authorities available as to whether the tax authorities will follow the ruling of the Federal Fiscal Court. In light of the detailed reasons of the ruling, it seems to be doubtful whether the tax authorities will react by way of a decree stating that the ruling will not be applied. However, in the past, the tax authorities were not hesitant to go down that road, although the grand coalition agreed to reduce such practice. In addition, it should be mentioned that in the past the legislator often abolished disagreeable rulings of the Federal Fiscal Court by amending the law in a clarifying (sic!) manner.