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The upstream merger as a tax trap for a share swap

The German Federal Tax Court judgment of 24 January 2018 – Case I R 48/15 focused on corporate transformations


In accordance with § 21 of the German Act on the Transformation of Companies (UmwStG), the contribution of shares to a corporation can be tax-neutral under certain conditions in return for the granting of new shares in the absorbing company (share swap). However, if the contributed shares are sold within a lock-up period of 7 years, the share swap is retroactively subject to taxation (Contribution Gain II). This is intended to prevent transformation structures that allow a better tax position to be abusively obtained. At the beginning of the year, the First Division of the Federal Tax Court (BFH) had to decide whether the merger of a subsidiary with the parent company (upstream merger) following a contribution of shares constitutes such a sale.

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

II. Dispute

In the state of affairs in question, the two plaintiffs each held a 50% share in a German limited liability company (GmbH) (A-GmbH). The shareholders contributed their shareholding to a second GmbH (B-GmbH), in which each shareholder also held a 50% share. As a result, A-GmbH (subsidiary after the share swap) was merged with B-GmbH as parent company.

III. Legal rulings of the lower court

Previously, the Tax Court of Hamburg (judgment of 21 May 2015 – Case 2 K 12/13) did not recognise the subsequent upstream merger as a sale, contrary to the opinion of the revenue administration. To constitute the elements of a sale, a transfer is required to another legal entity in return for payment. If the parent company is the sole shareholder in the subsidiary, the shares are dissolved by way of the merger and not transferred to a third party. In addition, in the opinion of the tax court, the two successive transformations (share swap and upstream merger) do not achieve an undesired tax improvement. It would therefore not be in line with the objective of the Act on the Transformation of Companies to hinder for tax purposes transformations permitted under commercial law and possible in a tax-neutral fashion solely because they are combined. An appeal on points of law has been lodged against this decision.

IV. Decision of the Federal Tax Court

In its judgment of 24 January 2018 (I R 48/15), the Federal Tax Court then defended a legal opinion that differed from the lower court. According to the Federal Tax Court’s legal rulings, the upstream merger does indeed fulfill the elements of a sale. This is because an exchange-like transaction can be recognised in the subsequent transformation and such a transaction is basically equivalent to a sale of shares that is subject to a lock-up period. The loss of the shares represents the consideration for the transfer of the assets to the parent company. However, the fact that the successive transformations obviously do not constitute a case of tax abuse due to their tax neutrality was ignored. In the dispute, the upstream merger ultimately triggered retroactive taxation of the share swap (Contribution Gain II).

V. Implications for advisory practice

Despite critical voices in the literature, the Federal Tax Court’s decision requires urgent attention when structuring transactions. According to the judgment, even the obvious lack of intention to abusively obtain a better tax position is not sufficient to prevent retroactive taxation. The First Division of the Federal Tax Court thus supports the strict view of the tax authorities and rejects a limitation of the tax consequences to abusive cases. This makes it all the more important to be extremely careful within the 7-year lock-up period following a contribution and, if in doubt, to consider alternative structures. The above decision shows that not only the sale of taxable shares, but also subsequent transformations can lead to tax consequences. In the present dispute, for example, a sideways merger of A-GmbH into B-GmbH could have achieved the same target structure and avoided retroactive taxation.



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