Use the Lexology Getting The Deal Through tool to compare the answers in this article with those from other jurisdictions.
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?
German tax law distinguishes between two fundamentally different cases of enterprise acquisitions.
The first (case 1) is the acquisition of stock in a corporation (share deal). The second (case 2) is the acquisition of the assets and liabilities of a corporation or other enterprise, the acquisition of a whole enterprise run by a single natural person and the acquisition of interests in a partnership. The asset deal rules also apply if only a part of a business shall be acquired. In addition, German corporate and tax 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.
Corporations are subject to German income tax and trade tax. Only a corporation possesses a fiscal identity separate from its shareholders. Therefore, in case 1, the book values of all the single assets and liabilities in the accounts of the target company remain unchanged for income tax and trade tax purposes. The purchase price paid by the buyer is allocated to the buyer’s acquisition cost of the shares in the corporation as such. Neither the buyer nor the target may facilitate the purchase price for tax-effective depreciations, apart from rare cases where the value of the company is permanently decreasing because of permanent significant losses. In that scenario a current-value depreciation may be applicable. The purchase price only becomes tax-effective for the seller if it resells the target. 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 case 2, the net purchase price paid by the buyer is equally 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 purposes of its personal income taxation. In addition, the acquiring entity can deduct the depreciation of the assets from its trade tax base.
Partnerships are treated as being transparent for German income tax purposes. The acquisition of partnership interests for tax purposes is treated as if the buyer had bought, proportionately, all the single assets of the partnership.
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?
Goodwill and other intangibles may only be added to the tax balance sheet of a company if they have been purchased (section 5(II) of the Income Tax Act (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 dispute 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 in itself an opportunity to add intangibles to the balance sheet for later depreciation. As for type 2 deals, they are generally open to tax depreciation, which becomes effective on the level of the buyer (see above). 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).
More generally, a step-up in basis in the business assets of the target company is only possible under German tax law in an asset deal. A step-up in basis is realised if the purchase price plus the liabilities taken over is higher than the book values of the assets together. 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.
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 a purchase described in questions 1 and 2, it makes no difference in principle whether the acquisition company is established in Germany or abroad, as long as the target has a permanent establishment in Germany.
It may be preferable, however, to have a German acquisition company, with respect to the tax treatment, in the post-acquisition time. 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. 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). Nevertheless, it is possible that a German permanent establishment (PE) of a foreign corporation may form a tax group with a German subsidiary, but only if the shares are held in this PE and limited to the profits and losses related to this PE.
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 corporation is to be acquired, it can also be advantageous to structure the purchase with a German acquisition vehicle 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 problem can be avoided by using a German acquisition vehicle, 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 frequently chosen forms of acquisition in Germany, as the Reorganisation Tax Act (UmwStG) generally provides for the parties having the choice of whether they want to realise a step-up in basis in an amount to be determined flexibly up to any amount up to fair market value of the assets or if the buyer takes a carry-over basis in the assets acquired. 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. In addition, it is generally required 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. Therefore, the receiving company will need to have its residency, place of management or at least a branch in Germany. 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?
From the seller’s perspective, issuing its own shares as consideration for shares in the target can be advantageous, since the UmwStG allows for the option to take a carry-over basis in the shares acquired instead of a realisation of the hidden reserves in the target shares. However, choosing this option would be disadvantageous for the buyer, as the buyer would then have less acquisition cost for the target shares acquired and would therefore realise a higher taxable profit in a future sale of the shares. This effect may be of less importance because the profit from the later sale of the shares would be 95 per cent exempt from tax. If the option is not exercised, issuing stock as consideration is not treated differently from paying cash.
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?
There are no documentary taxes in Germany. 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. There are no other transaction taxes in Germany that apply to company sales. Nevertheless, one has to bear in mind that 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.
However, special attention must be paid to real estate transfer tax if the target owns real estate that has a great value. The acquisition of 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 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 can be avoided by leaving at least 5.1 per cent of its shares in the hands of the original owners. After a waiting period of five years, the remaining stake can be transferred to the buyer without any negative fiscal consequences. This solution is not an option if the target company is a corporation or a partnership. To avoid the real estate transfer tax in this latter case, a permanent division of the target’s shares into two separate entities is necessary and those entities must not belong to the same group. Section 6(a) GrEStG exempts an otherwise taxable transfer within the same group, but this exception only works when the target has belonged to the buyer for at least five years before the transfer takes place. New legislation came into force in 2013. The new rule looks not at the nominal percentage of 95 per cent but takes an ‘economic view’ and takes into account all direct or indirect participations of the buyer in the respective company. Nevertheless the new rule does not apply to reorganisations within a group of companies. A proposal to have even more restrictive rules against RETT blocker structures is in the legislation. Most probably the shreshold of 95 per cent will go up to 90 per cent and the minimum holding period will go up 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 a surplus, the minimum taxation rule prevents it from instantly setting off all accumulated losses against new surpluses. Instead, usage of carry-forward losses is capped at 60 per cent for each fiscal year. Only the first million of losses can be offset without limitations. For example, a company with a surplus of €10 million in 2016 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 either proportionately (25.1 per cent to 50 per cent of shares acquired; anything less has no effect) or entirely (50.1 per cent and above) for purposes of corporate income and trade tax (section 8(c)(I) of the Corporate Income Tax Act (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 entirely belong 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 € 1,000,000). Remaining losses are then carried forward, up to an amount of € 1,000,000 with no limitations, 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. Existing losses carried forward are cancelled according to the rules in the Corporation Tax Act:
- in full if more than 50 per cent of the shares of a corporation are transferred within a period of five years; or
- proportionately to the amount of shares transferred if more than 25 per cent but less than 50 per cent of the shares in a corporation are transferred within a period of five years.
