Applications related to exchanges of shares under section 21 of the German Reorganisation Tax Act

Exchanges of shares under section 21 of the Reorganisation Tax Act  

In many respects, the exchange of shares under section 21 of the Reorganisation Tax Act represents a special case within the Act. It is the only provision in which retroactive effect, which is otherwise so prominent (sections 2, 20(5) and 6), is specifically excluded. It is also one of the provisions within the Reorganisation Tax Act that permits individual legal succession within its scope (section 1(3) no. 5; Federal Finance Ministry Circular on the application of the Reorganisation Tax Act of 2 Jan 2025, Federal Tax Gazette [Bundessteuerblatt] I 2025, p. 92, para. 01.46 (bb). As a further exception, private assets for tax purposes in the form of shares under section 17 of the Income Tax Act may also be included here, whereas shares under section 20(2) of the Income Tax Act – i.e. outside the scope of the Reorganisation Tax Act – are to be treated in accordance with section 20(4a) of the Income Tax Act (Federal Finance Ministry Circular on the application of the Reorganisation Tax Act of 2 Jan 2025, para. 21.02).

As the name suggests, an exchange of shares constitutes in principle an exchange transaction that under general income tax law would have to be valued at fair market value (section 6(6) sentence 1 of the Income Tax Act; section 21(1) sentence 1 of the Reorganisation Tax Act). As a special provision, section 21(1) sentence 2 permits a lower valuation if the acquiring company applies for this (Federal Fiscal Court judgement of 15 Jun 2016, file ref. I R 69/15). This requires a “qualified exchange of shares” (section 21(1) sentence 2 no. 1) as well as the circumstance that any “other consideration” (in addition to the newly issued shares) remains below the statutory limits (section 21(1) sentence 2 no. 2). This application for a lower valuation under section 21(1) sentence 2 is made by the acquiring company (section 21(1) sentence 3 in conjunction with section 20(2) sentence 3) – in stark contrast to the sections of the Reorganisation Tax Act governing mergers (sections 3-19).

In turn, section 21(2) sentence 1 generally attributes the consequences of any errors in making the application to the transferring party by way of “substantive legal binding”. From a procedural law perspective, this therefore necessitates a “challenge by a third party” of the acquiring company’s corporate income tax assessment (Federal Fiscal Court judgement of 25 Apr 2012, file ref. I R 2/11).

Cross-border aspects of exchanges of shares

Furthermore, section 21 is a particularly “liberal” provision with regard to personal requirements: section 1(4) sentence 1 no. 1 merely requires that the acquiring company be resident in the EU/EEA and that it has been incorporated under the laws of an EU/EEA jurisdiction. By contrast, there are no requirements whatever for the transferring company (Federal Finance Ministry Circular on the application of the Reorganisation Tax Act of 2 Jan 2025, Federal Tax Gazette I 2025, p. 92, para. 21.03) or the “acquired company” (in the language of section 21(1) sentence 1 of the Reorganisation Tax Act; Federal Finance Ministry Circular on the application of the Reorganisation Tax Act of 2 Jan 2025, Federal Tax Gazette I 2025, p. 92, para. 21.05). 

This gives effect to the Federal Fiscal Court’s basic pronouncement, according to which “the Reorganisation Tax Act is on the whole aimed at facilitating the economically viable restructuring of companies and granting a tax deferral for the condition on realisation having occurred according to general income tax principles. However, this relief is subject to the proviso that it is not linked to a definitive waiver of taxation” (Federal Fiscal Court judgement of 30 May 2018, file ref. I R 31/16, Federal Tax Gazette II 2019, p. 136, para. 26).

The loss or impairment of the German right to tax [“Entstrickung”] referred to in this context is in the case of an exchange of shares subject to very specific statutory provisions. It is not mentioned at all in subsection 1 of section 21, whereas subsection 2 refers to it all the more. Section 21(2) sentence 2 provides for a deviation from the general binding nature of section 21(2) sentence 1 if, following the contribution, German tax law excludes or limits the taxation of gains from the sale of the contributed or received shares. Due to the German double taxation treaties, which are mostly based on Art. 13(5) of the OECD Model Tax Convention 2025, this situation frequently arises. According to the second sentence, this results in the contributor using the fair market value as the basis for valuation, in deviation from the valuation method under section 21(1) sentence 2 applied by the acquiring company. 

At this point, however, section 21(2) sentence 3 introduces a further requirement: if sentence 2 of section 21(2) requires a valuation at fair market value, sentence 3 may ensure a lower valuation in the case of a qualified exchange of shares if German tax law does not exclude or limit taxation of the gains from the sale of the shares received. The procedural law governing this is set forth, among other things, in section 21(2) sentence 4, according to which this must be applied for not by the acquiring company, but by the contributor, and no later than when they first file their tax return with the tax office responsible for their taxation.

Federal Fiscal Court rules for the first time on the procedural law governing applications under section 21(2) sentences 3 and 4 of the Reorganisation Tax Act

The question of when and, above all in what form – including implicitly – applications under section 21(2) sentence 3 of the Reorganisation Tax Act are to be made has now been addressed by the Federal Fiscal Court in its ruling with file ref. X R 32/23. In the case of a qualified exchange of shares with a European acquiring company, German taxation of the contributed shares will generally be excluded by the DTTs in place with all EU member states (Art. 13(5) OECD Model Tax Convention 2025; in the case at hand, the DTT with Spain 2011). However, in the case of a contributor subject to resident tax liability, the shares received will be subject to tax – as they were in the case before the Federal Fiscal Court.  

Nevertheless, in addition to these substantive legal requirements, the application must be made correctly under procedural law – with the correct applicant and at the correct time – an issue that the legislature was also recently occupied with (sections 3(2a) and 13(2) sentence 2). According to section 21(2) sentence 4, it must be submitted “no later than when the first tax return is filed with the tax office responsible for the taxpayer’s taxation”. 

Like the lower tax court, the tenth chamber of the Federal Fiscal Court was unable to find such an application. Terms such as “tax return” and the “filing” of it must be precisely clarified here (para. 38 and following). In particular, the share purchase agreement (SPA) at issue in the case could not be considered as such (para. 48 and following). 

In advisory situations, this means that, in addition to the substantive legal situation, the procedural aspects of implementation have once again come to the fore. Private law contracts have no direct relevance to the legal relationship between the taxpayer and the tax authority. This may be different, however, if documents are transmitted to the tax authority by a notary (Federal Fiscal Court judgement of 10 Jul 2024, file ref. IV R 8/22).