Germany: Federal Constitutional Court finds change-in-ownership rules partially unconstitutional
Germany's Federal Constitutional Court has ruled that the German change-in-ownership rules relating to loss carryforwards partially infringe the constitution, and must be amended with retroactive effect.
Under the change-in-ownership rules that have applied from 2008, a direct or an indirect transfer of more than 25% (and up to 50%) of the shares of a company that has loss carryforwards results in a pro rata forfeiture of the tax loss and interest carryforwards; and a transfer of more than 50% of the shares results in a complete forfeiture of all available carryforwards. There are three exceptions to the loss forfeiture rules: the intragroup restructuring exception and the built-in-gains exception (which have applied since 2010), and the business continuation exception (introduced in 2016).
The case before the court involved a direct transfer of between 25% and 50% of a company's shares in a year where no exception applied, so the transfer resulted in a partial forfeiture of the taxpayer's tax loss carryforwards. The court concluded that the rules violate the constitutional principle that companies should be taxed on their financial performance. The legislative intent to prevent loss trafficking by using 'empty loss companies' may be an acceptable justification for an exception to this principle, but a partial forfeiture of loss carryforwards where there is a change in shareholders of between 25% and 50% is considered too broad and cannot be used to deem the taxpayer's behavior to be abusive. The court also clarified that the introduction of the intragroup restructuring and the built-in-gains exceptions to the change-in-ownership rules do not affect its analysis. However, the business continuation exception introduced from January 1 2016 potentially could change the analysis because, under this exception, the taxpayer may be permitted to demonstrate the lack of any abusive intent for the share transfer. The court, therefore, limited the scope of its decision to the period January 1 2008 through to December 31 2015.
The court did not opine on the constitutionality of the rule resulting in a full forfeiture of loss carryforwards following a transfer of more than 50% of the shares, so this decision will not affect those transfers. However, it should be noted that another case involving transfers of more than 50% is pending before the federal tax court.
The Constitutional Court has asked the German legislature to draft and implement an amended change-in-ownership rule that is in line with constitutional principles by December 31 2018, and that would apply retroactively from January 1 2008 through to December 31 2015. If the rules are not amended within this timeframe, the change-in-ownership rules for ownership transfers of between 25% and 50% of the shares in a company automatically will become void on January 1 2019 for the 2008-2015 period.
Taxpayers should ensure that tax assessment notices for the 2008-15 period that are not considered preliminary pending a decision of the Constitutional Court, should be kept open to be able to benefit from the court's decision.
Alexander Linn (firstname.lastname@example.org)
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