A special rule had been introduced into § 8c KStG in order to facilitate the preservation of losses during the takeover of a crisis-stricken company. This rule has been relaxed by new legislation in § 8d KStG concerning preservation of losses carried forward in cases of share transfers within groups of companies or if the business is continued without major changes.
Existing losses can be preserved in the course of a share transfer aimed at avoiding a company’s bankruptcy, if the business of the company is continued and either one of the following prerequisites is met (§ 8c KStG):
- a works council agreement on the restructuring scheme including provisions for the preservation of a certain number of jobs;
- in the five years following the share transfer, the company pays at least 400 per cent of the wages it has paid in the five years preceding the transfer; or
- the company’s equity is raised by at least 25 per cent of the company’s assets.
§ 8d KStG concerns the preservation of losses in a company in 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 no adverse event like the closing of the business or the implementation of new business activities occurs.
If the company realises profits in the course of a reorganisation due to a cancellation of debt, the tax authorities may grant a deferral and later a waiver of the taxes on these profits, but only after all net operating losses and losses carried forward have been used up to offset against these profits. That was an instruction of the Federal Ministry of Finance (‘restructuring decree’). With its judgment of 28 November 2016, the German Supreme Tax Court has decided that the restructuring decree is not compatible with the principle of legality of administration. The court dismissed the application of the restructuring decree and pointed out that the taxation of restructuring gains is only subject to the German tax law provisions. The conditions for a tax remission on equitable grounds, which are laid down in the restructuring decree, do not describe any case of objective unfairness within the meaning of articles 163 and 227 of the German Fiscal Code. In response to these judgments, the rules of the restructuring decree were introduced in a new section 3a in the German Income Tax Act. However, it will only enter into force on the day on which the European Commission decides that the new section 3a does not constitute a state aid within the meaning of article 107(I) of the Treaty on the Functioning of the European Union, or it is a state aid but compatible with the common market.
Tax credits (ie, withholding tax credits that have been accumulated before the acquisition) stay with the corporation even after a change of control. They 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.
Does an acquisition company get interest relief for borrowings to acquire the target? Are there restrictions on deductibility where the lender is foreign, a related party, or both? Can withholding taxes on interest payments be easily avoided? Is debt pushdown easily achieved? In particular, are there capitalisation rules that prevent the pushdown of excessive debt?
German tax law has extremely strict limitations to 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)); it is one of the greatest obstacles to deal with in large transactions in Germany.
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. In contrast to the minimum taxation rule discussed in question 7, the interest-barrier rule spares no base amount from this restriction, so it is all or nothing in this case. 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 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 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, he or she 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?
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 the due diligence have given the purchaser the complete and correct picture of the situation. The seller 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 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 would be treated as extraordinary income and would be subject to the normal tax in the respective business year. No withholding tax would become due.
What post-acquisition restructuring, if any, is typically carried out and why?
A typical restructuring measure after the acquisition of a company is a merger of the acquisition vehicle into the target in order to realise debt pushdown without the adverse tax consequences a simple assumption of debt would have (see question 8). Other than in upstream mergers the existing losses carried forward are not lost in the absorbing company.
Another frequent post-acquisition measure is a change of legal form in order to change the tax treatment of the profits distributed by the target to the buyer under the relevant double taxation agreement. For example, a transformation of a partnership into a corporation might be sensible if the respective double taxation agreement provides for a withholding tax relief for dividends, while a transformation the other way around can be advantageous if there is no withholding tax relief in the double taxation agreement.
An upstream merger of the target into the acquisition vehicle might help avoid the taxation of 5 per cent of the profit distributions of the target to the acquisition vehicle pursuant to section 8(b) KStG.
If the target owns real estate that is rented to other parties, it is advisable to transfer the real estate from the target into a separate company. Rental income is free of trade tax (sections 9(1) and 2 to 6 GewStG), but only for companies that exclusively rent out real estate and do not participate in any other business activities.
