Acquisitions (from the buyer’s perspective)Tax treatment of different acquisitions
What are the differences in tax treatment between an acquisition of stock in a company and the acquisition of business assets and liabilities?
The acquisition of a German enterprise can be organised in two different forms: the investor can acquire the assets and liabilities of the target company by a multitude of individual transfers (asset deal). Alternatively, the investor can achieve his economic objective by acquiring participation in the target company (share deal).
German tax law adopts these two organisational forms of enterprise acquisitions. For the purposes of taxation, a differentiation is to be made, in principle, between an acquisition by way of a share deal and an acquisition by way of an asset deal. However, this differentiation does not take place consistently according to civil law. There are many special tax features. In addition, German law provides rules where, under certain conditions, parts of the business could be split off on a book-value basis into a new or existing corporate entity.
An important feature of German tax law is that the acquisition of shares in a partnership is generally treated like an asset deal. Partnerships are treated as being transparent for German income tax purposes; their income is attributed to the shareholders and taxed on them. The acquisition of partnership interests for tax purposes is treated as if the buyer acquires, proportionately, all the single assets and liabilities of the partnership.
The choice of the organisational form of a company acquisition leads to significantly different tax results in Germany. As a rule, these differences result in a conflict of interest between the seller and the acquirer: for the seller, the tax treatment of capital gains in a share deal is usually more favorable. Conversely, an asset deal usually provides the greatest tax benefits to the buyer.
Corporations are intransparent under German tax law. They possess a fiscal identity separate from their shareholders and are, in contrast to partnerships, subject to German corporation tax of 15 per cent and trade tax of approximately 15 per cent (depending on the municipality), the same as partnerships. Therefore, in the case of a share deal, the book values of all the single assets and liabilities remain unchanged both in terms of trade and taxation in the accounts of the target company. However, an acquisition of more than 50 per cent of the shares in the target company may result in the loss of tax loss carry-forwards.
The participation in the target company by way of a share deal is recognised for tax purposes in the balance sheet of the buyer at the acquisition cost (ie, at the purchase price paid by the buyer plus acquisition costs). Neither the buyer nor the target company may facilitate the purchase price for tax-effective depreciations. Even if the value of the company is permanently decreasing because of permanent significant losses (section 6(I) No. 2 of the Income Tax Act (EStG)), depreciation rarely has a tax impact (section 8b(II) and (III) of the Corporate Income Tax Act (KStG)). The purchase price only becomes tax-effective if the target company is resold. If the seller is a corporation subject to German corporate income tax, only 5 per cent of the capital gains from the transaction are taxed, otherwise capital gains may be 40 per cent tax-free.
The purchase of assets and liabilities of a business, no matter whether it is run by a single natural person or any other entity, for tax purposes is treated as if the buyer had bought all the single assets separately. The liabilities allocated to the target are treated as a (negative) part of the purchase price. Therefore, in the case of an asset deal, the net purchase price paid by the buyer is allocated to the single assets of the target company up to the market value of the assets. If the purchase price exceeds the market value of all assets, the exceeding amount can be activated as goodwill. As far as the assets have a limited useful life, the buyer benefits from depreciation for the purposes of personal income taxation; the acquiring entity can deduct the depreciation of assets from its tax base.
If the purchase price is externally financed in the case of an asset deal, then the financing costs within the framework of the general regulations (interest barrier) can reduce the profit of the acquired company for tax purposes.Step-up in basis
In what circumstances does a purchaser get a step-up in basis in the business assets of the target company? Can goodwill and other intangibles be depreciated for tax purposes in the event of the purchase of those assets, and the purchase of stock in a company owning those assets?
German tax law generally provides a step-up in basis in the business assets of the target company only in the case of an asset deal or in the case of the acquisition of partnership investment. A step-up in basis is realised if the purchase price plus the liabilities taken over is higher than the book values of all assets. The excess purchase price is allocated to all the assets of the target proportionately to their market value. If there is still a mismatch between the purchase price and the accumulated market values of the assets, the difference is treated as acquired goodwill.
Goodwill and other intangibles may only be added to the tax balance sheet of a company in Germany if they have been purchased (section 5(II) EStG), the only exception being a merger. Because depreciation of an item is inconceivable without its prior entry into the balance sheet, such assets need to be traded at least once before they can be used for tax depreciation. The buyer is advised to include in the purchase agreement a specific price for each intangible asset to avoid later disputes over their value.
Assuming that goodwill and other intangibles are already included in the target’s balance sheet and thus responsible for a part of the share price, a depreciation of their market value can indeed be used for tax purposes in a share deal, but only if that depreciation leads to a traceable loss in the share price.
