German tax pooling (Organschaft) – Federal Tax Court rules on requirements of fulfilling obligations under profit and loss transfer agreement

Summary of Facts 

The plaintiff, a German limited liability company ("GmbH"), entered into a profit and loss transfer agreement ("PLTA") with its sole shareholder ("Shareholder") in 2002, under which GmbH served as the controlled company (Organgesellschaft) and the Shareholder as the controlling company (Organtraeger). With effect of the PLTA, the parties established a tax pooling / fiscal unity (Organschaft) of corporate income tax and trade tax purposes. 

During 2009 to 2011 (the "Disputed Tax Years"), GmbH generated profits which, under the PLTA, were to be transferred to the Shareholder. GmbH recorded the profits to be transferred to the controlling company in an account entitled "Liabilities to Shareholders" (the "Liabilities Account").  

However, the Liabilities Account recorded no counter-claims or payments, nor any regular account settlements, i.e. there was not a genuine current account relationship. Account movements were therefore limited to the regular recording of annual profit transfer obligations and interest on the claims.

It was not until 2017, six to eight years after the Disputed Tax Years, that the parties agreed to settle the payment obligation of the Liabilities Account by way of a set-off.

Tax Audit and Court Decision

A tax audit concluded that, due to the lack of actual implementation of the PLTA, the mandatory requirements of a tax pooling were not met. Obligations under the PLTA, i.e. the transfer of profit or the balancing of losses of the Organgesellschaft, must be fulfilled. The continuous recoding on the Liabilities Account without any balancing or recoding of counter claims, does not qualify as fulfilment of the PLTA's obligations. 

The German tax authority subsequently issued amended assessments for corporate income tax and trade tax against GmbH, which GmbH objected. GmbH's objection was unsuccessful and the action before the Fiscal Court was dismissed as unfounded.

The Federal Fiscal Court ("BFH") then dismissed the plaintiff's appeal, agreeing with the Fiscal Court that it was unfounded and, for the first time at the highest judicial level, clarified that claims arising from a PLTA must generally be satisfied within twelve months of becoming due. 

The mere recording in a clearing account, without booking counter-claims and without regular account settlement, was insufficient to satisfy the requirements. 

Further, the set-off in 2017 for the Disputed Tax Years was belated, as the 12-month deadline had already expired several years earlier. 

The BFH also reaffirmed its strict interpretation of fiscal unity law, emphasising that the restrictively drafted statutory requirements must not be relaxed.

Practical Implications:

• 12-month deadline as binding timeframe for satisfaction: Claims arising from a PLTA must generally be satisfied within twelve months of becoming due. Late satisfaction may lead to non-recognition of the fiscal unity for the relevant assessment period.
• Fictitious clearing accounts insufficient: The mere recording in a clearing account without counter-claims and without regular account settlement is insufficient to satisfy the strict requirements. Genuine clearing accounts (section 355 German Commercial Code) with regular balance settlement may be compliant with fiscal unity requirements; however, the specific accounting entries and accounting treatment are key.
  
  Whether a novation of the profit transfer obligation into a shareholder loan meets the BFH's requirements was not a subject matter of the case. At least in the case of long-term loan relationships without actual payments (interest and/or principal), a comparable factual situation could exist.
• Loss of utilised loss set-off opportunities: If the fiscal unity fails, the set-off of profits and losses within the fiscal unity is not possible. This can lead to significant tax payments, particularly if individual fiscal unity members were profitable while others were loss-making. The profitable company must pay tax on its profits whilst the loss-making company merely accumulates loss carry-forwards, which may or may not be economically valuable.
• Retroactive loss of fiscal unity: A Fiscal unity must be concluded with a minimum term of five years. If the fiscal unity fails during the minimum term, it will not be recognized retroactively for the entire period since it was meant to take effect. If actual implementation fails for individual years after expiry of the five-year minimum term, the effects of the fiscal unity lapse for those years only. It should be noted that a one-time failure of the fiscal unity, for example in year 6, may lead to a fresh start of the fiscal unity for year 7.
• Recharacterization as hidden profit distributions: If the fiscal unity is not recognised, the commercial law profit transfers that have been made are recharacterized as hidden profit distributions, which leads to withholding tax on capital gains and potentially further tax claims. However, it should be noted that withholding tax on capital gains is generally not levied in purely domestic situations (which should typically be the case for failed fiscal unities).
• Financial reporting - provisioning: Depending on the taxpayer's individual risk assessment and the anticipated tax consequences, it may be appropriate to create balance sheet provisions for potential tax payments and ancillary charges. Particularly in situations very similar to the facts of this decision, it may be considered more likely than not that a failed fiscal unity exists.
• Anticipation of the decision in upcoming tax returns: Depending on the specific circumstances, it may be appropriate to anticipate a failed fiscal unity in upcoming tax returns and accordingly not declare a fiscal unity.