The Bundesfinanzhof (BFH) had to clarify whether reductions in profits in the form of partial value write-offs on the participation in a (foreign) limited company, as well as a loan granted to the investment company according to § 8b (3) sentences 3, 4 KStG should not be taken into account in the determination of income. On the other hand, damages rendered in the economic context of this participation in the shareholder are subject to full taxation and are not exempt under Section 8b(2) KStG. We clarify why the design chosen in the case was awkward for the dispute between societies and how this could have been optimized.

1st problem

In accordance with §8b(2), first sentence, KStG, profits from the sale of shares in a limited liability company remain out of recognition when determining the income of a corporation – subject to certain exceptions. The same applies according to § 8 sentence 3 KStG to profits from the dissolution or reduction of the nominal capital or hidden deposits treated as equivalent for disposals. 5 % of the respective profit is in turn considered as non-deductible operating expenses (so-called box penalty).

According to § 8b (3) sentence 3 KStG, reductions in profits related to the share referred to in paragraph 2 are not to be taken into account when determining income. They are added off-balance sheet. In this way, the legislature has established a correspondent for the tax exemption for capital gains.

However, there is no correspondence between the revenue side and the expenditure side that can be understood broadly in the sense of an economic view. What remains tax-free under § 8b(2) KStG and under § 8b(3) KStG as a reduction of profit is to be determined solely by the concept of profit within the meaning of § 8b(2) KStG and by the reduction of profit within the meaning of § 8b(3) KStG on the other hand. An economic link of some kind between profits and losses alone is not sufficient.

2nd issue: dispute between companies

2.1 Actual circumstances

The facts were as follows:

The plaintiff was A GmbH. A GmbH took a 36 % stake in A-Ltd, whose managing directors were E and F. This should establish a ship register in Romania. For this purpose, the GmbH made capital payments totalling EUR 250,000. Other participants in A-Ltd were B GmbH with 36 % and C GmbH & Co. KG.

For the operation of the ship register, the A-Ltd. concluded a service concession contract for 30 years with the local shipping authority in Romania. On the basis of this contract, A-Ltd established the operation of the register.

In 2013, the operation of the ship register failed. The reason for this was that the Romanian Government did not put into effect various legal regulations on the operation of the ship register required for this purpose.

The plaintiff, B GmbH and D GmbH granted A-Ltd. a loan of EUR 50,000. This served to finance the liquidation of A-Ltd. and to prepare a legal dispute with the local shipping authority.

Since doubts arose as to the enforceability of claims for damages by A-Ltd. against the Romanian shipping authority, the plaintiff concluded a “comparison on damages claim” of EUR 300,000 in December 2013 with C-GmbH & Co. KG and E, which were considered to be the initiators of the ship register.

There was a conflict between societies. The plaintiff took the view that she was entitled to damages against C-GmbH & Co. KG and E in the amount that she had transferred to A-Ltd. paid-in capital of at least 300,000 euros as well as the lost profit, as it had invested in A-Ltd. mainly on the basis of the assessment of C-GmbH & Co. KG and E. Part of this amount was paid. At the beginning of 2014, the plaintiff sold its stake in A-Ltd. to C GmbH & Co. KG for a symbolic purchase price.

2.2. Legal assessment by A GmbH

In its balance sheet as at 31 December 2013, the plaintiff dismissed its participation in A-Ltd. initially with a value of EUR 250,000. The loan granted to A-Ltd. in 2013 was recorded at nominal value. The compensation was considered by A-GmbH as extraordinary income. Subsequently, the plaintiff claimed by way of the balance sheet adjustment that the declared profit was to be reduced by EUR 50,000 (depreciation on the loan). In addition, it was to increase the remaining claim for damages of EUR 190,000 at the balance sheet date. The result is a loss.

The tax office, on the other hand, made an off-balance-sheet correction of EUR 300,000 based on § 8b(3) sentences 3 and 4 KStG with regard to the partial value write-off. Compensation was recognised for profit.

Objection and action of A GmbH against this classification remain unsuccessful. The applicant argued that the compensation payments directly related to the partial write-off should be treated tax-neutrally on the basis of the classification of § 8b KStG. The partial write-downs should not be taken into account to reduce profits. The economic context justifies the fact that, conversely, the damages are tax-free. The tax office and the tax court did not join.

3. assessment of the dispute by the BFH

BFH argued that the reduction in profit due to the partial value write-off on the participation in A-Ltd. and the loan oriented towards it should not be taken into account in the determination of income pursuant to § 8b(3), third sentence and (4) KStG. There was no dispute between the interested parties as to the existence of a permanent impairment of the participation in A-Ltd. and the loan granted. Therefore, a partial write-off could be made in this respect (§ 6 (1) no. 2 sentence 2 EStG in conjunction with § 8 (1) KStG).

But this does not mean that the damages are tax-free. The FG has not found in the revision law to be objectionable that the damages and the contract for the sale of shares in A-Ltd. on the other hand, they are separate from each other for tax purposes. It does not depend on an economic consideration.

Therefore, the compensation provided by C GmbH & Co. KG and E to the plaintiff cannot be regarded as part of a profit on the sale of the shares in A-Ltd. within the meaning of § 8b (2) sentence 1 KStG, which would remain unrecognised in the determination of income. Insofar as the plaintiff submits for the first time in the final complaint proceedings that a sale of the shares had already been agreed orally on the occasion of the “Comparison on Claims for Damage”, this was a new submission of facts which could not be taken into account in the final complaint proceedings.

4th discussion: Our design recommendation

A satisfactory result for the plaintiff could have been easily achieved. To this end, the damages should have been regarded as part of a capital gain within the meaning of §8b(2) KStG. However, a corresponding interpretation is denied to the BFH.

It is therefore important to attach importance to the concrete (exit) design in comparable constellations. The tax exemption for damages could have been obtained by the applicant in another way. As compensation for the loss of assets of the applicant from its participation in A-Ltd. and the loan granted, she could have agreed on a sale at a book value of EUR 300,000 with the later acquirer of the shares, C GmbH & Co. KG. The profit on the sale of the shares under §8b(2) KStG would then have been 95 % tax-free.

In this respect, it should also be noted that the BFH can only verify findings of an actual nature to a limited extent. On the basis of § 118 (2) FGO, he can only check the assessments in the appeal proceedings concerning the factual circumstances to determine whether they have been made in a procedurally erroneous manner or whether they violate laws of thought or general sets of experience. Furthermore, BFH is bound by the assessment of FG. This also applies if a different assessment is equally possible or obvious. Therefore, proceedings concerning the interpretation of agreements will in principle be won or lost in the tax courts.

Therefore, a comprehensive and careful presentation of facts is essential. A new submission of facts, which allows an interpretation in the sense of the plaintiff contrary to the evaluations of the FG, is not possible in the appeal proceedings.

The facts show that care must be taken in the context of disputes in order to avoid tax surprises.