Profit and loss transfer agreements between two companies are necessary under German tax law for an industrial & manufacturing business to establish a tax group in Germany for corporation tax purposes (Ertragsteuerliche Organschaft). The German Federal Tax Authority has changed its position on not paying interest on a claim for compensation under a profit and loss transfer agreement where losses are transferred which will potentially affect many industrial & manufacturing businesses. To now secure the existence of a German tax group, any payments of compensation must now bear interest.
On 14 February 2005, the German Federal Supreme Court (Bundesgerichtshof) (II ZR 361/02), confirmed that a loss compensation claim under a profit and loss transfer agreement arises on the balance sheet date and becomes due on the date of accrual. The date of approval of the annual financial statements is not relevant and the claim for loss compensation will bear interest from the balance sheet date pursuant to section 352 to 353 of the German Commercial Code (Handelsgesetzbuch) ("HGB").
According to the previous view of the Federal Ministry of Finance (Bundesfinanzministerium) ("BMF") in its decision of 15 October 2007 (IV B 7 - S 2770/0), a violation of an obligation to pay interest on a claim for loss compensation had no impact on the existence of the tax group. In case of a non-payment of interest, the parties had merely violated a contractual ancillary obligation.
According to Schleswig-Holstein Ministry of Finance in its regulation dated 22 February 2016, the BMF's view is no longer applicable. Any violation of the obligation to pay interest now results in a defective balance sheet value.
According to the new regulation, failure to pay interest results in an incomplete payment of the profits under the profit and loss transfer agreement. In such case, the existence of the German tax group for the industrial & manufacturing business can no longer be assumed. The only remedy then available is provided by section 14 of the German Corporation Tax Act (Körperschaftssteuergesetz) ("KStG"). According to the KStG the profit and loss transfer agreement is considered to be performed despite the error if the following conditions are fulfilled:
- the annual financial statements have been validly approved;
- it had not been obligatory to detect the error when preparing the annual financial statements despite applying the due care of a prudent business man; and
- any error reprimanded by the tax authority is corrected directly within the framework of the following annual financial statements of the controlled entity and the parent company and the correct profit is paid accordingly, insofar as it is an error which has to be corrected in the commercial balance sheet.
Ultimately, any claim for loss compensation by a German company should now bear interest in order to prevent a defective balance sheet and to ensure an uninterrupted existence of the German tax group.
Industrial & manufacturing businesses with German tax groups should set out in writing in a newly agreed profit and loss transfer agreement for the sake of clarity to ensure its German tax grouping is maintained.