Legal succession with restrictions in share for share exchanges (Sect. 21 of the Reorg Tax Act)

Legal succession in the case of reorgs

Sect. 45(1) of the General Tax Act regulates universal succession with regard to claims and liabilities arising from tax obligations. Sect. 4(2) of the Reorg Tax Act (with references in Sect. 12(3) second half-sentence of the Reorg Tax Act and Sect. 23(1) of the Reorg Tax Act) also stipulates comprehensive legal succession in the case of reorgs. The acquiring legal entity in a reorg under the of the Reorg Tax Act "thereafter assumes the tax status of the transferring entity, in particular with regard to the valuation of the acquired assets, depreciation allowances, and reserves reducing taxable profits". The provision thus stipulates that, regardless of the valuation method chosen under Sect. 3 of the Reorg Tax Act, the "characteristics" of assets and other legal positions are "transferred" from the transferring entity to the acquiring entity. 

However, this principle is restricted in cases where the "transfer" of characteristics is undesirable from a fiscal perspective. On the one hand, the legislature does not allow the transfer of losses or loss-like "positions" in sentence 2 of Sect. 4(2) of the Reorg Tax Act. This applies not only to losses for corporate income tax purposes, but also to trade tax losses pursuant to Sect. 18(1) sent. 2 of the Reorg Tax Act. This means that, contrary to the state of the law in the past, the transfer of losses in the case of restructuring is now exceedingly rare (for the transfer of trade tax losses under Sect. 10a of the Trade Tax Act in the case of a spin-off from a corporation to a partnership, see Judgment of the Federal Tax Court dated February 1, 2024, file number IV R 26/21, Federal Tax Gazette II 2025, p. 51).

In addition, Sect. 4(2) sent. 3 of the Reorg Tax Act means that the period during which the asset belonged to the business assets of the transferring entity must be credited to the acquiring entity. An example of this would be the "holding period" for non-current assets of six years for the purposes of Sect. 6b(4) sent. 1 no. 2 of the Income Tax Act (Circular of the Federal Ministry of Finance dated January 2, 2025, Federal Tax Gazette 2025, p. 92, margin no. 04.15).

Special aspects in case of share for share exchanges 

In the case of a "share for share exchange" pursuant to Sect. 21 of the Reorg Tax Act, in which shares in a corporation are transferred to another corporation in exchange for newly issued shares in the acquiring company, the question of legal succession also arises. Sect. 23(1) of the Reorg Tax Act refers, in the event that the acquiring company values the contributed business assets at a value below the fair market value (Sect. 20(2) sent. 2 of the Reorg Tax Act, Sect. 21(1) sent. 2 of the Reorg Tax Act), to the corresponding application of, among other things, Sect. 4(2) sent. 3 of the Reorg Tax Act.

Only certain "characteristics" of the contributed shares in the corporation are relevant in this context. The "holding period" for the purposes of Sect. 6b of the Income Tax Act is irrelevant, for example, because Sect. 6b(10) of the Income Tax Act excludes corporations from its scope anyway. However, the question arises as to how Sect. 4(2) sent. 3 of the Reorg Tax Act affects the trade tax assessment basis. Trade tax is also covered by the scope of the Reorg Tax Act (Sect. 18, 19 of the Reorg Tax Act), so that the question arises on the merits.

The tax authorities take the view that a "period of ownership credit" for the purposes of the deductions of Sect. 9 no. 2a, 7 of the Trade Tax Act for dividends and hidden profit distributions is not applicable (Circular of the Federal Ministry of Finance dated January 2, 2025, Federal Tax Gazette 2025, p. 92, margin no. 23.06 in conjunction with margin no. 04.15). Since the share for share exchange under Sect. 21 of the Reorg Tax Act does not allow retroactive application (Circular of the Federal Ministry of Finance dated January 2, 2025, Federal Tax Gazette 2025, p. 92, margin no. 21.17), the question often arises in the year of the share for share exchange as to whether a distribution by the acquiring company is exempt from trade tax: Is the date of the "beginning of the assessment period" (“Erhebungszeitraum”) within the meaning of Sect. 9 No. 2a, 7 of the Trade Tax Act transferred by virtue of Sect. 4(2) sent. 3 of the Reorg Tax Act?

The Federal Fiscal Court has consistently ruled (Judgment of the Federal Tax Court dated April 16, 2014, file number I R 44/13, Federal Tax Gazette II 2015, p. 303): No! Contrary to the decision of the lower court (Judgment of the Tax Court of Düsseldorf of November 24, 2022, file number 14 K 392/22), the Federal Tax Court has reaffirmed this principle in its most recent ruling (file number I R 9/23): The wording of Sect. 4(2) sent. 3 of the Reorg Tax Act is "unambiguous" in this respect, as it only covers a period of time, but not a specific point in time. There can be no "broad interpretation."

Problems and solutions regarding the case law of the Federal Fiscal Court 

The problem posed by the judgments with the file numbers I R 44/13 and I R 9/23 arises increasingly in the case of share for share exchanges under Sect. 21 of the Reorg Tax Act, even though Sect. 4(2) sent. 3 of the Reorg Tax Act is also applicable in other cases of reorgs. A distribution by the company whose shares are transferred in the share for share exchange after the date of transfer of beneficial ownership of the transferred shares, but before the end of the assessment period of the acquiring corporation, is critical in this regard. Open distributions can be deliberately controlled. In the case of hidden profit distributions, which also fall under Sect. 9 No. 2a, 7 of the Trade Tax Act (Sect. 9.5 sent. 3 of the Trade Tax Guidelines), control becomes particularly difficult in the case of "formal hidden profit distributions" (Sect. 8.5(2) of the Corporate Tax Guidelines), i.e., those that arise from a violation of the "prohibition of retroactivity" in the case of controlling shareholders. Since a tax-neutral share for share exchange in any case requires a majority of voting rights in the acquiring corporation after completion (Sect. 21(1) sent. 2 No. 1 of the Reorg Tax Act), this problem will typically arise. The fiction of distributions under Sect. 14(3) sent. 1 of the Corporate Income Tax Act (in cases of a German fiscal unity) also represents a hazard here.

However, there are instruments for controlling the assessment period (“Erhebungszeitraum”) of the acquiring company. The "beginning of the assessment period" does not necessarily coincide with the calendar year (Sect. 14 sent. 2 of the Trade Tax Act). Rather, it can also take the form of an abbreviated assessment period if the actual trade tax liability (Sect. 2(2) sent. 1 of the Trade Tax Act) only begins after the start of the calendar year (Sect. 14 sent. 3 of the Trade Tax Act).