In future, in particular the classic 94/6 structures for property transactions should be critically reconsidered and adjusted, as the case may be, otherwise there might a risk that capital gains from the sale of GmbH (limited liability company) shares (share deals) are subject to taxation.

Background – legislative discussions regarding the 95/ tax exemption

On 21 July 2015, the German Federal Ministry of Finance presented a discussion draft concerning the reform of the German Investment Tax Act (Investmentsteuergesetz) (“Discussion Draft”) which is supposed to amend the German Corporate Income Tax Act (Körperschaftsteuergesetz), amongst others. Accordingly, gains from the sale of GmbH shares for shareholders subject to German corporate income tax shall only be exempted from corporate income tax (at 95%) in the future if the seller “directly [held] at least 10% of the share capital [of the GmbH] at the start of the calendar year”.

Currently, the 10% participation threshold only applies to distributions of a GmbH to another corporation. If a shareholder who is subject to German corporate income tax holds less than a 10% participation in a GmbH, a tax leakage to the profits of the GmbH can therefore be avoided by not making distributions (full retention). From a commercial point of view, the shareholder collects the profits as a result of the higher purchase price when the GmbH shares are sold. The shareholder generates “capital gains instead of distributions”.

The German Federal Ministry of Finance’s Discussion Draft intended to tackle this design. The background in this regard, amongst others, is that the lower chamber of the German parliament (representing the governments of the German states), the Bundesrat, pushed for this regulatory change several times in the past. Only in November 2015, the German Federal Audit Office (Bundesrechnungshof) joined in this request.

Federal Government draft presented to parliament does not comprise extension of 10% threshold to capital gains

On 24 February 2016, the German Federal Cabinet (Bundeskabinett) adopted the Draft Investment Tax Reform Act (InvStRefG-E). Contrary to the Discussion Draft, the InvStRefG-E does not provide for the 10% participation threshold. However, it cannot be excluded that a respective provision will be re-included in the course of the legislative procedure.

Adjustment requirements in light of the legislative discussions?

Since especially for property-related transactions, structures are often implemented where a minority shareholder does not reach the 10% threshold envisaged in the German Federal Ministry of Finance’s Discussion Draft and requested by the Bundesrat and the German Federal Audit Office, one could consider increasing the participation of the minority shareholder to at least 10% for existing or future structures.

On the basis of the wording of Section 8b (4) sentence 1 German Corporate Income Tax Act in the version of the Discussion Draft, the increase of the participation should have as a result that capital gains generated after 31 December for which the 10% threshold is met would continue to be (to 95%) exempted from German corporate income tax. Moreover, there are options in principle which should make it possible for the majority shareholder – from an economic perspective – to continue to collect the profit from the participation transferred to the minority shareholder.

Application

The Discussion Draft provided for the 10% threshold to apply to sales after 31 December 2017 only. It is not clear whether this date would be kept if the the InvStRefG-E was to be amended during the legislative procedure in line with the Discussion Draft. In any event, it cannot be excluded on the basis of the case law of the German Federal Constitutional Court that in the context of the parliamentary consultations, the legislator might already opt for an application to capital gains triggered in the calendar year 2016 (even if the law was only adopted in December 2016, for instance). 

Nicolas Wolski, LL.M., lawyer and tax advisor, Frankfurt