Another post-acquisition restructuring is the formation of a tax group between the target and the acquisition vehicle for corporate tax and trade tax. This can usually be achieved by signing a profit-and-loss-sharing agreement with a minimum term of five years but may be achieved retroactively if the profit-and-loss-sharing agreement is properly registered in the commercial register until the end of the respective year. VAT tax groups arise automatically if the subsidiary is sufficiently integrated into the parent company (section 2(II)(2) Value Added Tax Act).
Can tax neutral spin-offs of businesses be executed and, if so, can the net operating losses of the spun-off business be preserved? Is it possible to achieve a spin-off without triggering transfer taxes?
A tax-neutral spin-off can generally be achieved under the UmwStG, but a sale of more than 20 per cent of the shares in the spun-off business within the following five years will lead to a retroactive taxation of the hidden reserves (section 15(II)(4) UmwStG).
The net operating losses cannot be transferred in their entirety; rather they follow the spin-off in proportion to the assets received from the transferring company (section 15(III) UmwStG).
In a spin-off scenario real estate transfer tax of 3.5 to 6.5 per cent (depending on the federal state in which the property is located) becomes due on the value of real estate transferred in the course of the spin-off. Spin-offs taking place within a group of companies may be exempt from the real estate transfer tax if 95 per cent of the shares in the spin-off are held for at least five years by the transferring company or another member of the group (section 6(a) GrEStG).
Migration of residence
Is it possible to migrate the residence of the acquisition company or target company from your jurisdiction without tax consequences?
If a corporation’s residence is migrated from Germany to a state that is not a member of the EU or EEA, the corporation is treated as if it were liquidated (section (12)(III)(1) KStG), pursuant to the market value, and the shareholders are taxed on this basis.
If a partnership’s residence is moved to any foreign state or a corporation’s residence is moved to an EU or EEA state, this will not lead to adverse tax consequences as long as no assets are moved away from Germany. Several recent court decisions suggest that, even when moved away, their hidden reserves remain taxable under section 49 EStG, but this judicial twist may yet be overturned by new legislation.
Interest and dividend payments
Are interest and dividend payments made out of your jurisdiction subject to withholding taxes and, if so, at what rates? Are there domestic exemptions from these withholdings or are they treaty-dependent?
Interest payments are only subject to withholding taxes if either the debtor is a bank or other financial institution or the debt has been registered in a public register (section 43(I)(1)(7) EStG). This restriction applies irrespective of the residency of the lender. If the lender is a foreign entity, which is not subject to unrestricted tax liability, the interest payments are - in addition - only subject to withholding taxes if the debt is collateralised by German real estate (section 49(I)(5)(c)(aa) EStG).
Dividends paid by German corporations are generally subject to German withholding taxes under national German law (section 43(I)(1) EStG).
The withholding tax rate for interest and dividends is 25 per cent (section 43(a)(I)(1)(1) EStG). The tax may partly be reimbursed on the grounds of a double tax treaty. If a particular certificate can be obtained before the dividend is paid, no withholding tax will be charged in the first place (section 50(d)(II) EStG).
Until February 2013, under the old German tax regime, dividends to shareholders holding over 10 per cent were not subject to withholding tax if the shareholder was resident within the EU or were only subject to a reduced withholding tax under the respective tax treaty if the shareholder was resident in a country outside the EU. Whereas for German shareholders with participation under 10 per cent there was basically no withholding tax burden, shareholders in other member states were left with the definite withholding tax burden of 15 per cent on dividends received. With the Act for the implementation of the decision of the European Court of Justice of 20 October 2011 in case C-284/09 German legislation followed the order of the court to review the withholding tax regime for minority shareholders. The new law has been in force since 1 March 2013. The main details of the new law are as follows:
- All dividends paid after 28 February 2013 to shareholders with a shareholding of up to 10 per cent are subject to withholding tax, regardless of the residency of the shareholder, whereas capital gains from the alienation of shares remain exempt from tax for domestic shareholders.
- For all dividends paid to shareholders before 1 March 2013 the new section 32(5) of the German Corporate Tax Act entitles foreign entities to reclaim withholding tax that has been paid to the German tax administration under the old regime.
- There is a complex list of conditions with which foreign shareholders have to comply and evidence to be provided if they want to successfully reclaim the withholding tax, and the new law also contains rules under which investment funds under the German Investment Tax Act can benefit for the past and the future. According to these provisions, foreign investment funds that are exempt from tax in their country of residence are not entitled to a refund of withholding tax.
- To solve pending disputes about the competent authority for the reclaiming process, a new rule has been implemented to centralise the administration process at the Federal Central Tax Office.
Dividends can only be tax-free if the respective amount has been subject to tax paid at the subsidiary level and further provided that the shareholding exceeds 10 per cent.
