/>iThe question whether restructuring profits are taxable or not has been answered differently in Germany in the past. However, on 7 February 2017, a decision of the Grand Senate of the Federal Fiscal Court (the “FFC Decision”) was published, in which the highest German tax court declared the Restructuring Decree as unlawful. The FFC found that the administration had acted as legislator violating its obligation to apply the existing law. The FFC Decision has far-reaching consequences not only for future restructurings, but also raises the question who may rely on the Restructuring Decree for past restructurings.
From 1977 until 1997, § 3 No. 66 of the German Income Tax Code (EStG), which also applied for corporate income tax, provided for an explicit tax exemption of restructuring profits. In 1997, this exemption was abolished by a change of law, which resulted in taxation of restructuring profits in several cases. In 2003, the Federal Ministry of Finance issued the restructuring decree (the “Restructuring Decree”), based on the general rules of German tax laws
(i) that taxes may be assessed at a lower amount and individual bases of taxation which increase the tax may be ignored in assessing the tax where the levy of the tax would be inequitable depending on the individual case, and
(ii) that tax authorities may decide to waive tax claims where the collection of the same would be unreasonable given the circumstances.
According to the Restructuring Decree, tax authorities should exempt restructuring profits from taxation in certain circumstances, and the conditions which needed to be met were similar to those of the previously abolished § 3 No. 66 EStG. Also, in case of an existing restructuring plan, these conditions were deemed to be met. The Restructuring Decree has become a reliable basis for many successful restructurings, and nearly all restructuring plans have been made on the basis of a tax relief which was then subsequently granted. Restructuring opinions which have been issued during the last couple of years have regularly contained an assumption along the following lines:
“The restructuring of the company’s financial liabilities will result in an extraordinary income in the amount of EUR XXX due to the (partial) waiver of creditors’ claims. It is assumed that the fiscal authorities will accept a complete tax relief based on the restructuring decree (Sanierungserlass).”
This is now history: on 7 February 2017, the Grand Senate of the Federal Fiscal Court published the “FFC Decision” in which the highest German tax court declared the Restructuring Decree as unlawful because the administration had acted as a legislator violating its obligation to apply the existing law.
The case underlying the FFC Decision was brought before the grand Senate of the Federal Fiscal Court in March 2015, so it was known from that time that the court would decide on this question. However, the matter was brought before the court with a very strong argument that the Restructuring Decree is legal, and the common expectation was that the court would confirm this. So the FCC Decision was unexpected for most restructuring professionals.
The FFC Decision has far-reaching consequences not only for future restructurings, but also raises the question who may rely on the Restructuring Decree for past restructurings. If no binding tax ruling had been obtained and the taxation of a restructuring is not yet binding, tax authorities could now treat the restructuring profits as taxable. Also, binding tax rulings which have been obtained prior to the FFC Decision may be revoked by the fiscal authorities in certain situations due to changed circumstances. While the FFC Decision has clarified that tax authorities can still review individual cases and grant a relief based on the general rules following such review, the specific requirements which a company must show to obtain a relief without the Restructuring Decree as a legal basis is untested ground, and it remains to be seen whether the fiscal authorities are prepared to even consider such relief. At least, it can be expected that tax authorities will review each case individually and thoroughly examine the situation before granting a tax relief, which will add to the uncertainty in many restructuring situations.
The potential additional tax burden resulting for troubled companies in case of restructuring profits is substantial, in particular because such profits can only be applied to any existing tax-loss carried forwards in limited amounts (at least 40% of profits in excess of EUR 1 million will remain subject to tax). In many cases, increased liquidity requirements due to additional tax obligations will not be met, possibly resulting in the failure of restructurings which could have been successful with tax-relief. It can therefore be expected that alternative structures for corporate restructurings, e.g. subordination of claims instead of waivers, will be used in order to try to avoid taxable restructuring profits, at least until a more permanent solution for the taxation problem has been found by the legislator.
Immediately after the court decision was announced, discussions started about changing the law re-implementing the tax privilege for restructuring profits. However, it is uncertain when such new legislation will be enacted. With general elections scheduled for September 2017, the time for the current parliament to pass such law is limited. Also, there are ongoing discussions whether a tax-exemption of restructuring profits could be seen as a hidden subsidy in violation of laws of the European Union. Should the legislator decide to consult with the relevant EU authorities on this point before passing the new law, the process will certainly take until after the general election. Restructurings in Germany will therefore be more difficult in the near future due to the new obstacle of potential taxation of restructuring profits.
