04.04.2024Federal tax court clarifies conditions for transfer of trade tax NOL carryforwards in a hive-down transaction
In a decision dated 1 February 2024 and published on 21 March 2024, Germany’s federal tax court (BFH) ruled that net operating loss (NOL) carryforwards for trade tax (TT) purposes were transferred from a corporation to a partnership in a hive-down transaction pursuant to section 24 of the reorganization tax code (RTC), as the corporation transferred all of its German business activities to the partnership and no German business activities remained at the level of the corporation, except for its interest as a limited partner (LP) in the partnership and its shareholding in the general partner (GP) of the partnership. The potential utilization of the NOL carryforwards for TT purposes at the level of the receiving partnership is relevant because, based on partnership taxation principles, the partnership is transparent for corporate income tax but opaque for TT purposes and, therefore, subject to TT.
Background
The case decided by the BFH involved a US limited liability company (LLC), which qualified as a corporate entity for German tax purposes, that operated in Germany via a registered branch that qualified as a permanent establishment (PE) in Germany. With effect as from 1 October 2011, the LLC “hived down” its German PE by transferring all of the PE’s German activities, as well as all of the PE’s assets and liabilities (e.g., customer contracts, employment contracts) into a German limited liability partnership (KG). The LLC held 100% of the interest in the KG as an LP. The 0% GP interest was held by a German limited liability corporation (GmbH), which was wholly owned by the LLC. The KG continued the operations of the hived-down business without any changes. Apart from being the LP of the KG and holding 100% of the shares in the GP, the LLC did not engage in any further activities in Germany.
The tax authorities were of the opinion that NOL carryforwards that were incurred at the level of the LLC/the German PE of the LLC did not transfer to the KG for TT purposes as a result of the hive-down transaction, arguing that the business of the KG was not identical to the business of the German PE of the LLC (i.e., the “business identity” requirement was not met), which excludes the possibility of utilizing the NOL carryforwards for TT purposes at the level of the KG.
The lower tax court of Cologne ruled in favor of the taxpayer in a decision dated 27 October 2021, reaching the conclusion that the business identity requirement had been met and the NOL carryforwards could be used at the level of the KG for TT purposes.
BFH decision
In its decision, the BFH confirmed the ruling of the lower tax court, stating that the German PE’s NOL carryforwards were transferred for TT purposes to the KG and available for use. The BFH explained that the LLC had no other business in Germany after the hive down and its sole activity related to Germany was being the 100% LP in the KG and holding the 100% shareholding of the GP. This was sufficient for the BFH to conclude that the business identity requirement and a shareholder identity requirement were met at the level of the KG. The business identity was met, as the business the German PE of the LLC was continued in its entirety by the KG without a change and no German business activities remained at the level of the LLC after the hive down. The shareholder identity was met, as the business, which was operated formerly by the LLC directly through its German PE, continued to be attributed to the LLC in its function as the 100% LP in the KG.
The BFH highlighted that the condition of the business identity was met only because the LLC did not have any other business activities in Germany after the hive-down transaction. This emphasis is seen in connection with an earlier BFH decision dated 17 January 2019. In this decision, the BFH reached the conclusion under a very similar fact pattern, where a corporation hived down its operational business into a KG pursuant to section 24 RTC; however, the TT NOL carryforwards at the level of the transferring corporation did not transfer over to the KG. The difference in the 2019 BFH decision is that the corporation did not hive down its entire business, since it continued to hold shares in subsidiaries apart from being the LP of the KG. In such a case, the BFH decided that the business identity requirement between transferor and transferee was not met, since the corporation continued to operate its (reduced) business. In its 2019 decision, the BFH explicitly left open whether a different conclusion applies where a corporation has no activities apart from being the 100% LP in the KG and holding 100% of the shares of the GP in the KG.
Comments
The BFH decision is a welcomed decision for taxpayers, as it gives clarity that, in certain cases, TT NOL carryforwards of the contributing entity can be utilized at the level of the partnership after a hive down pursuant to section 24 RTC. After the above mentioned 2019 BFH decision, it was uncertain whether this could be the case. Both BFH decisions viewed together should provide more clarity to taxpayers about the treatment of TT NOL carryforwards in a hive-down transaction pursuant to section 24 RTC, as there are no explicit rules in German tax law in regard to such a case.
The BFH decision demonstrates and highlights the importance of careful tax analysis and structuring in advance of reorganization measures to ensure that the entire (German) business is hived down if a utilization of TT NOL carryforwards at the level of the receiving partnership is desired. If certain assets remain at the level of the contributing entity or its German part of the business (e.g., shares in subsidiaries), the business identity requirement might not be met and, therefore, TT NOL carryforwards of the contributing entity might not be available for utilization at the level of the receiving partnership. The mere holding of 100% of the LP interest in the partnership along with the 100% shareholding in the German GP should not be harmful for meeting the business identity requirement based on the decision of the BFH.
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