A share buyback occurs when a corporation acquires shares in itself. A quotal share repurchase therefore exists if the repurchase of the shares takes place in accordance with the company relations. Even the tax assessment of a share buyback in itself is problematic. Further problems arise, however, with a quota share buyback. What problems occur and how to avoid tax disadvantages, we explain in this article.

1st Definition and Commercial Admissibility of Quota Share Repurchase

A share buyback occurs when a corporation acquires shares in itself. This is conceivable both at the GmbH and at a stock corporation. Almost all major German corporations have their own shares in their balance sheet. The share buyback is based in particular on the introduction of the withholding tax on January 1, 2009 and the amendment of the Commercial Code (HGB) by the Balance Sheet Law Modernization Act (BilMoG).

The share buyback is only permitted under commercial law if the requirements of § 33 paragraph 2 GmbHG are met. All deposits must be made in full. Furthermore, it must be possible to build up a reserve equal to the acquisition cost at the time of acquisition without attacking share capital or a non-distributable reserve. The determination about the possibility of the reserve is to be made on the basis of a balance sheet corresponding to the requirements of § 42 GmbHG at continued book values without taking into account unresolved hidden reserves.

Shares in corporations are objects of business. A corporation as such can also direct ownership claims against itself. The acquisition of own shares as such always constitutes a transaction of the company with its shareholders. Financial resources are transferred to the shareholders against abandonment of their property rights. The ownership rights of the shareholders are based on the contribution capital and on the surpluses still arrested in the enterprise.

Own shares have no voting rights and no dividend entitlements. They are only on the balance sheet but have no rights. The result is that the voting rights and dividend rights are distributed among the remaining shareholders. The company can issue its own shares and thus make new persons a shareholder. It is also conceivable that the co-shareholder collects the shares. Then his shares grow accordingly.

2nd tax treatment of share repurchase

2.1 Treatment at shareholder level

The BMF did not comment on the quota share buyback in the BMF letter of 27 November 2013 (BMF v. 27 November 2013 – IV C 2 – S 2742/07/10009 BStBl 2013 I S. 1615). There, it merely specified how the acquisition of own shares should be treated for itself at company and shareholder level.

For tax purposes, the share repurchase in the divesting partner constitutes a sale transaction. This is subject to taxation in accordance with general principles. The tax liability of the sale can therefore arise, inter alia, from §§ 13 – 18 and 20 paragraph 4 EStG. Only in exceptional cases, if the shares are held in a deposit with a domestic bank or with a domestic financial services company, capital gains tax on the capital gains is to be withheld (§ 44 (1) sentence 3 and 4 EStG).

For tax purposes, the consequences of a capital measure are therefore not drawn at shareholder level. When selling via the stock exchange, the divesting shareholder does not know whether the acquirer is the company or a third party. The BMF has therefore not joined the thesis of partial liquidation. Rather, the principle of the assumption of a divestment transaction at shareholder level remains.

2.2 Treatment at the level of society

At company level, the BMF implements the commercial concept of a capital measure for tax purposes. The acquisition of own shares in the company does not constitute an acquisition operation, but is to be treated as a reduction of the nominal capital. It is irrelevant whether the company subsequently resells the shares or whether they are withdrawn by other shareholders. In the case of the company, the acquisition and sale of its own shares therefore constitute a tax-neutral capital measure regardless of its acquisition purpose. Therefore, as far as the company level is concerned, the BMF follows the theory of a capital measure and thus pursues a different concept than at the shareholder level.

2.3. Reconciliation between shareholder level and company level required

This approach forces the BMF to bring about a coordination between the regulations on tax equity (§§ 27, 28 KStG) and the commercial law treatment of the acquisition of own shares. This was carried out by the BMF in favour of the taxpayer. Insofar as the treatment as a capital reduction at the company level would lead to inconsistencies in value with the treatment as a sale transaction at the shareholder level, the BMF accepts an adjustment not laid down in the law.

The provisions of § 28 paragraph 2 KStG apply. In the amount of the nominal amount of the own shares, the tax deposit account is first increased. The amount paid to the shareholders as a purchase price then reduces this again. An existing special card within the meaning of § 28 (2) sentence 1 KStG shall not be reduced as a priority. If, on the other hand, the special statement were to be reduced, the repayment of capital would be regarded as a distribution of profits which would lead to remuneration for the shareholder within the meaning of § 20 (1) no. 2 EStG (income from capital assets). This would lead to discrepancies in the value of the transaction at shareholder level. Therefore, the BMF assumes a capital reduction only economically, but not formally.

Furthermore, the BMF assumes that the amount exceeding the repayment of the reduced nominal capital constitutes a service by the company to the disposing shareholder. § 27 (1) sentence 3 KStG applies to this service. Therefore, the benefit to the shareholder reduces the tax deposit account only to the extent that it exceeds the relevant distributable profit. As far as the distributable profit is reduced, the company would actually have to withhold capital gains tax. However, this once again creates a contradiction with the treatment at shareholder level. Capital gains tax is therefore not to be withheld on the part which does not reduce the tax deposit account in accordance with § 27 (1) sentence 3 or § 28 (2) sentence 3 KStG. However, the BMF leaves open how the quota share buyback is to be treated.

