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published on 19 October 2021 | reading time approx. 4 minutes
If companies being the target of an M&A transaction are part of a tax group for income tax purposes, various issues should be examined as part of tax due diligence. These are, on the one hand, oriented toward past events; on the other hand, they concern tax implications of the transaction itself.
A transaction has implications in particular if only the subsidiary participating in the tax group is being acquired. In this context, considered may be, among other things, issues arising from (early) termination of the tax group and the possibility of forming an abbreviated financial year in order to ensure the tax effectiveness of the tax group, if possible, until the shares are transferred to the buyer.
In the case of an acquisition of the head entity of the tax group (the tax group parent) and the subsidiary participating in the tax group, the tax group continues to exist, so that the aforementioned transaction-related issues do not arise, as a rule.
If additionally no loss carryforwards are involved, no transaction-related risks arise at first glance.
Transaction-related risks exist if there are current losses in the case of an acquisition performed during the year at the level of one of the companies of the tax group. This can be the case even if the companies generate a consolidated (intra-year) profit.
This should be illustrated based on an example.
The tax group parent (M-GmbH) holds 100% of the shares in the subsidiary participating in the tax group (T-GmbH). The companies form an effective single entity for income tax purposes. The financial years of the companies correspond to the calendar year.
Effective 30/06/2021, the buyer acquires 100% of the shares in M-GmbH (mere holding company).
The tax situation of the companies on a stand-alone basis (without taking into account the tax group) is as follows:
M-GmbH
T-GmbH
At the date of the share acquisition, M-GmbH reports a current loss of EUR 400 thousand. According to the stance of the tax authorities, an intra-year consolidation of the results of the companies constituting the tax group is not possible (BMF letter dated 28/11/2017, marginal ref. 37). This is attributable to the fact that the right of the tax group parent to the transfer of profits only arises at the end of the financial year of the subsidiary participating in the tax group.
The acquisition of 100% of the shares in M-GmbH constitutes a harmful share acquisition pursuant to Article 8c of the German Corporate Income Tax Act (Körperschafts-teuergesetz, KStG). According to this, existing loss carryforwards and current losses are forfeited if there are no taxable hidden reserves in Germany (the so-called hidden reserves clause).
Hidden reserves exist at the level of M-GmbH only with respect to the shareholding in T-GmbH. However, the hidden reserves arising from the shareholding in T-GmbH should not be included in the calculation of the hidden reserves within the meaning of Article 8c KStG, as in the event of a sale of T-GmbH the capital gain would be tax-free pursuant to Article 8b (2) KStG, and thus the hidden reserves are not taxable in Germany (BMF letter dated 28/11/2017, marginal ref. 52).
In the opinion of the tax authorities also the hidden reserves at the level of T-GmbH should not be taken into account – despite the existence of a tax group – when calculating the hidden reserves within the meaning of Article 8c KStG at the level of M-GmbH (BMF letter dated 28/11/2017, marginal ref. 58).
As a result of the transaction, the current loss of M-GmbH as of 30/06/2021 in the amount of EUR 400 thousand is forfeited. This increases the 2021 taxable income from EUR 2,000 thousand to EUR 2,400 thousand. Assuming a combined tax rate of 30%, the transaction will result in an additional tax burden of EUR 120 thousand.
Since the additional tax burden is caused by the transaction, this additional burden will, in practice, have to be borne in financial terms by the purchaser alone.
Practical problems may arise with regard to the calculation of the current loss until the transfer date if no interim financial statements are prepared. This is because, depending on the branch of industry or seasonality of the business model, a pro rata allocation of the current annual loss may not always be possible.
A method to keep the additional tax burden as low as possible is to change the start/end date of the financial year of the subsidiary participating in the tax group. By forming an abbreviated financial year, an intra-year consolidation can be achieved at the level of the tax group parent prior to the transfer of the companies. However, this requires the seller's cooperation, since prior to the transfer (1) a corresponding application must be filed with the competent tax office and (2) the amendment to the articles of association (in this case – a change in the financial year dates) must be entered in the commercial register before the start of the new financial year. A corresponding provision obliging the seller to cooperate can be incorporated into the company acquisition agreement.
The German Corporate Income Tax Modernization Act (Gesetz zur Modernisierung des Körper-schaftsteuerrechts, KöMoG) has resulted in a change in the treatment of profits and losses allocated as part of tax groups. This may result in the taxation of the investment income due to the transition to the new treatment method.
In the context of tax due diligence, this change in the law gives rise to a further aspect to be examined in the case of transactions in which (1) both the tax group parent and the subsidiary participating in the tax group are the target companies and (2) whose effective date is set before 31/12/2022.
The amendment replaces the previously applicable so-called adjustment item solution with the so-called contribution solution. Due to the change in the taxonomy, existing tax group adjustment items from previous years must be reversed in the financial year ending after 31/12/2021. This means the assessment period 2022.
If there is a tax group adjustment item on the liabilities side as of 31/12/2021, and its value exceeds the sum total of (i) the tax book value of the shareholding in the subsidiary participating in the tax group and (ii) the tax group adjustment item on the assets side (thus, overall, there is a "negative book value" of the shareholding in the subsidiary participating in the tax group), there will be taxable investment income at the level of the tax group parent in the 2022 assessment period.
Depending on the legal form of the tax group parent, it is taxable according to the partial income method or according to Article 8b KStG.
In many cases, the transition will not result in any direct tax burden or, in the case of incorporated companies acting as the tax group parent, this will not have any significant impact due to the application of Article 8b (2) and (3) KStG (95% tax-exempt).
However, if the transition leads to a significant tax burden, for example because the application of Article 8b (2) KStG is excluded (e.g. for financial companies pursuant to Article 8b (7) KStG) or the tax group adjustment item on the liabilities side significantly exceeds the sum total of the tax book value and the adjustment item on the assets side, the question will arise as to whether the tax burden arising from the transition is to be borne – in economic terms – by the seller or the buyer.
Transaction advisory | Mergers & Acquisitions