Buyers are advised that a share deal does not provide an opportunity to include goodwill and other intangible assets in the balance sheet for later depreciation. In the case of an asset deal, they are generally open to tax depreciation, which becomes effective on the level of the buyer. Tangible assets are treated no differently, as long as they have a limited useful life. Goodwill, for instance, is considered by the Income Tax Act to have a life span of 15 years (section 7(I)(3) EStG).Domicile of acquisition company
Is it preferable for an acquisition to be executed by an acquisition company established in or out of your jurisdiction?
For the consequences of an acquisition by way of a share deal or asset deal, it makes no difference in principle whether the acquisition company is established in Germany or abroad, as long as the target enterprise has a permanent establishment in Germany. It may be preferable, however, to have a German acquisition unit, with respect to tax treatment, in the post-acquisition period. The determination of the German acquisition unit has significant tax effects in this case.
When acquiring shares in corporations, the choice of acquisition company primarily affects the offsetting of debt-financing costs against operating income and the planning of the exit. A German corporation may claim the debt-financing costs for a share deal as an operating expense, subject to restrictions on the interest barrier (see question 8). Forming a tax group enables the two companies to offset the losses of one company (eg, the interest expenses of the acquisition company) against the profits of the other company (eg, the target company). However, buyers are advised that the acquisition company and the target company may only form a tax group if the acquisition company has its residence or place of management in Germany. Nevertheless, it is possible that a German permanent establishment (PE) or a German partnership of a foreign corporation may form a tax group with a German subsidiary, but only if the shares are held in this PE or partnership and limited to the profits and losses related to this PE or partnership.
A German acquisition company is also required if restructuring measures are planned after the acquisition. For example, mergers can be structured tax-neutrally, but this is only the case if the merger does not lead to a restriction of the German entitlement to levy income taxes on the assets transferred during the merger. The sole restriction of the German entitlement to levy trade tax does not have any adverse effects; this is mainly due to its design as a municipality tax.
If only a part of the shares in a target company is to be acquired, it can also be advantageous to structure the purchase with a German acquisition company in order to avoid adverse withholding tax issues with respect to future dividend payments. For dividends paid by a German corporation to a foreign shareholder, the EU Parent-Subsidiary Directive and many double taxation agreements stipulate minimum shareholding quotas in order to avoid or reduce withholding taxes. This issue can be avoided by using a German acquisition company, since a German corporation as a shareholder can generally receive almost (95 per cent) tax-free dividends and demand a refund of the withholding taxes.Company mergers and share exchanges
Are company mergers or share exchanges common forms of acquisition?
Company mergers and share exchanges are widely used operations in Germany, and are the most frequently chosen forms of acquisition. The legal and tax conditions for company mergers and share exchanges are for the most part Europeanised. For cross-border restructuring, the European Merger Directive (2009/133/EG) forms the basis for the common rules.
The German Reorganisation Tax Act (UmwStG) grants many privileges and tax advantages under certain conditions. It is possible that reorganisations will be carried out with income tax neutrality. However, the UmwStG generally only applies if both companies have been founded under the laws of a member state of the EU or the European Economic Area (EEA) and have their residence and place of business in one of these states. Therefore, the receiving company will need to have its residency, place of management or at least a branch in Germany.
The UmwStG provides for the parties to have the choice of whether they want to realise a step-up in basis in an amount to be determined flexibly of any amount up to the fair market value of the assets or if the buyer takes a carry-over basis in the assets acquired. A decisive factor for this is, inter alia, that the transferred assets or corporation shares remain subject to German taxation after the transaction in order to have the option to valuate the assets or corporation shares at a value lower than the market value. It is also, for some types of reorganisation measures, necessary to have independent branches of activity (Teilbetrieb), which may cause a challenge for holding companies.
However, a step-up in the single assets owned by the target company is only possible in a company merger or demerger. In a share exchange, the assets of the target have to be valued on a carry-over basis. The right to opt for a step-up refers only to the shares of the acquired company. If no choice is made in the context of the first tax return after the merger, a step-up in basis is the rule.Tax benefits in issuing stock
Is there a tax benefit to the acquirer in issuing stock as consideration rather than cash?
The acquirer may use its own newly issued shares as acquisition currency to finance the acquisition of a company (share-for-share transaction). In this case, the German Reorganisation Tax Act (UmwStG) grants a tax deferral to the seller. Under certain conditions, the seller may assume a carry-over basis in the shares acquired instead of a realisation of the hidden reserves in the target shares. This tax privilege does not apply, however, if the acquiring company does not immediately hold the majority of the target shares after the acquisition (section 21(I)2 No. 1 UmwStG).Transaction taxes
Are documentary taxes payable on the acquisition of stock or business assets and, if so, what are the rates and who is accountable? Are any other transaction taxes payable?
