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Legal Update

Restructuring Privilege for the Use of Tax Loss Carry Forwards for Corporations Incompatible with EU Law

2 February 2011
Mayer Brown Legal Update
The EU Decision

The EU Commission has held on January 26, 2011 that the so called restructuring privilege offered by German corporate tax law, which allows corporations in a distressed financial situation to continue to set off tax loss carry forwards against future profits even if their shareholder structure has substantially changed, is incompatible with EU State Aid provisions.

The recipients, which have applied the restructuring privilege, are now threatened with the reclaim of the tax benefits.

The Forfeiture of Tax Loss Carry Forwards in Case of the Change of Shareholders

Pursuant to Section 8c KStG (the German corporate income tax act) tax loss carry forwards of a company are lost on a pro rata basis when more than 25 percent, but not more than 50 percent, of the shares in a corporation are transferred to a purchaser within five years. A transfer of more than 50 percent leads to the complete forfeiture of losses carry forwards.

The Restructuring Privilege

The provision of Section 8c KStG has proven to be an obstacle for corporations looking for investors during the crisis. To address this, during the financial crisis, the restructuring privilege according to Section 8c (1a) KStG was introduced with retroactive effect as of January 1, 2008. The clause stipulated that tax loss carry forwards are not lost in restructuring cases.

“Restructuring” meant a measure aimed at avoiding or remedying the illiquidity or over-indebtedness of a company. Simultaneously, the essential business structures had to be preserved, which could, inter alia, be achieved by maintaining the sum of the yearly aggregate wages of the business within a period of five years above a certain percentage of the initial yearly aggregate wages amount.

The EU State Aid Procedure

The formal proceeding regarding Section 8c (1a) KStG was opened by the EU on February 24, 2010 (C 7/2010). Following this, the German tax authorities tentatively ceased to apply the restructuring privilege (BMF of April 30, 2010, Federal Tax Gazette 2010 I, p. 488). We had reported on this in our Legal Update of May 10, 2010. The EU Commission has now held that the privilege distorts competition and that it is not in accordance with the state aid provisions.

Further Steps

Germany now has a period of two months to present to the EU Commission a list of the beneficiaries and to inform the EU Commission on the total amount of the reclaims of the state aid. The restructuring privilege had been used actively. Pursuant to estimates the privilege caused annual tax deficits of approximately 900 million Euro.

The Federal Ministry of Finance at first intends to wait for the reasoning of the decision. Then it shall be decided whether Germany will challenge the decision of the Commission before the European Court of Justice (ECJ).

If you would like to obtain more information about the foregoing, please contact the authors of this Legal Update (Tax) at +49 69 7941 1591 or (Corporate) at +49 69 7941 2731.

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