Summary

The German Federal Court of Finance (BFH) has recently decided on the tax treatment of profits resulting from debt waived in the course of a company´s restructuring (case file no. GrS 1/15, 28 November 2016).

The BFH:

  • dismissed the administrative instruction containing standard regulations issued by the Federal Ministry of Finance (BMF) as of 27 March 2003 (the Restructuring Order) which led to an abatement of tax collected in such restructuring scenarios
  • held that the Restructuring Order by BMF did not comply with the requirements under applicable German tax and constitutional law
  • emphasised that the taxation of such restructuring measures is subject to the competent finance court’s discretion (pursuant to applicable tax law provisions)

Facts

  • The claimant owner of an enterprise challenged the income tax assessment issued by the defendant tax authority
  • After the claimant’s business incurred losses for several years, his creditors formally agreed to waive (in part) their claims. The claimant´s 2007 income tax assessment included taxes on the book profits resulting from the waiver of those creditor claims
  • The claimant sought a tax exemption, inter alia, by referring to the Restructuring Order which would lead to a ‘tax neutral’ treatment of those book profits

Ruling

BFH had to decide whether the Restructuring Order was valid; and whether restructuring profits comply with the requirements of an ‘inequity’ as defined under ss 163 and 227 of the German Fiscal Code, therefore justifying an abatement of taxes.

BMF’s Restructuring Order was dismissed since – according to BFH - restructuring profits do not generally comply with the requirements under the German Fiscal Code. In the absence of a legal basis, the Restructuring Order also infringes the constitutional principle of the separation of powers.

The question on restructuring taxes could not be decided generally by an administrative instruction. The BFH held that whether the requirements of ‘inequity’ are met has to be determined on a ‘case-by-case’ basis.

Comment

This decision will complicate future restructurings based on debt waivers. The strict requirement for a case-by-case assessment significantly affects the actions and flexibility of debtor companies and leads to uncertainty.

Legislative reform proposals are currently under debate and the German Federal Council has already suggested a corresponding amendment to the applicable law. Further developments and decisions are eagerly awaited.