The German Federal Constitutional Court has decided that part of the German change of control rules (GCCRs) are not consistent with the egalitarian principle and therefore are unconstitutional (BVerfG, decision dated March 29, 2017, 2 BvL 6/11, published on May 12, 2017). The legislature has been asked to amend the GCCR with retroactive effect from the date the GCCRs came into force, and to do so before December 31, 2018. If the legislature fails to meet this deadline, these rules will be null and void as of the date they came into force.
In view of this development, all tax assessments increased by a forfeiture of tax loss carry forwards (TLCFs) or interest carry forwards (ICFs) under the GCCRs for years 2008 to 2016 may be reopened. Companies whose TLCFs and ICFs have been assessed to be partially or fully lost in prior years may wish to investigate whether those can be reinstated.
Background on the German change of control rules
The relevant GCCRs were introduced in 2007 and came into force beginning on January 1, 2008. Under these rules, corporations subject to German corporate income tax lose their TLCFs and ICFs if such corporations undergo a direct or indirect change in ownership of more than 50 percent of their shares or voting rights within a period of five years. A pro-rata forfeiture of TLCFs and ICFs applies if more than 25 percent but not more than 50 percent are transferred to new shareholders under the same conditions.
Between 2009 and 2015, exceptions were added to these basic rules for (i) intragroup restructurings or (ii) to the extent a transferred entity has built-in gains subject to German taxation. Transactions taking place after January 1, 2016 may benefit from a new provision intended to provide further relief for startup companies (under a very strict set of conditions for a certain period prior to and after the transaction).
Decision of the GFCC
The current decision of the Court relates to a case in which a pro-rata forfeiture (48 percent) of TLCFs was assessed by the German tax authorities under the GCCRs. The Court decided that the underlying concept established by the basic rules of the GCCRs constituted a violation of the prohibition of arbitrariness when more than 25 percent but not more than 50 percent of the shares and/or voting rights in a corporation are transferred. The Court further noted that this violation was not rectified by the exceptions added for intragroup transactions or instances in which sufficient taxable built-in gains were available. The GCCRs are therefore not consistent with the egalitarian principal; hence, they are unconstitutional. The egalitarian principle requires the legislature to treat equal things equally and unequal things unequally. In the context of taxes, this results in the obligation to tax all taxpayers pursuant to their economic capacity.
As a consequence, the Court set a deadline of December 31, 2018 for the legislature to amend the GCCR retroactively. If the required changes are not made by the deadline, the GCCRs will be null and void with retroactive effect from January 1, 2008.
The German legislature is expected to amend the GCCRs by the deadline set by the Court. It remains to be seen whether the legislature will only adjust the rules for pro-rata forfeitures of TLCFs and ICFs (as targeted by the above decision) or whether it will also address the rules governing full forfeitures of TLCFs and ICFs.
The German Federal Constitutional Court did not comment on the following issues:
- Whether the complete forfeiture of losses in case of ownership changes of more than 50 percent complies with the constitutional principles and
- Whether the new provision for startup companies amended the GCCRs in a way that makes the GCCRs compliant with the constitutional rule of equal taxation.
Nonetheless, the reasons set forth by the Court may be seen as a strong indicator that these rules may also be unconstitutional.
Most notably, however, in the wake of the Court's decision, all tax assessments comprising a forfeiture of TLCFs or ICFs under the GCCRs for years 2008 to 2016 will no longer be final and binding. This creates opportunities for taxpayers to reassess TLCFs and ICFs that have been partially or fully lost in prior years.
Against this backdrop, companies should also discuss with their auditors whether the reacquired TLCFs or ICFs will result in an increase in their deferred tax assets for financial reporting purposes.
Learn more about this opinion by contacting either of the authors.