In Germany, fees for notarisation and registration to the commercial register and the land register have to be paid. These are statutory fees according to a fixed schedule depending on the value (purchase price) of the matter. Apart from that, there are no documentary or stamp taxes in Germany.
There are currently no transaction taxes in Germany. The introduction of a financial transaction tax is currently being discussed both in Germany and at the European level. If there is no agreement on a financial transaction tax at the European level, Germany is prepared to introduce a financial transaction tax on its own. This has been agreed in the government’s coalition agreement. The structure of a financial transaction tax has not yet been clarified in detail.
The sale of shares in a corporation or partnership is generally VAT-exempt, but the seller is entitled to opt for VAT. This can be sensible under certain circumstances; for example, if the seller has received certain services with respect to the shares in the past, which have been burdened with input VAT.
However, special attention must be paid to real-estate transfer tax if the target owns real estate. The acquisition of currently at least 95 per cent of the shares in a corporation or partnership that owns a piece of land by one buyer or related parties is treated as if the piece of land itself was sold. In the case of several participation levels, it is necessary that there is a participation limit of 95 per cent at each level. However, the participation limit of 95 per cent will most probably be lowered to 90 per cent by 1 January 2020; a bill has already been drafted. In this case, real-estate transfer tax of 3.5 to 6.5 per cent of the value of the piece of land becomes due (section 1(II)(a), III and III(a) of the Real Estate Transfer Tax Act (GrEStG)). The rates depend on the German federal state where the real estate is located. In the past, this result could be avoided by RETT-blocker structures. If the target company is of the non-incorporated type, the tax has so far been avoided by leaving at least 5.1 per cent of its shares in the hands of the original owners or transferring them to third parties. In future, the previous owners or third parties would have to take over at least 10.1 per cent of the shares. The reform also concerns the waiting period. At present, after a waiting period of five years, the remaining stake can be transferred to the buyer without any negative fiscal consequences. The reform currently under discussion extends this waiting period to 10 years.Net operating losses, other tax attributes and insolvency proceedings
Are net operating losses, tax credits or other types of deferred tax asset subject to any limitations after a change of control of the target or in any other circumstances? If not, are there techniques for preserving them? Are acquisitions or reorganisations of bankrupt or insolvent companies subject to any special rules or tax regimes?
Section 10(d) of the EStG stipulates a minimum taxation that works as follows: if a net annual loss arises, it may be carried back to the previous fiscal year up to an amount of €1 million. If the loss is still not neutralised after that, it is carried forward into future fiscal years. Once the company makes an annual profit, the minimum taxation rule prevents it from instantly setting off all accumulated losses against new annual profits. Instead, usage of carry-forward losses is capped at 60 per cent for each fiscal year. Only the first €1 million of losses can be offset without limitations. For example, a company with an annual profit of €10 million in 2019 and an equal amount of carry-forward losses has a taxable income of €3.6 million, which may be called the minimum taxable income. The remaining losses are carried on until they are used up. Forming a tax group can reduce the impact of the minimum taxation clause by eliminating losses within the group immediately instead of carrying them forward.
While the aforementioned limitations only defer the usage of carry-forward losses, additional rules pertaining to a change of control in share deals affect the very preservation of such losses. Acquiring a company’s shares eliminates carry-forward losses entirely (50.1 per cent and above) for purposes of corporate income and trade tax (section 8(c)(I) KStG and section 10(a)(X) of the Trade Tax Act (GewStG)). Shares bought by a group of acquirers with common interests are added. The loss-elimination clause covers not only direct transfers of shares, but any similar type of transaction, leaving almost no room for a preservation of losses. However, the elimination does not kick in if the target and acquiring corporation belong entirely to the same group or if the target’s carry-forward losses exceed its existing hidden reserves.
Losses from one business year can be carried back to the previous year (restricted to amounts of up to €1 million). Remaining losses are then carried forward up to an amount of €1 million with no limitations, and after that, at a rate of 60 per cent of the remaining losses. The rest may be used in future years. The utilisation of losses is permitted in company groups under certain requirements.
A special rule in section 8c KStG facilitates the preservation of losses during the takeover of a crisis-stricken company. Existing losses can be maintained in order to avoid the bankruptcy of a company and under certain conditions.
