In a resolution, published on 7th February 2017 (though already passed on 28th November 2016), the German Federal Tax Court (“Bundesfinanzhof” (BFH)), decided that the so-called “Decree on Turnaround” (“Sanierungserlass”) issued by the Federal Ministry of Finance (“Bundesministerium der Finanzen” (BMF) contravenes principles of the lawfulness of the administration and is therefore nil and void. Now, so-called “turnaround-profits” might be taxed, a fact which seriously endangers future turnarounds.
The court first establishes succinctly that so-called “accounting profits” (“Buchgewinne”), which arise when a creditor waives a claim against a debtor in crisis (or insolvency) in order to assist the recovery of the latter, are generally taxable (so-called “turnaround profits” (or generally “accounting profits” or “extraordinary gains”; in German: “Sanierungsgewinne”). However, until the recent BFH’s decision, this – essentially conclusive – legal consequence could largely be avoided through the use of the so-called “Decree on Turnaround” (“Sanierungserlass”) issued by the Federal Ministry of Finance (“Bundesministerium der Finanzen” (BMF) on 27 March 2003. Through this Decree, the responsible tax authorities were instructed to waive tax claims arising out turnaround profits under certain circumstances.
In its decision, the BFH now attests to the BMF that the latter – by enacting the Sanierungserlass – acted unconstitutionally: the legislator, who had taken an express decision to abolish the law regulating the taxable effects on turnaround profits then contained in para 3 no. 66 EStG (“Einkommenssteuergesetz” German Income Tax Act), applicable until 1997, would also be the only one to re-regulate the tax-consequences of the aforedescribed turnaround profits again. The administration (to which the BMF belongs) has no such authority.
Keeping in mind that in typical corporate turnaround cases, “haircuts” of more than 50% of the claims are not unusual, the significance of this decision can not be overestimated. For the (not liquidity-effective) book gain incurred through the waiver now directly leads to a (liquidity-effective) tax claim, which is based on the tax rate of the respective legal entity. Although, the actual tax claim should normally not be as high as the amount of the debtors’ original debt, there is still a risk that numerous attempts at for turnarounds will fail in the future.
Also, turnarounds effected through an insolvency plan (“Insolvenplan“) and / or through a Debt-Equity-Swap will in the future run the risk of being taxed accordingly. From the wording of the BFH-resolution it seems that the court is aiming to also block attempts to argue that the turnaround-situation per se qualifies for a better tax-treatment. Solely, so-called “übertragende Sanierungen” (turnaround through the transfer of assets to a newco) might offer a certain glimpse of hope. However, these transactions carry other risks which should be discussed before even contemplating such an alternative.
Due to the strictness of the BFH-resolution, which will probably only allow for equitable considerations in a few cases, the legislator has to act now in order to avoid a dramatic decline in corporate turnarounds. However, it is already questionable whether it is possible to create a new provision which conforms with European Union Law. In a recent decision, dealing with another tax aspect of turnarounds, the European Court of First Instance has namely issued several arguments which could render a new provision to avoid taxation in case of turnaround profits void with regard to EU law. Also, Federal Elections in September already loom over the process. Hence, it seems rather improbable that the German Parliament will be able to adopt a new law incorporating the now defunct Sanierungserlass before the elections.
On the other hand, the EU Commission should not be too content with this outcome: Its own project of a “preventive restructuring mechanism” (cf. here) might lead to a complete failure of the envisaged procedure. Hence, the EU Commission will not be able to also deal with tax issues influencing business turnarounds and to curtail some of the aforementioned effects of the EU-Courts’ jurisdiction. In current cases and for the near future, though, debtors in crisis and their advisors should consider whether “their” case still qualifies for a tax exemption under German equitable rules. In parallel they should also plan for a transfer of the assets as alternative.
BFH, Beschl. v. 28.11.2016 – GrS 1/15
BGH, Urt. v. 14.7.2010 – X R 34/08
BMF-Schreiben vom 27. März 2003 – „Sanierungserlass“