Until the end of 2004, the so-called trust model (Treuhandmodell) was a structuring tool widely used in reorganisations and leveraged transactions in Germany. The model provided for the possibility to achieve consolidation for trade tax as well as corporate income tax purposes. The reasoning behind the implementation of the model was that, among other things, consolidation could be achieved without the need to meet the same conditions other tax consolidation tools require to be met. In addition, the trust model could be used to implement certain reorganisation schemes in a tax-neutral manner irrespective of the rules of the German Income Tax Act (Einkommensteuergesetz) and the German Reorganisation Tax Act (Umwandlungssteuergesetz). At last, in a transactional context, tax-efficient debt push-down and recapitalization measures could be implemented under the trust model.
Typically, the trust model was based on this structure: assets were transferred to a newly established company in the legal form of a German limited liability partnership (GmbH & Co. KG/NewCo) with its general partner being the transferring company. The only limited partnership interest (with a minimum participation in NewCo only) was held by a wholly owned corporate subsidiary of the transferring company. In fact, the subsidiary held the partnership interest on trust for its parent. Problems arose if NewCo was not a newly established, but an already existing limited liability partnership in which the limited partner did not hold the interest on trust before entering into the trust agreement with its parent. To avoid disclosure of hidden reserves for tax purposes in that case, either the rules of the Reorganisation Tax Act or the principles on accretion (Anwachsung) were applied.
Diagram 1: Trust model structure
While under this structure, NewCo was recognised as a separate partnership from a civil law perspective, it was, according to the prevailing view in German tax literature, ignored for tax purposes. Rather, NewCo was deemed a permanent establishment (Betriebsstätte) of its parent for tax purposes. From a tax perspective, the transfer of the assets was viewed as not existent. Hence, the transfer did not have any trade tax or corporate income tax implications. However, a step-up for GAAP purposes could be implemented by a transfer of assets from the general partner to the limited liability partnership while hidden reserves were disclosed in the GAAP balance sheet only, resulting in a higher equity of the general partner.
The treatment by the tax authorities
While the tax authorities had initially shared this view, they changed their mind at the end of 2004 and shut down the trust model. A decree from the Superior Tax Office of Münster on March 16 2005 said that the partnership to which the assets are transferred shall henceforward qualify as a separate trade or business unit within the meaning of the Trade Tax Act (Gewerbesteuergesetz). To determine the relevant trade tax base, the decree requires the taxpayer to set up a separate balance sheet for trade tax purposes, that is, a separate profit determination for trade tax purposes on the one hand and for income tax purposes on the other hand is required. This not only prevents a taxation on a consolidated basis, but entails various further questions which are open and unsolved. At least the decree denies the question as to a potential disclosure of hidden reserves as a result of the asset transfer for trade tax purposes. Nevertheless, in practice, from 2004/2005 onwards, the trust model could only be used in exceptional cases and based on a respective binding ruling (verbindliche Auskunft) by the tax authorities. With the latter, the tax treatment of a transaction can generally be clarified with the German tax authorities upfront if certain conditions are met.
The Federal Fiscal Court Ruling
In its decision (in German) dated February 3 2010 (IV R 26/07), the Federal Fiscal Court overruled this view of the tax authorities. The court explained in detail why it deemed the view of the tax authorities unlawful. In particular, it held that there are no legal grounds for the requirement of a separate profit determination for trade tax purposes based on a balance sheet set up for trade tax purposes only. Furthermore, the court opposed the view that said the rules on the fiscal unity for trade tax purposes are the only way to achieve consolidated results for (trade) tax purposes. And the court added that the systematic inconsistencies that would otherwise arise prevent such exclusiveness of the fiscal unity for trade tax purposes.
On this basis, the Federal Fiscal Court argued that the assets and liabilities of the partnership are attributable to the trustor under the trust model. Thus, they have to be taken into consideration when determining the profits at the level of the trustor. Consequently, the partnership is ignored for income tax purposes as well as for trade tax purposes.
New (old) structuring tools?
By its ruling, the Federal Fiscal Court restores the legal situation as it was widely accepted before late 2004 when the tax authorities changed their mind. In doing so, the court provides for a renewed possibility to use the trust model as an interesting structuring tool.
This is particularly true in a transactional context. While, among other things, the German Reorganisation Tax Act provides for a variety of structuring instruments, the tax neutrality is often subject to tight requirements, for example, qualification as (partial) business unit ((Teil)-Betrieb). Furthermore, in many cases, negative real estate transfer tax implications, which may arise if one of the real estate transfer tax exemptions does not apply, as well as corporate law restrictions have to be taken into account. Hence, after the decree of the Superior Tax Office of Münster, the tax-neutral structuring of step-up models for the purposes of the implementation of debt push-down and recapitalisation measures is subject to the restrictive conditions mentioned before. Therefore, the trust model provides for an enormous relief for certain types of structures.
However, it has to be taken into account that the trust model entails certain issues which will still be relevant (although under different circumstances). This holds true, for example, for the GAAP treatment of the trust model. A viable option to achieve a step-up in basis upon the transfer of the assets only exists if the hidden reserves are disclosed for purposes of the GAAP balance sheet of the transferring company. In this respect, close cooperation with the company's auditors will be necessary. Additionally, the new accounting rules of the Accounting Law Modernisation Act (Bilanzrechtsmodernisierungsgesetz) which have only recently come into effect will be particularly relevant. The latter introduced a new concept for the accounting treatment of deferred taxes according to which deferred taxes will typically decrease the step-up capacity.
In addition to these aspects, the taxation on a consolidated basis resulting from the trust model provides for an alternative to the implementation of a fiscal unity (Organschaft). The implementation of a fiscal unity is subject to certain requirements so, under certain circumstances, may not offer the necessary flexibility. In particular, in contrast to a fiscal unity, the trust model can be designed in a way allowing for termination of the trust agreement by the parties at any time. Furthermore, while in terms of the result for tax purposes the trust model is comparable to the implementation of a fiscal unity, an affiliated group is barred from implementing a fiscal unity if the subsidiary (Organgesellschaft) is a partnership.
At last, the trust model can be used as a tool to avoid the application of the German interest barrier rule (Zinsschranke). While the latter only applies to business units which are part of an affiliated group, a limited liability partnership should not be considered a business unit for that purpose as long as the trust structure mentioned before is complied with. In that case, application of the interest barrier rule is limited to the general partner if the general partner is part of an affiliated group for purposes of the interest barrier rule.
However, there is one minor flaw: So far, the tax authorities have made no statement about whether they will follow the ruling of the Federal Fiscal Court. In light of the detailed reasons of the ruling it seems to be doubtful whether the tax authorities will react by issuing a decree stating that the ruling will not be applied beyond the ruled case (Nichtanwendungserlass). In that case, the structuring tools mentioned earlier could be invalidated in practice. In the past, the tax authorities were not hesitant to go down that route although the grand coalition agreed to reduce such practice. In addition, it should be mentioned that in the past the legislature often abolished disagreeable rulings of the Federal Fiscal Court by amending the law in a clarifying (sic!) manner. Therefore, for the time being trust models should only be implemented on the basis of a binding ruling of the competent tax office. However, hope remains that the tax authorities will eventually follow the ruling of the Federal Fiscal Court. This would indeed offer new opportunities for reorganisations and leveraged transactions.
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