If GmbH shares are transferred to another GmbH (share exchange in accordance with § 21 UmwStG), a so-called status improvement is created. This is due to the fact that in this holding structure a tax-free sale would be possible. Therefore, the shares in the transferred GmbH are subject to a seven-year blocking period. During this period, a sale of the shares leads to retroactive taxation of contribution profits (transfer profit II). Now the BFH has ruled in its judgment of 24.01.2018 (reference I R 48/15) that a merger within a company construct also leads to a blocking period violation. On the one hand, this is understandable, since the GmbH shares are no longer held. On the other hand, however, the status improvement (=holding structure) that triggered the blocking period at all is cancelled.

1st General Issue – Merger after Exchange of Shares

The starting point for this situation is the similar and half shareholding of two sole shareholders (A and B) in an acquired limited company (A-GmbH) in 2011. Similarly, A and B each have a 50% stake in another limited liability company (B-GmbH). By transferring the shares in A-GmbH to B-GmbH, A and B compensate for the increase in the share capital of B-GmbH. As a result, B-GmbH describes itself as a new, sole shareholder of A-GmbH. In the following year 2012, B-GmbH is subsequently merged with its sole shareholder C-GmbH. The plaintiffs (A and B) take the view that the merger operation in 2012 does not constitute a capital gain and therefore no transfer profit II is taxable. The tax administration expressed the opinion of a taxable conversion operation in the form of an upward merger.

The facts of the direct action involve two conversion operations. So-called conversion operations under the Conversion Tax Act serve to carry out operations in a tax-neutral manner under the conditions laid down in the law.

2.1. Qualified share exchange § 21 para. 1 UmwStG

On the one hand, this is a qualified share exchange according to § 21 para. 1 sentence 1 UmwStG. Through the transfer of shares in A-GmbH (acquired company) to a limited company, in this case B-GmbH (acquiring company) and the granting of new shares in A-GmbH, all the requirements for a complete exchange of shares are met. Insofar as the share is transferred below the book value, the transferred shares are subject to a blocking period of 7 years in accordance with § 22 Abs. 2 sentence 1 UmwStG in conjunction with § 21 para. 1 UmwStG. During this period, the direct or indirect sale of the shares transferred is taxable. The profit from the sale then triggers the transfer profit II according to § 22 para. 2 sentence 3 UmwStG. Each elapsed year from the time of the transfer reduces the transfer profit II by 1/7.

2.2. upward merger § 22 para. 1 UmwStG

In addition, the second conversion process is an (upward) merger for reception according to § 22 para. 1 UmwStG. Due to the parent-subsidiary structure of the GmbH shareholding, the process is called upward merger. Compared to a merger for a new establishment, the merger in which the receiving company already exists is for acquisition. B-GmbH ( Mutter-GmbH) takes over all assets of A-GmbH upon merger of A-GmbH (Subsidiary-GmbH) on itself. Nevertheless, this process takes place at book values, so that the retention of the hidden reserves is ensured.

3. reason for revision of the financial administration in the case of merger

Based on the fact that the requirements of conversion operations are met in accordance with the Conversion Tax Act, the conversion operation is not treated as a sale. However, the tax administration does not see the conditions fulfilled in the present case. Under a sale pursuant to § 22 Abs. 2 UmwStG is in principle to be understood as a change of legal entity of the shares of B-GmbH in A-GmbH. It also stipulates that a consideration must be given.

The shares of B-GmbH in A-GmbH do not undergo a change of legal entity due to the upward merger. However, the process of the destruction of the shares by merger is equivalent to an exchange. As an example, this can be transferred to cases in which the company whose shares have been transferred is merged to the sole shareholder as an assuming legal entity. As a result, no new shares are created, but the total assets of the daughter are transferred to the mother and the shares in the daughter are lost. In conclusion, the upward merger of a parent-subsidiary company is treated as a swap-like transaction and must therefore be assessed as a transaction for remuneration.

The consequence of the payability of the merger is the retroactive occurrence of the taxable contribution profit II according to § 22 para. 2 sentence 3 UmwStG in the year of submission.

Cross-border impact for the Limited – merger solution

Due to the final judgment of the BFH, there are also cross-border effects, especially for English Limiteds. In advance of the upcoming Brexit, many Limiteds were transferred to German GmbHs by share exchange and were subsequently merged to the German parent GmbH. This approach was recommended by English lawyers who bypassed the English creditor protection.

Now it has been decided in court that the upward merger between Mutter-GmbH and Tochter-Limited is not a tax-neutral practical solution. If you want to merge the Limited cross-border to a German GmbH in order to continue to use the liability protection after Brexit, you must now choose the path of sideways merger. This still offers tax neutrality and the exclusion of a contribution profit through disposal. Here we have published a comprehensive article on limited conversion.