The last few years have presented extremely challenging conditions for many businesses, and the prospects for economic recovery are still bleak. Corporate losses, and indeed failures, are an inevitable consequence of the current financial climate, with pressure on profits and limited availability of credit. Lower profits mean reduced tax revenues, but even where companies are profitable, they may be able to use carried forward losses, or losses from a group member, to reduce or eliminate their exposure to tax. In the face of falling tax receipts, some European governments have taken action to limit the availability of loss relief. In this feature, we look at the steps taken in Germany, the Netherlands and Spain to restrict the use of tax losses in an attempt to bolster their tax takes.
Tax loss carry-forward
The basic rules are quite simple: The loss carry-forward is unlimited in time and amount. Beyond this introductory position, however, the situation becomes more complicated. The loss carry-forward facility does not distinguish between capital gains and ordinary income. For German financial and tax accounting purposes, there is no such differentiation. It is worth noting that certain income is exempt in Germany; for example, the income derived from the sale of shares (by non-financial institutions) and the income derived from foreign-source income where the respective treaty provides for exemption in Germany. In each of these cases, any losses incurred would, reflecting the exemption for positive income, not be available for tax loss carry-forward purposes.
Loss cancellation by change of financial control
The loss carry-forward is cancelled where there is change of financial control for the loss company, whether directly or indirectly, from shareholdings of more than 25 percent up to 50 percent in any five-year period and resulting in a proportional loss cancellation. A change of control of more than 50 percent results in full cancellation.
There are two escapes from the loss cancellation consequence. The loss carry-forward is retained to the extent the loss company can show it has unrealised taxable gains. These legacy gains qualify for protection by the loss carry-forward, whereas new business introduced by the new shareholder does not. There is also retention of the loss if the loss company is sold by one wholly owned subsidiary to another in the same group of companies. "Wholly owned" thus excludes group parents where these are listed or held by more than one shareholder. The concept also excludes partnerships as transferee or transferor, since these are, by their nature, not wholly owned unless all partners in the partnership and the transferee or transferor respectively have a common “grand” parent company higher up the chain. In any case, it must be ensured that one entity directly or indirectly owns all shares in the transferee and transferor. The loss cancellation rules, which apply to transfers of shares in the loss company, are currently subject to challenge before the Constitutional Court on the grounds that they violate the principle that taxes must only be levied in accordance with the financial ability to settle them.
Loss cancellation by merger
The loss carry-forward is cancelled where the loss company is merged into another company.
In a situation where the loss company spins off a part of its business, a corresponding part of its loss carry-forward is cancelled. This is different in a situation where the loss company drops part of its business down to a subsidiary. In this second case, its loss carry-forward is not cancelled or reduced.
Absent one of the cancellation situations, the loss carry-forward can be used through the introduction of new and profitable business activities. It can also be used by merging a profitable company into the loss company, provided that this does not, at this time, result in a change of control of 25 percent or more.
The twin of the loss carry-forward – the loss carry-back – is stunted, by comparison. There is no loss carry-back for municipal trade tax purposes at all and there is a one-year loss carry-back for corporate income tax purposes limited to EUR511,000. A bill currently introduced to Parliament provides for the loss carry-back for corporate income tax purposes to be increased to EUR1 million.
Tax loss carry-forward
A tax loss incurred during a fiscal year may be carried back to the preceding year or carried forward to the nine subsequent years. This means that a tax loss incurred in 2012 may be set against taxable profit of the year 2011 and/or the years 2013 up to and including 2021. There are no restrictions on the amount of tax losses that may be carried back or carried forward.
Recent development: As a temporary measure in 2009, 2010 and 2011, a Dutch taxpayer could opt to extend the carry-back period to three years, in which case the carry-forward of losses would be limited to six years instead of nine. Extension of the carry-back period in this way is limited to EUR10 million per (fiscal) year. As from 1 January 2012, this temporary measure has been abolished.
There are also certain anti-abuse provisions that limit the carry-back or carry-forward of tax losses:
Change of control provision
The change of control provision disallows the carry-forward of losses if 30 percent or more of the ultimate shareholders in a Dutch company have changed as compared to the earliest year in which the losses were incurred, unless:
- the company did not terminate or reduce its business activities to less than 30 percent of the activities as compared to the earliest year in which the losses were incurred; and
- at the time of the change of control, it is not intended to reduce the business activities of the Company to less than 30 percent of the activities as compared to the earliest year in which the losses were incurred.
Recent development: Up to 1 January 2011, the change of control provisions only disallowed the carry forward of losses that were realised in the years prior to the (financial) year in which the change of control occurred. Therefore, losses incurred in the same financial year as the change of control were not targeted by the change of control provision. For example, if a change of control occurred on 1 July 2010, the losses incurred in the period 1 January 2010 up to 1 July 2010 were still available to be offset against profits made by the company in future years.
As from 1 January 2011, the change of control provision has been amended so that the carry-forward of losses incurred in the same year as the change of control is also disallowed.
Limitation on loss carry-forward for holding and/or financing companies
If during a fiscal year, the activities of a Dutch company consisted of 90 percent or more of holding and/or group financing activities, that company qualifies as a holding company. Losses incurred by a holding company may only be set against profits derived in years during which the taxpayer also qualifies as a holding company. This rule is intended to prevent pure holding companies from initiating active operations with the (exclusive) aim of setting off their (holding) losses against operating profits. Nor may holding company losses be carried forward if a holding company increases the balance of its intercompany loans and liabilities (compared to the balance in the year when the loss was incurred) in order to generate additional interest income which is to be set against previous losses.
Limitation on the use of losses in Spain
Royal Decree-Law 20/2012 of 13 July established some tax measures that affect the Spanish Corporate Tax Act with the intention of increasing tax revenues for the years 2012 and 2013.
One of these measures entailed a change in the way that losses carried forward could be offset in Spain. To that end, the Royal Decree-Law establishes a limitation on the amount of losses to be set against profits in order to calculate the final taxable amount. This limitation is, in principle, applicable for the financial years starting in 2012 or 2013.
The limitation on the use of losses depends on the amount of turnover the company had in the 12 months immediately preceding the fiscal year in which the limitation will apply. There is no limitation if the turnover in that period is lower than EUR6,010,121.04.
The maximum amount of losses which can be carried forward in the fiscal years is as follows, depending on the level of turnover in the preceding 12-month period:
- turnover more than EUR20 million but less than EUR60 million: 50 percent of the taxable profits for the fiscal years starting in 2012 and 2013 before setting off losses
- turnover more than EUR60 million: 25 percent of the taxable profits in the fiscal years starting in 2012 and 2013 before setting off those losses
- less than EUR20 million: no limitation
The above thresholds must be calculated on a consolidated basis for a group of companies filing a group tax return. Losses can be utilised to offset profits during the 18 years after they are generated. The result of this measure is that companies with a turnover or more than EUR20 million in the preceding fiscal year will always have positive taxable profits in the financial years starting in 2012 and 2013, even if the amount of the losses carried forward could have offset the whole profit for the year had this measure not been implemented.
Losses carried forward on a merger
Losses carried forward by the absorbing entity which generated the losses can be kept and utilised by that company after the merger on the same terms and conditions as if the merger had not taken place. On the other hand, losses generated by the absorbed entity in a straight-up merger may be reduced by the difference between the amount of equity contributed by shareholders to that company and the accounting value of those shares in the absorbing entity’s balance sheets.
Losses carried back
Spain does not allow losses to be carried back.