Forfeiture of Unused Tax Losses Pursuant to German Corporate Income Tax Act Partly Unconstitutional
In its decision published on 12 May 2017 (file no. 2 BvL 6/11), the Federal Constitutional Court (Bundesverfassungsgericht; BVerfG) ruled that the forfeiture of unused tax losses and tax loss carry forwards in the event of a (direct) acquisition of shares pursuant to section 8c sentence 1 KStG violates the general principle of equality under Article 3 (1) German Constitution (Grundgesetz; GG). The legislator is obliged to adopt a new provision applicable for the period 1 January 2008 through 31 December 2015 with retroactive effect by no later than 31 December 2018.
Pursuant to section 8c sentence 1 KStG (now: section 8c para. 1 sentence 1 KStG), the direct or indirect acquisition of more than 25% and up to 50% of the subscribed capital, the membership rights, shareholder rights or the voting rights in an entity by an acquirer or a group of related acquirers within five years results in the forfeiture of the unused tax losses and tax loss carry-forwards in the corresponding amount; the same applies in case of comparable transactions (e.g., a capital increase). The BVerfG now had to decide on the constitutionality of this provision.
Decision of the BVerfG
The BVerfG decided that, in the event of direct transfers of shares, the provision of section 8c sentence 1 KStG violates the principle of equal taxation derived from Article 3 (1) GG, because the distinction made in the treatment of an acquisition of shares of below 25% and an acquisition of shares of more than 25% was arbitrary in the Court's view.
According to the BVerfG, there is no justifying reason for the unequal treatment. While the Court conceded that the legislator is generally permitted to implement loss cancellation rules aimed at combating the abusive trade with loss companies, the Court concluded that the legislator exceeds its discretion where the loss cancellation rule is triggered only because there is a mere transfer of shares of more than 25% and up to 50%.
In the Court's view, the principle of economic identity between the taxpayer using the loss and the taxpayer suffering the loss likewise does not justify the unequal treatment, either. The BVerfG further stated that, while the acquisition of more than 25% of the shares in a corporation created a blocking minority under corporate law, the shareholder's potential influence did not lead to the irrebuttable presumption that the company's economic identity had changed.
So far the BVerfG exclusively ruled on the constitutionality of
section 8c sentence 1 KStG. In its decision, the BVerfG expressly left in particular
open whether the provision in section 8c sentence 2 KStG (now: section
8c para. 1 sentence 2 KStG), according to which in the event of a transfer of more
than 50% of the shares the entire unused tax losses and tax loss carry-forwards
become forfeited, is also unconstitutional.
The same applies to the question of whether – as of 1 January 2016 – the unconstitutional condition was remedied as a consequence of the introduction of section 8d KStG (so-called loss carry forward subject to continuation of the business (fortführungsgebundener Verlustvortrag), which preserves unused tax losses and/or tax loss carry-forwards of a company under certain circumstances where such unused tax losses and/or tax loss carry-forwards would otherwise have been cancelled as a result of the application of Section 8c sentence 1 or 2 KStG.
The BVerfG set the legislator a time limit for removing the unconstitutional condition with retroactive effect for the period 1 January 2008 through 31 December 2015 by 31 December 2018. If the legislator fails to meet its obligation, the provision will automatically become invalid with retroactive effect.
The legislator will have to respond to the decision of the BVerfG by means of an amendment of section 8c sentence 1 KStG; such amendment is, however, not to be expected during the current legislative period due to upcoming elections in autumn this year. In line with the reasons for the decision of the BVerfG, it is to be expected that the amendment will aim at limiting the scope of the norm to cases of abuse.
Taxpayers who were affected by section 8c sentence 1 KStG in the past and whose notices are no longer subject to appeal should verify whether there are still any chances to apply for an amendment of such notic-es. Notices that have already been issued but are still subject to appeal should be kept "open", i.e., taxpayers should consider filing an appeal. If no notice has been issued yet, the tax office has to observe section 165 (1) no. 2 German General Tax Code (Abgabenordnung; "AO"), which means that new notices issued based on Section 8c sentence 1 KStG have to include the note of being provisionally only.
As previously noted, the BVerfG did not expressly comment on the constitutionality of section 8c sentence 2 KStG. Taxpayers affected by this provision should, however, verify whether taking action against notices that were or are based on this provision will have any chances of success.