3rd share buyback as a design model

There are several reasons for a share buyback. The acquisition can take place in the interest of the company, but also be caused by the interests of the shareholders.

From the company’s point of view, motives for acquiring own shares can be, for example, the targeted influence on the group of shareholders, possibly to defend against hostile takeovers or the optimization of the capital structure. In addition, corporations regularly acquire their own shares in order to pass on the liquidity available in the company to the shareholders.

Also from the point of view of the shareholder, the acquisition of own shares by the company has advantages. Share repurchase is an alternative to distribution. The distribution of profits to a shareholder is regularly disadvantageous from a tax point of view compared to a share buy-back if this leads to capital gains for the shareholders. The share buy-back is advantageous in particular with regard to the withholding of withholding taxes and also for companies whose shares are held in free float (§ 8b (4) KStG).

In addition, co-shareholders who wish to acquire shares of the divesting partner would have to pay the purchase price for the shares from their net taxed income: If the co-shareholder pays the purchase price from the profits distributed to him by the GmbH, the GmbH has paid 25 % capital gains tax on the distribution. Therefore, the GmbH would have to pay out correspondingly higher. This can be avoided by selling these shares to the company. Then the willing co-partner does not raise the purchase price, but the company. Nevertheless, he receives the voting rights and dividend rights. The purchase price paid by the company to the selling co-shareholder does not incur any withholding tax. For the selling partner, it does not matter whether he sells his shares to the co-partner or to the company. He always achieves a capital gain according to § 17 EStG. All these considerations also apply to share buy-back.

Quotal share repurchase

4.1. Definition of proportional share repurchase

A proportionate share buy-back occurs when the company acquires the shares from all shareholders or from its sole shareholder in a proportionate manner. This case is also called equal share repurchase. In this case, there are also doubts as to whether the acquisition of own shares constitutes a sale process and an acquisition process.

The BMF has failed to resolve the remaining legal uncertainty that exists in a planned proportionate repurchase. However, a quota share buyback can have tax disadvantages. Therefore, you must continue to deal with how shareholders and company avoid a proportionate buyback.

4.2 BFH: Income from capital assets

The jurisprudence of the Bundesfinanzhof from 1979 gives rise to doubts about the valuation of the proportionate share buyback. In the case at hand, all shareholders of a GmbH had transferred equal parts of their shares to the company against offsetting against loan debts of the shareholders. According to the BFH, the loan claim is an advantage within the meaning of § 20(2)(1) EStG a.F. (§ 20(3) EStG n.F.). Thus, there was income from capital assets.

The decisive factor for BFH was that the shareholders transferred their shares equally to the company against payment of a redemption amount. As a result, the structure of the company has not changed either by a reduction in its nominal capital or by a reduction in the rights arising from the shares. Such a change could only result in terms of voting rights, profit rights and entitlement to liquidation proceeds. Since there was no change here, the structure of society has not changed.

It is controversial whether this case law is obsolete. However, the proportionate share buy-back is still regularly seen as an exception to the principle that the shareholder achieves capital gains. The judgment must therefore be observed as a precautionary measure. The acquisition of own shares should therefore be designed in such a way as to avoid a proportionate share buy-back in order to prevent the retention of capital gains tax.

4.3. Avoidance of proportional share buyback

Arrangements which exclude a quota share buy-back are linked to the consideration underlying the judgment that, in the case of the quota share buy-back, the rights of the shareholders to each other do not change. BFH does not impose any requirements on the amount of the quota change in the company structure. The only decisive factor is whether the company structure remains completely identical according to plan. Only then can the acquisition of own shares even come close to a distribution.

If individual shareholders do not participate in the repurchase of own shares by the company, the participation rates of the individual shareholders are shifted. It should therefore be sufficient if a shareholder does not participate in the redemption of the shares. This model is therefore based on the waiver of individual shareholders to participate in the share redemption.

In addition to this model, it is discussed whether the disproportionality of share buy-back can be achieved via the creation and trading of tender rights. These offer rights correspond in their legal nature mirror-image to the subscription rights arising from a capital increase. In the case of tender rights, the question then arises in practice as to whether the company is obliged to set up tender rights trading, since otherwise the transferability of the tender rights might be empty. If the shareholders succeed in enabling the transfer of their offer rights, this may create an incentive not to sell the shares held but only the offer right to other shareholders and thus avoid an equal share repurchase. The establishment of a tender rights trade can promote the desired disproportionality of share buy-back.

A right of offer must also be recognized by the GmbH in principle and transferred as such. However, there are greater difficulties in determining the value of the offer right. Unlike a public limited liability company, the value of the offer right cannot be determined on the basis of the buy-back premium paid on the stock exchange price of the shares.