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BREXIT Rescue Packages in German Tax and Reorganization Law

The bill for a Brexit tax law and the Fourth Act Amending the Reorganization Act

1. Background

The most recent developments in the Brexit process have created additional uncertainty. Now that the European Court of Justice (ECJ) has ruled that the withdrawal declaration can be lawfully revoked and the Brexit vote in British Parliament has been postponed, an exit from Brexit is not unlikely. Still, the United Kingdom (UK) expects that it will no longer be a member of the European Union as of 30 March 2019.

Nevertheless, the proposed withdrawal agreement calls for a transitional period extending through the end of December 2020, during which time the EU treaties will continue to apply. Regardless of whether any bilateral agreements are concluded with the EU, the UK will revert back to the status of a third country for tax purposes once this transitional period expires, at the latest. The loss of EU/EEA status means that, in addition to the tax Directives in secondary EU law, numerous provisions of German tax law will also no longer apply. Given the current legal situation, there is also a risk that Brexit alone will have substantial tax and legal consequences even for matters that occurred in the past.

In order to prevent unfair tax consequences from arising without any positive act on the part of the taxpayer, the German Ministry of Finance published its departmental draft for a Brexit tax law on 9 October 2018. The changes proposed in this draft were included in the German government’s bill, which was published on 12 December 2018, and more were added. British companies based in Germany (particularly limited liability companies) also face the risk of being treated as German partnerships post-Brexit and losing their limited-liability status.

The Fourth Act Amending the Reorganization Act [Umwandlungsgesetz] was recently enacted in order to help the affected companies effect an orderly transition to a German corporate form. This article provides an overview of the proposed new rules.

2. Exit Tax

When fixed assets are transferred abroad, the hidden reserves they contain are generally realized, and are therefore taxable. However, if the asset is assigned to a place of business in the EU, a compensatory tax item may be formed, upon application, in accordance with § 4g of the German Income Tax Act [Einkommensteuergesetz], which is to be reversed over a five-year period. But if the asset is transferred outside the tax territory of the EU, the item is reversed immediately, and the value of the asset is added to taxable income. Under existing law, assets affected by Brexit fall under this rule as well. In order to prevent this adverse tax effect from occurring in cases where assets were transferred to a British place of business in the past, the Brexit tax bill adds a new paragraph to § 4g of the Income Tax Act, Paragraph 6, stating that Brexit alone does not immediately trigger reversal of the compensatory item for exit tax. To clarify, transfers of assets from the UK back to domestic business assets will continue to be tax-neutral under the proposed changes despite Brexit.

 3. Taxation of Contribution Gains

Contributions of business units and shares within the EU and/or the EEA may be tax-neutral in certain cases, upon application. In such cases, the contribution gains are not taxable. Due to the loss of EU/EEA status, however, past contributions of business units or shares into a UK corporation result in retroactive taxation of contribution gains within the seven-year statutory blocking period. The bill calls for the inclusion of a Paragraph 8 in § 22 of the Reorganization Tax Act [Umwandlungssteuergesetz], stating that Brexit results in no tax expense for contributions for which the transformation resolution or contribution agreement was adopted before the EU withdrawal took effect.

4. Liquidation Tax

The bill clarifies that liquidation tax, which accrues when a corporation relocates to a third country in accordance with § 12(3) of the Corporate Tax Act [Körperschaftsteuergesetz], is not triggered by Brexit alone.

5. Expatriation Tax

If a natural person holds an interest of at least one percent in a corporation and the corporation changes its domicile, the person’s interest in the company is taxable. However, if the company moves to an EU/EEA state, the tax may be deferred interest-free. This tax deferral is revoked if certain circumstances apply. The Ministry of Finance’s draft clarifies that revocation of the deferral requires a positive act on the part of the taxpayer: Brexit alone cannot trigger such a revocation. The government’s bill contains language which expressly states that no adverse tax effects are to come from Brexit.

 6. Prejudicial Use for “Riester” Assistance

The bill also adds provisions to §§ 92a, 93 and 95 of the Income Tax Act. These provisions are intended to prevent Brexit from having the consequences of prejudicial use within the context of “Riester” assistance in certain “old cases.”

7. Interest on Installment Payments if a Replacement Purchase is not Made

If an asset is sold and the proceeds are reinvested in a new asset, the capital gains from the sale may be transferred to the replacement asset in accordance with § 6b of the Income Tax Act or a reserve may be formed. However, this is only the case for assets of a domestic business. In the replacement asset is purchased in an EU/EEA state, the tax on the capital gains may be spread out over five years, upon application. But if the replacement investment in an EU/EEA state fails to materialize, in whole or in part, § 6b of the Income Tax Act, as amended by the Annual Tax Act of 2018, now calls for payment of interest on the installment payments. The German government has included provisions in its bill amending § 6b of the Income Tax Act so as to allow affected companies to avoid paying interest in cases where a future replacement purchase in an EU/EEA state can no longer be made as a result of Brexit.

Marcel Jordan, M.Sc., MOORE STEPHENS Koblenz GmbH

8. Merger into a Partnership

British companies with registered office in Germany face the risk of losing recognition of their status as corporations once Brexit takes effect. The result would be that they would have the status of a German partnership, and that the liability of the partners would be unlimited. In order to help the affected companies transition into a German corporate form, the recently enacted Fourth Act Amending the Reorganization Act includes provisions governing the merger of limited-liability companies into German limited partnerships. British companies may take part in such mergers as the transferring entity provided the merger agreement is notarized before Brexit takes effect and the merger is reported to the Commercial Register without delay, no later than two years after Brexit takes effect. In doing so, lawmakers seek to allow affected companies to merge into a limited partnership with a (limited-liability) entrepreneurial company as general partner, in addition to their existing options. This is intended as a way of easing the transition to a German corporate form while preserving their limited-liability status.

9. Conclusion

Brexit will have unfair consequences, from a tax perspective, due to the reversion of the UK to third-country status. As a result, the initiative to enact a Brexit tax law is a positive development. In the departmental draft of 9 October 2018, the Ministry of Finance had already proposed changes to the law in an effort to prevent income tax consequences, and the government’s bill of 12 December 2018 takes up these changes and adds more. The law is to take effect as early as 29 March 2019. In addition, a provision is to be inserted into the Reorganization Act concerning the merger of companies into German limited partnerships in an effort to make it easier for German-based British companies which are affected by Brexit to transition to a German corporate form. This is fortunate, since it creates a national legal framework outside the scope of European law. However, critical voices in the literature question whether this new provision will suit the practical needs of the companies affected by Brexit.

 

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