The globalisation of the German Reorganisation Tax Act through the Corporate Modernisation Act

Many countries have their own versions of tax-free or tax-neutral reorganisations. We are seeing instances where such domestic legislation now is subject to amendment with some added or bonus enhancements to these laws.  What follows below are some recent changes to the German restructuring tax code provisions.  We aim to continue to highlight more countries as they become unveiled and topical.

According to the German Reorganization Tax Act (RTA), restructurings can be carried out in a tax-neutral manner if certain conditions are met. The application of the RTA for the transformation of corporations is currently limited to domestic companies and companies from the EU/EEA states.

The law is now to be globalised for certain transformations of corporations. This is justified by the fact that globally active companies with a subsidiary outside the EU/EEA for which other restructuring measures not previously covered by the RTA are also necessary and relevant. The Corporate Modernisation Act (CMA) was adopted on 30 June 2021.

Current legal situation

Within the personal and material scope of the RTA, it is intended to facilitate the “economically sensible restructuring of companies and guarantee a tax deferral according to general principles of income tax principles”.

The basic requirements for the applicability of the RTA are both material (type of restructuring) and personal (a requirement for the legal entities involved). If only one of the requirements is not met, the RTA does not apply.

The material scope applies to transformations and generally refers to the types of transformation regulated by the Reorganisation Act (RA), i.e. merger, split-up, split-offs, transfer of assets, and change of legal form.

As a result of the Europeanisation of the RTA, the personal scope has been extended to companies that have been established under the law of an EU/EEA member state and whose registered office and place of management is located within EU/EEA. Thus, these states are treated as domestic legal entities.

The globalisation of the German Transformation Tax Act – Planned changes through the CMA

The CMA is intended to partially extend the personal scope of the RTA to cases involving third countries. This applies to conversions involving corporations as the transferring legal entity.

Thereby, § 1 para. 2 RTA will be removed without replacement. The personal applicability of the RTA would thus be extended to companies as well as to natural persons – as acquiring legal entities – with residency in a third country. In this respect, the legal situation would be comparable to that of contributions to partnerships of § 24 RTA. It does not exist any restrictions on the personal applicability for such cases.

In deviation from the previous regulations, the following cases will therefore be possible under the RTA:

• Mergers as well as splits and spin-offs of corporations to partnerships and individuals/natural persons,
• change of legal form of a corporation to a partnership,
• mergers as well as splits and spin-offs of corporations to other corporations.

The extensions will apply for the first time to conversions and contributions for which the taxable transfer date is after 31 December 2021.

However, the “comparability” of the previously mentioned conversions with the respective domestic conversion is still a strict prerequisite for the applicability of the RTA, since § 1 para. 1 RTA is not intended to be changed by the CMA. Comparability is given if the following conditions are met:

• the transfer of all assets and liabilities of one or more legal entities to the acquiring legal entity;
• the extinction of the transferring legal entity without liquidation;
• the granting of shares in the acquiring or new legal entity to the shareholders of the transferring legal entity.

Furthermore, German taxation rights may not be restricted or excluded.

In addition to the possibility of a merger or mergers with a third country connection, which have already been possible tax-neutral and which are now integrated into the RTA, the law will in future also allow spin-offs or splits of third-country companies as well as changes of legal forms. However, even for corporations, no complete opening of the RTA is envisaged, since the contribution of business or part of a business and interest in a partnership and also a share swap remains unaffected in terms of content.

No improvement for cross-border third country conversions with domestic reference

If a domestic corporation is directly involved in a cross-border transformation with a third country company in such a way that it is either transferring or acquiring the legal entity, the proposed globalisation of the RTA should not result in any changes compared to current law. This possible result is due to § 1 para. 1 RTA. It limits the material scope for the second to the fifth parts of the RTA in principle to those transformation transactions that are conclusively regulated in the RA.

Example 1

H-GmbH (private limited company) domiciled in Germany, is to be merged into X-Ltd. or Y-LLP, which is domiciled in a third country (from a German point of view a partnership) on a cross-border basis.

Example 2

X-Ltd. domiciled in a third country is to spin-off a part of its business to its sister company domiciled in Germany, Z-GmbH, on a cross-border basis, or, conversely, Z-GmbH is to spin-off a part of its business to X-Ltd.

In the current law, the material scope of the RTA only applies if there is a merger, a spin-off, or comparable foreign transactions. In the cross-border context, the RA currently only provides regulations for cross-border mergers for EU/EEA companies. A cross-border outward merger into a third country corporation or partnership – as in example 1 – is therefore not possible under company law due to the current legal situation. This also applies to the reverse case of a cross-border merger into a company.

For cross-border spin-offs, the RA currently lacks any corporate law regulations, so that in example 2 a cross-border spin-off or spin-off from or to a foreign third country corporation is also not possible under civil law.

The current limitation and the planned extension of the territorial scope of application by deleting are irrelevant as a result since the material scope of the RTA in third-country cases is usually not given. Under current law, the territorial blocking of third-country cases in § 1 para. 2 RTA has no effect. Consequently, the proposed deletion of the provision – without a simultaneous change in § 1 para. 1 RTA or the company law provisions in the RA – for cross-border conversion from or to third-country companies has no effect.

Significant improvement for foreign conversions with a domestic connection

The planned globalisation of the RTA will, on the one hand, eliminate issues that have been controversial for years in connection with third-country conversions. On the other hand, the RTA could be applicable for the first time for third-country conversions that were previously not covered by it.

Example

H-AG (stock company), which is domiciled in Germany, holds 100% of the shares in Y-Ltd. and Z-Ltd. which are domiciled in a third country. Y-Ltd. is to be sidestep merged into its sister company. Y-Ltd. and Z-Ltd. are resident in the same third state F. The merger in state F is to be comparable to a domestic merger within the meaning of § 2 RA.

For the application of the material scope of the RTA, it is decisive whether a comparable foreign process exists in the present case.

Although a comparable process is assumed to exist in the example case, the personal scope of the RTA would not be met under current law. In the future, the RTA would be directly applicable to comparable third-country mergers. Therefore, H-GmbH (public limited company) could apply for book value continuation under the conditions of § 13 para. 2 sentence 1 no. 1 RTA.

Conclusion

The globalisation of the RTA is a step in the right direction, as it will also allow mergers, splits, spin-offs, and asset transfers in third country cases and thus clearly meets the needs of globally active companies, for example with subsidiaries outside the EU or EEA area.

Unfortunately, however, even after the planned extension of the conversion of the RTA for third countries cases, in particular, the exchange of shares with third countries (e.g. involvement in participation programmes in US companies through the contribution of shares in a German company, or in the case of start-ups or venture capital projects) will continue to be excluded from the tax-neutral contribution.

According to the current legislative procedure, it must be stated that no complete globalisation of the RTA is envisaged. This is because the personal restrictions of the sixth to eight chapters of the RTA are to be retained so that the RTA is only applicable to such third country conversions to a limited extent.