03.04.2024Lower tax court decides on tax deductibility of costs for IT consolidation in the context of a merger
In a decision dated 19 October 2023 and published on 21 March 2024, Germany’s lower tax court of Bremen ruled that costs for the consolidation of information technology (IT) systems after a merger do not qualify as “costs for the transfer of assets” within the meaning of section 12(2) sentence 1 of the German Reorganization Tax Act (RTA) and are therefore immediately deductible for corporate income tax purposes. The decision, which is line with the principles expressed by the federal tax court in previous decisions, is based on the reasoning that the consolidation of the IT systems is an operational business decision related to the functions of the combined entities rather than related to the merger transaction itself.
Background
Section 12(2) sentence 1 of the RTA provides that in the case of an upstream merger, a merger gain must be calculated based on the difference between the tax book value of the shares in the transferring corporation and the recognized value of the acquired assets minus the costs for the transfer of assets. The merger gain should however be 95% tax exempt based on the German participation exemption rules. According to the jurisprudence of the federal tax court, this also applies in the case of a side-stream merger (i.e., a merger between two subsidiaries of the same parent entity) whereas the “fictitious” book value of the shares in the transferring corporation is nil. The determination of the merger gain and the inclusion of expenses related to the merger transaction effectively result in the nondeductibility of such expenses at the level of the acquiring corporation for tax purposes. According to the case law of the federal tax court, the qualification of expenses as merger expenses has to be interpreted in the same way as the qualification of expenses related to the disposition of shares in a corporation. The approach of the federal tax court is based on the court’s view that reorganization transactions have to be treated in line with the principles for share acquisition and share disposal transactions. What is important for the qualification as expenses related to a merger transaction is the proximity or nexus to the merger transaction itself or to the ongoing operations of the business.
Facts of the case
In the case decided by the lower tax court of Bremen, a German corporation was merged into an affiliated German corporation. For tax purposes, the merger was carried out on a rollover basis with regard to the assets of the corporation that no longer existed after the merger, and no merger gain was recognized in the income statement of the surviving entity. As part of the merger, the different IT systems of the two corporations were integrated and consolidated. The surviving entity treated the expenses of the IT consolidation as immediately tax deductible business expenses. However, during an audit of the surviving entity, the German tax authorities took the view that the costs of the IT consolidation (consulting and legal advice fees) resulted from the merger transaction. The tax office qualified the costs as merger costs and hence nondeductible for corporate income tax purposes. The taxpayer argued that the costs had to be treated as immediately deductible business expenses due to the lack of a sufficient connection between the merger transaction and the IT consolidation.
Decision of the lower tax court
The lower tax court decided that the costs for the IT consolidation and integration did not qualify as costs for the transfer of assets and therefore allowed the costs to be treated as immediately deductible business expenses. The decision was based on the principles established by the federal tax court in previous decisions. The lower tax court recognized that costs for the IT consolidation would not have been triggered without the merger; however, the court did not consider the nexus to be the merger transaction itself but rather the operational decision to consolidate and integrate the IT systems post-merger. The court therefore allocated the costs to the future ongoing operations rather than to the merger-related transfer of assets.
Comments
The distinction between merger-related costs (which are generally nondeductible) and subsequent integration expenses (which are immediately deductible business expenses) is of high relevance in practice and the confirmation by the lower tax court, albeit very fact specific, is likely to be welcomed by taxpayers. An appeal by the tax authorities is currently pending with the federal tax court.
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