A share buyback occurs when a corporation acquires shares in itself. In particular, when the GmbH shareholder leaves, a share buyback must be considered. There can be various tax advantages. We explain all this in this post.

1st background to share buyback

1.1. Definition and commercial admissibility of share repurchase

A share buy-back occurs when a corporation acquires a share 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.

1.2 Discussion on the tax treatment of share buyback

The tax treatment of the acquisition of own shares has long been discussed. The discussion seemed clarified when the Federal Ministry of Finance (BMF) had answered essential questions about the tax treatment in 1998 in a BMF letter. However, the legislature fundamentally changed the commercial law requirements applicable until then by BilMoG in 2009. The uncertainty then arose when the BMF lifted the letter on the tax treatment of the acquisition of own shares without replacement in August 2010.

Since then, numerous authors have dealt with the question of how the acquisition of own shares should be treated for tax purposes by the company and the shareholder and how a harmony between these two levels can be established. However, there was no public statement from the Financial Administration on how it handled these cases. In a new letter, the BMF then commented in August 2010. In it, however, the BMF has not answered all existing doubt questions. We clarify what the BMF determined and what problems remain open.

1.3. Problems with share buyback

In essence, the problem of the tax assessment of share repurchase is whether the acquisition of own shares is to be regarded as a normal acquisition operation or as a company law operation in the form of a partial liquidation. It is particularly important that BilMoG stipulates for commercial law purposes that the acquisition of own shares should be regarded as a partial liquidation. Whether this also applies to tax law has not yet been finally clarified.

Discussions will also be held as to whether the same transaction can be treated differently at the shareholder level and at the company level or whether a synchronisation between the company level and the shareholder level is to be established. In addition, there are doubts as to whether there are deviations in a so-called quota share buyback.

Share repurchase 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 selling 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.

3. Share repurchase: acquisition transaction or partial liquidation

3.1 Share repurchase as acquisition business

After the acquisition business thesis, the company acquires an economic asset that is potentially worthwhile, accountable and saleable. With regard to the resale and until it comes to this, the accounting of the shares serves only to register them with the company, so-called “parking function”. The resale of the shares represents a successful process. Acquisition and resale at company level correspond to a divestment and acquisition business at company level.

3.2 Share repurchase as partial liquidation

The partial liquidation thesis assumes that the share buy-back is a company law operation, which is basically comparable to a capital reduction. The counterpart to this is the capital increase in the event of the resale of the shares. On the balance sheet, the redemption is reflected by a financial asset disposal and a capital adjustment.

3.3. Differences between acquisition business and partial liquidation

Acquisition business and partial liquidation are not necessarily accounted for differently. Both require an adjustment of the liabilities to the cash withdrawal. For the acquisition business, passive correction assumes a parking function. In the case of partial liquidation, on the other hand, it ideally anticipates the result after the capital reduction has been completed.

Partial liquidation can also be understood as partial total liquidation. This leaves open the question of which part of the tax capital is deemed to be dissolved. If the correspondence principle is observed, the use of the distributable profit would then have to be accompanied by a profit allocation to the owner, which must be accompanied by capital gains tax. However, this is only conceivable when repurchasing the known shareholder. In the case of acquisition from the unknown shareholder, for example via the stock exchange, this is not possible. Therefore, even if a partial liquidation is assumed, the repurchase from the shareholder is treated as a sale transaction. There is therefore a diverging treatment of share buy-back at company and shareholder level.

4th Commercial Treatment of BilMoG Share Repurchase: Capital Reduction

Originally, the legislature differentiated according to the goal with which the company acquired the shares. Insofar as the company did not acquire the shares for collection, it had to capitalize the shares in the trade and tax balance. In addition, it had to form a reserve for its own shares in the balance sheet (§ 272 (4) HGB a.F.). On the other hand, shares acquired for collection had to be deducted from the capital on the liabilities side and thus not shown as an asset (§ 272 (1) sentence 4 – 6 HGB a.F.).

BilMoG changed the commercial accounting of the share buyback. Accordingly, the company must always openly deduct the nominal amount of its own shares in the trade balance from the item “Subscribed capital” on the liabilities side in the pre-column. In addition, it must offset the difference between nominal amount and acquisition costs with freely available reserves (§ 272 paragraph 1a sentence 1 HGB). Under commercial law, the acquisition of own shares is therefore to be treated as a capital reduction. Own shares are no longer to be shown on the asset side (so-called net statement). Thus, the economic content of the repurchase of own shares as a provision of freely available reserves to shareholders is taken into account in the commercial balance sheet.

Tax treatment according to the new BMF letter

5.1 Treatment of share repurchase at shareholder level

By letter dated 27.11.2013 (BMF v. 27.11.2013 – IV C 2 – S 2742/07/10009 BStBl 2013 I S. 1615), the BMF regulated the tax treatment of the share buy-back. It is noteworthy that it partially reinstates the repealed 1998 letter. The core message of the letter is that, in the case of the divestiture partner, the acquisition of own shares by the company constitutes a sale transaction. This is subject to taxation in accordance with general principles. The tax liability of the sale can arise, among other things, 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.

5.2 Treatment at the level of society

At company level, the BMF implements the commercial concept of a capital reduction for tax purposes. 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, irrespective of their purpose, a tax-neutral capital measure. 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.

5.3. 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.

5.4. Then capital gains tax is to be withheld

In summary, capital gains tax is to be withheld and paid only in cases where there is a hidden distribution of profits due to an excessive purchase price (§ 20 paragraph 1 no. 1 sentence 2 EStG). However, the BMF clarifies that an excessive purchase price is usually not to be assumed if the shares are acquired via the bad or in the tender procedure. In which cases an exception to this rule is to be assumed, the BMF leaves open.