Section 8d KStG concerns the preservation of losses in a company in the case of a change in ownership, and the losses cannot be used otherwise. In cases where a new shareholder or a change in the shareholders is necessary for the continuity of the business and to receive proper financing, the losses carried forward may be preserved if the business of the company will be continued without major changes as far as the services or products, customers and suppliers, the markets served and the qualification of employees are concerned. Further restrictions apply as far as the business is concerned. The losses can be carried forward until they are fully used and provided that no adverse event, such as the closing of the business or the implementation of new business activities, occurs.
Tax credits (ie, withholding tax credits that have been accumulated before the acquisition) stay with the corporation even after a change of control. These are subject to the regular limitation periods.
In asset deals, the tax losses accumulated by the target before the change of control can generally not be used by the acquirer in the future because they always stay with the former shareholder or owner of the business.Interest relief
Does an acquisition company get interest relief for borrowings to acquire the target? Are there restrictions on deductibility generally or where the lender is foreign, a related party, or both? In particular, are there capitalisation rules that prevent the pushdown of excessive debt?
German tax law has strict limitations on the deductibility of interest payments by a company belonging to a group (the interest-barrier rule, (section 8(a) KStG and section 4(h) EStG)); this is one of the greatest obstacles to deal with in large transactions in Germany. Existing German rules have been taken as an example for the BEPS report on interest limitation and the EU Anti-Tax Avoidance Directive.
If a group company has outgoing interest payments that exceed its incoming interest earnings by €3 million, only 30 per cent of the profits (earnings before interest, taxes, depreciation and amortisation) can be offset against interest payments. Additionally, profits that have not been offset against interest expenses can be carried forward for five years at the most, but they may be lost in a case of change of control. If they remain unused until then, they become definite profits. Unused excess interest, on the other hand, can theoretically be carried forward indefinitely.
A group company remains unaffected by the interest-barrier rule if its equity-to-assets ratio is higher than or equal to the ratio of the corporate group as a whole.
This rule does not only apply if the lender is foreign, a related party, or both, but applies to interest payments to any kind of lender. To make matters worse, the exceptions provided for companies not belonging to a group or equipped with a good equity-to-asset ratio are largely overridden by special stipulations in section 8(a)(II) and (III) KStG if more than 10 per cent of the excess interest payments go to a person that owns at least one-quarter of a corporation, or to someone related to or controlling that person (section 8(a)(II) and (III) KStG).
Withholding taxes on interest payments are usually not an issue, as the obligation to withhold taxes on interest payments applies only if the debtor is a bank or financial institution or the loan has been registered in a public debt register. However, for related-party debt, additional restrictions apply, as the interest payments are only deductible if assessed at arm’s length. Otherwise, they are treated as hidden profit distributions and trigger withholding tax. If the acquirer is a foreign company, any withholding taxes can be a definite tax burden.
Debt pushdown cannot be achieved by a simple assumption of debt, as this can be treated as a hidden profit distribution from the target to the acquirer. In this case, withholding taxes become due. Under certain circumstances, these consequences may be avoided by executing the debt pushdown as a reorganisation under the Reorganisation Tax Act, but this is more complicated and more expensive than a simple assumption of debt.
There are no restrictions for debt pushdown other than those mentioned above. Should the acquirer be unwilling to undergo the effort of a reorganisation, it can at least realise a partial debt pushdown to take full advantage of the €3 million interest excess allowance per company and year.Protections for acquisitions
What forms of protection are generally sought for stock and business asset acquisitions? How are they documented? How are any payments made following a claim under a warranty or indemnity treated from a tax perspective? Are they subject to withholding taxes or taxable in the hands of the recipient? Is tax indemnity insurance common in your jurisdiction?
Protections for acquisitions are found in most asset or share-purchase agreements concluded in Germany. Usually, the seller guarantees that all tax obligations have been fulfilled in the past and that the tax liabilities as presented in the annual accounts and the documents provided during due diligence have given the purchaser a complete and correct picture of the situation. The seller also (or instead) customarily provides for a tax indemnification and commits him or herself to pay any taxes assessed after the transaction by the tax authorities, as far as the cause of these taxes is to be found in the time before the closing of the transaction.
Payments under a warranty or indemnification claim reduce the profit from the sale on the side of the seller. If the payment is made to the purchaser, it reduces the acquisition price and, at the same time, the value of the target. A tax would be triggered only in a future sale. If the payment is made into the target company, it is treated as extraordinary income and will be subject to normal tax in the respective business year. No withholding tax would become due. Contractual documentation should therefore provide that any warranty or indemnification is treated as an adjustment to the purchase price.