I. Current situation: extinction of tax loss carry-forwards according to § 8c KStG

According to the wording of § 8c KStG, the usage of tax losses of corporations is restricted in the case of so-called detrimental acquisition of participation: if more than 25 % of participation or voting rights are indirectly or directly transferred to one purchaser or to persons closely associated to the purchaser within a period of five years, the tax loss carry-forwards are lost proportionally in the amount of the ratio of the participation or voting rights transferred. However, the German Federal Constitutional Court (Bundesverfassungsgericht) recently declared the provisions of § 8c KStG unconstitutional to the extent they stipulate that such proportionate extinction of tax loss carry-forwards occurs if more than 25 %, but not more than 50 % of the participation or voting rights are transferred.
The full extinction of tax loss carry-forwards, which occurs if more than 50 % of participation or voting rights are transferred, remains unaffected by the decision of the German Federal Constitutional Court.
The purpose of § 8c KStG was to stop the so-called acquisition of shelf corporations with tax losses – that is, the acquisition of corporations without activities and with high tax loss carry-forwards. However, not only did the broad wording of § 8c KStG affect the purchase of shelf corporations with tax loss carry-forwards, but also, among other things, impede restructurings and disadvantage start-up companies.
Companies which are in need of restructuring often depend on the provision of fresh equity, such as by the entry of new investors or restructuring plans with the purpose that loan capital is converted to equity (so-called debt-equity-swap). In both cases the situation of a “detrimental” acquisition of participation will frequently occur and therefore the extinction of the tax loss carry-forwards. The provision in § 8c para. 1a KStG, which is envisaged as an exception from the extinction of tax loss carry-forwards, cannot be applied as it lacks conformity with European law.
Start-up companies very often have start-up tax losses which are carried forward in the normal course of business and are offset against profits later on. Young start-up companies are usually – in most cases several times – provided with “fresh” equity in the scope of financing rounds. The entry of investors usually results in a change in shareholders – and therefore in a “detrimental” acquisition in the sense of § 8c KStG.
There are few exceptions from the extinction of tax loss carry-forwards according to § 8c KStG envisaged by law: only in particular group constellations (§ 8c sec. 1 sentence 5 KStG) or if the company has enough hidden reserves subject to German taxation (§ 8c sec. 1 sentences 6-8 KStG), tax loss carry-forwards will be maintained.

II. New legal provision of § 8d KStG – tax loss carry-forward subject to continuation

1. Aim

The new provision of § 8d KStG serves the legislation purpose to regulate the extinction of tax loss carry-forwards in the cases of change of shareholders according to § 8c KStG based on its original purpose, that is, prevention of abuse (prevention of trading with tax loss carry-forwards). At the same time, tax obstacles in corporate financing should be removed by the new entry or change of shareholders.
The new provision stipulates that upon application by the taxpayer the extinction of tax loss carry-forwards according to § 8c KStG does not occur if the corporation has maintained only the same business operations since its foundation or at least since the beginning of the third business year before the business year of the detrimental acquisition of participation and the business operations are not discontinued within this time period until the end of the business year in which the detrimental participation was acquired.
The revised article applies to tax loss carry-forwards under corporate tax law and via the reference directive of § 10a sentence 10 GewStG (Trade Tax Act) also for tax loss carry-forwards under trade tax law of corporations and via the reference directive of § 8a sec. 1 sentence 3 KStG to the so-called interest barrier.

2. Business operations and application

The decisive factor is whether the same business operations have been maintained and are not discontinued. According to § 8d sec. 1 sentence 3 KStG, these business operations include “the corporation’s activities which are characterized by the consistent purpose of making a profit, in a sustainable manner, complementary and mutually supportive as well as by qualitative properties on an overall context.” The qualitative properties mentioned are in particular the services or products offered, the customer and supplier base, the markets served and the employees’ qualifications.

According to § 8d sec. 2 KStG the following cases are equal to the discontinuation of the business operations:

• The business operations are directed at a different purpose;
• the corporation starts additional business operations;
• the corporation becomes a co-entrepreneur (Mitunternehmer);
• the corporation takes the position of a controlling company in the sense of § 14 sec. 1 KStG; or
• business assets are transferred to the corporation and the corporation assesses them with a lower value than the fair market value.

If the corporation has maintained only the same business operations since its foundation or at least since the beginning of the third business year before the business year of the detrimental acquisition of participation and none of the above-mentioned cases occur, the corporation may file an application with the result that § 8c KStG is not applicable and the extinction of tax loss carry-forwards does not occur even though detrimental acquisition of participation was made.
The request for application of § 8d KStG has to be made in the tax declaration for the assessment of the assessment period in which the detrimental acquisition of participation is made.

3. Legal consequences

The tax loss carry-forwards that remain at the end of that assessment period in which the detrimental acquisition of participation is recorded separately and established as a “tax loss carry-forward subject to continuation”.
If the company makes profits in subsequent business years, the tax loss carry-forward subject to continuation has to be deducted before deducting a tax loss carry-forward determined according to § 10d Abs. 4 EStG (Income Tax Act). That means: the tax loss carry-forward subject to continuation is “used up” before any potential tax loss carry-forward subsequently arisen.
If, however, the business operations are discontinued in the subsequent years or one of the above-mentioned cases (§ 8d para. 2 KStG) occurs, the tax loss carry-forward subject to continuation most recently determined is in principle lost. Only if the company has enough hidden reserves subject to German taxation, the loss of tax loss carry-forward subject to continuation can be avoided.

4. Temporal scope of application

§ 8d KStG may be applied on detrimental acquisition of participation after 31 December 2015 in the sense of § 8c KStG.

III. Evaluation of the new provision

The provisions of § 8d KStG are appreciated as corporations with tax loss carry-forwards get the possibility to maintain the tax loss carry-forwards in the case of per se detrimental acquisition of participation.
In practice the relevant issue will be at which point the “discontinuation of business operations” or a “detrimental event” in accordance with § 8d para. 2 KStG will be assumed and how these properties are dealt with by the financial authorities. There are partially significant restrictions on entrepreneurial freedom in the cases mentioned and also on the implementation of economically useful restructurings. In addition to that, there are “grey areas”: where is the point when the reduction of the scope of business operations becomes “discontinuation” of business operations or when does the expansion of current business operations into neighboring areas of business become a detrimental change of the business model – according to the reasons given for the law, at least organic growth is not to be considered detrimental.