Tax-efficient extraction of profits
What other tax-efficient means are adopted for extracting profits from your jurisdiction?
Because dividend payments are not tax-deductible on the corporation level, but interest and royalty payments are, it is generally more efficient to pay royalties and interest rather than dividends, as long as the relevant double taxation agreement between Germany as the state of residency of the target and the state of residency of the acquirer allocates the right to levy taxes on interest or royalty income to the state of residency of the party receiving the payments. However, the acquirer has to meet certain ‘substance’ requirements in order to avoid the application of a special German anti-avoidance rule (section 50(d)(III) EStG, anti-treaty-shopping rule), and the royalties or interest rates have to be negotiated at arm’s length to avoid the assumption of hidden profit distributions by the tax authorities.
Section 50(d)(III) has recently been revised after its precursor was deemed too harsh by the European Commission. The latest version denies a foreign company the reimbursement of withholding taxes to the extent that its shares are held by anyone who would not be entitled to a reimbursement himself or herself and the company’s income does not stem from its own economic activity. However, the legislator accepts a structuring that shifts dividends out of Germany as long as both a good non-fiscal reason can be shown and sufficient business operation facilities exist to participate in the market.
In addition, a new licence limitation rule has been implemented to be applied for expenses arising from 2018. Licence payments are only limited deductible, § 4j EStG. The new section restricts the deduction of royalties and similar cross-border payments made to related parties if, in the other country, the payments are (i) subject to a preferential tax regime, such as an IP Box regime, and the rules in the other country are not compliant with the OECD nexus approach presented in its BEPS Report on Action Item 5, and (ii) subject to an effective tax rate of less than 25 per cent. A safe harbour exists for royalty payments to a company that carries on substantial research and development activities.
If the law applies, the percentage of the payment that will be nondeductible is calculated by making reference to the percentage shortfall between the effective rate and 25 per cent. Stated mathematically, the formula is (25 per cent - effective tax rate) ÷ 25 per cent. For instance, if the effective foreign preferential tax rate is 10 per cent, German law would regard 60 per cent of all royalty payments as nondeductible. Because 10 per cent amounts to 40 per cent of 25 per cent, the shortfall between the effective rate and 25 per cent is 15 per cent - which is 60 per cent of 25 per cent.
This new legislation also captures indirect licence payments and will apply irrespective of any tax treaties (ie, treaty override).
Disposals (from the seller’s perspective)
How are disposals most commonly carried out - a disposal of the business assets, the stock in the local company or stock in the foreign holding company?
In German tax law, a choice between share or asset deal only exists when the sold company is a corporation (see question 1). In all other cases, the type of deal is predetermined by the nature of the target. It must be remembered that this statement is true only in the area of tax law and does not extend to trade law, for example. Also, in restructuring matters the UmwStG strives to put all kinds of transformations on a par.
A disposal of the business assets of a German company as well as a sale of the shares in a partnership (type 2 deals as described in question 1) will generally lead to a full taxation of the difference between the book values of the assets and the purchase price received. In a sale of the shares in a German corporation by another corporation, only 5 per cent of the profits are subject to tax in Germany, so with a corporate income tax level of 15 per cent, the effective tax rate is less than 1 per cent. Germany does not levy taxes if a foreign holding company sells its assets in a German unincorporated company, provided that the holding company’s shareholders are also resident abroad. The transaction will be taxed only in the state of residence of the holding company, therefore when determining the seat of the holding company the seller should heed the advantages of a low-tax jurisdiction.
Disposals of stock
Where the disposal is of stock in the local company by a non-resident company, will gains on disposal be exempt from tax? Are there special rules dealing with the disposal of stock in real property, energy and natural resource companies?
As explained above, the disposal of stock in a local company by a non-resident company is generally subject to German tax. There are no special rules for the disposal of stock in energy and natural resource companies, but for real property companies the real estate transfer tax issues described in question 6 must be contemplated. Another problem with respect to the disposal of stock in a real property company is that the trade tax exemption described above (section 9(1)(2-6) GewStG; question 10) may become inapplicable for the future if the sale of the real estate is treated as a trading business.
Avoiding and deferring tax
If a gain is taxable on the disposal either of the shares in the local company or of the business assets by the local company, are there any methods for deferring or avoiding the tax?
Because the disposal of shares in a corporation is subject only to a very low effective tax burden if both parties of the deal are corporations, a restructuring of the holding may be desirable before a sale. It is possible to transfer the shares into a corporation’s property in a tax-neutral way under the Reorganisation Tax Act, but a waiting period of seven years until the disposal must be adhered to in order to avoid a retroactive taxation of the reorganisation (section 22(I)(1) UmwStG). Upon disposal of German real estate that belonged to the company’s assets for at least six years, the hidden reserves may be transferred to a new asset, if the substitute asset is acquired within four years (section 6(b) EStG).