Financial integration of a tax-consolidated group member in the case of corporate transformations carried out during the year

published on 18 April 2024 | reading time approx. 3 minutes

In the context of transactions, target companies can be members of tax-consolidated groups formed for income tax purposes. The legal requirements are clear, so certain aspects must be observed in the context of reorganisations or corporate transactions (conducted during the year) within a tax-consolidated group formed for income tax purposes in order to avoid undesirable tax consequences.

In four judgements dated 11 July 2023 relating to various corporate transaction cases, the Federal Fiscal Court (BFH) commented on legal questions regarding the financial integration of a tax-consolidated group member into the tax-consolidated group parent. The decisions of the BFH contradict the strict view of the tax authorities and open up new possibilities in the context of reorganisations of companies that are members of a tax-consolidated group formed for income tax purposes.

Financial integration

One of the key requirements for forming a tax-consolidated group for income tax purposes is the financial integration of the tax-consolidated group member (controlled entity) into the tax-consolidated group parent (controlling entity). Financial integration is deemed to exist if the tax-consolidated group parent directly or indirectly holds the majority of voting rights arising from the shares in the tax-consolidated group member. As a rule, this re-quirement is met if the tax-consolidated group parent holds more than 50% of the shares in the tax-consolidated group member. However, it should be emphasised that the requirement of financial integration is only deemed to be fulfilled if the tax-consolidated group parent already held the majority of voting rights in the tax-consolidated group member on an uninterrupted basis at the beginning of the respective financial year.

If a tax-consolidated group member is acquired during the year, this often means that a new tax-consolidated group relationship for income tax purposes cannot be formed between the acquirer and the acquired group member immediately after the acquisition (unless certain measures are taken), as the acquirer did not yet have a financial interest in the tax-consolidated group member at the beginning of the financial year. If a tax-consolidated group relationship is nevertheless desired in the year of acquisition, this problem is solved in practice by creating an deviating financial year at the level of the tax-consolidated group member.

The BFH (1st Senate) has issued four judgements in which it has commented on the financial integration of a tax-consolidated group member into a tax-consolidated group parent in the event of a reorganisation or contribution carried out during the year. Contrary to the opinion of the tax authorities, it is not mandatory for the merger to have retroactive effect in tax terms from the beginning of the financial year of the tax-consolidated group member in order to continue or form a new tax-consolidated group for income tax purposes in the financial year in which the reorganisation took place.

Merger during the year

Three judgements address the following fundamental issue:

A tax-consolidated group formed for income tax purposes existed between the (previous) tax-consolidated group parent and the tax-consolidated group member.
A new company ((new) tax-consolidated group parent) has acquired the shares in the (previous) tax-consolidated group parent and thus also indirectly in the tax-consolidated group member during the year.
The (previous) tax-consolidated group parent was then merged with the (new) tax-consolidated group parent during the year. In each case, the intention was to form a tax-consolidated group for income tax purposes between the (new) tax-consolidated group parent and the tax-consolidated group member immediately at the effective date of the merger.

The facts of the cases dealt with in the three judgements differ only in that in two cases limited liability companies (GmbH) were merged with each other and in one case a limited liability company (GmbH) was merged with a limited partnership where a limited liability company acted as the general partner (GmbH & Co. KG).

The following diagram illustrates the basic facts of the cases in a simplified manner:

The issue to be clarified in the judgements was whether the requirements for financial integration of the tax-consolidated group member into the (new) tax-consolidated group parent had been met in the year of the reorganisation, although the (new) tax-consolidated group parent did not have a financial interest in the tax-consolidated group member at the beginning of the financial year.

In all three judgements, the BFH decided that the requirements for financial integration of the tax-consolidated group member into the (new) tax-consolidated group parent (the acquiring legal entity) were met, which meant that the tax-consolidated group formed for income tax purposes had to be recognised.

The decisions were based on the so-called "footstep theory", according to which, in the event of a merger, the universal successor under civil law accedes to the legal position of the transferring legal entity. This also applies to financial integration, meaning that it was not detrimental that the financial integration with the (new) tax-consolidated group parent had not yet existed at the beginning of the tax-consolidated group member's financial year.

Thus, based on the “footstep theory”, a financial integration with the transferring legal entity existing from the beginning of the financial year is assumed to exist at the level of the acquiring legal entity as the legal successor.

However, the "footstep theory" is not applicable to transactions in which the shares in the tax group member (controlled entity) are only acquired after the start of the tax group member's financial year. The “footstep theory” is only applicable to a legal position that the transferring legal entity already held.

Swap of shares during the year

In the fourth judgement, a shareholder contributed 100% of shares in B-GmbH to a sister GmbH (A-GmbH) during the year by way of a qualified share swap and, subsequently, a tax-consolidated group for income tax purposes between the two GmbHs was formed, which was to exist from the beginning of the financial year. A-GmbH is the tax-consolidated group parent and B-GmbH the tax-consolidated group member.

The following diagram illustrates the facts of the cases in a simplified manner:

Conclusion
The four judgements of the BFH, which confirm that the requirement of financial integration of the tax-consolidated group member into the tax-consolidated group parent is met in the case of corporate transformations carried out during the year, create further legal certainty. Overall, it can be summarised that the statutory provisions on tax-consolidated groups are complemented by the corporate transformation tax provisions. The corporate transformation tax provisions regarding succession may not be ignored in this context.

The resulting structuring options can be taken into account in tax structuring advice. However, particular attention should be paid to the direction of the merger in order to take into account other transaction-related aspects such as real estate transfer tax, loss of tax attributes, etc.