In December 2016 the German Bundestag and the German Bundesrat have approved the new Sec. 8 d CITA (German Corporate Income Tax Act) according to which the present restrictions for the use of tax loss carryforwards have been substantially improved. The primary goal for the new Sec. 8d CITA is certainly to protect young innovative enterprises from the negative consequences of the often necessary change of shareholders.
Up until now the German corporations’ tax loss carryforwards have generally been forfeited if a new shareholder acquired more than 25 % of its shares. This forfeiture is based on Sec. 8c CITA. The new Sec. 8d CITA enables corporations to actively rule out the application of Sec. 8c CITA and thus to preserve their loss carryforwards.
The old Sec. 8c CITA mandates the proportionate forfeiture of loss carryforwards in the event of a direct or indirect transfer of shares of between 25 % and 50 %. Tax loss carryforwards are completely forfeited if more than 50 % of the shares are transferred. Currently, there are only two exceptions. One exception relates to intra- group share transfers. The second exception refers to cases where there are sufficient hidden reserves. These exceptions hardly apply to startups, which are often dependant on the joining of new shareholders and the need of new equity investors. The new Sec. 8 d CITA may prove useful to these startups in order not to be threatened by a forfeiture of tax loss carryforwards if new investors join.
Under der newly introduced provision tax losses are entirely deductible at the taxpayer’s election if specified conditions are met. In order to qualify the company must have carried on the same business for at least three years or since the corporation’s foundation before the harmful share transfer occurs. The term “business” means the company’s entire business activity and is defined by qualitative characteristics such as the corporation’s products and services, its customers and suppliers’ base, its markets and the qualification of its employees. Sec. 8d CITA also lists some harmful events, which in case of their occurrence, lead to the presumption of a change of business model. Thus, the corporation should not add another business, should not change the business purpose, must not participate in a partnership and must not receive assets below the fair market value in order not to be presumed to have changed the business model.
If the requirements are met, the taxpayer may elect that the tax losses are not forfeited upon the change of shareholders. The requirement for the continuation of an unaltered business model bears potential for conflicts in tax audits and tax law disputes.
The new Sec. 8d CITA applies retroactively with effect from January 1, 2016. This means that even the forfeiture of tax loss carryforwards based on substantial shareholder changes in 2016 can still be prevented, provided that all the requirements listed above are fulfilled. Detrimental is that in case the requirements are not fulfilled or will not be met in the future, the tax loss carryforwards are completely and finally forfeited, in contrast to the present Sec. 8c CITA, which provides for a proportionally forfeiture, if only 25 % to 50 % of shares are transferred.
Whereas the opting for Sec. 8 d CITA seems to be clear if more than 50 % of the shares are transferred, the transfer of shares between 25 % and 50 % call for an in-depth analysis, whether the requirements are met and will be met before opting under Sec. 8d CITA.
In Summary one can state that the new Sec. 8 d CITA is beneficial. New innovative start-ups, which are often in need of new equity investors could take advantage of this provision. The implementation of the provision, however bears the risk of potential conflicts especially in light of the definition and the requirement of “unaltered business model”.