M&A tax changes in Germany 2012/2013

Although the average deal size in Germany increased in 2012, the number of completed private equity deals remained broadly flat for the fourth year running, suggesting that the post-crisis activity level is now relatively established. The same can be said for the financing of transactions, with a stable debt-equity ratio of between 40% and 50% being evidenced in 2012.

Many funds believe the German deal market will improve in 2013, although this comes with a measure of uncertainty, in particular linked to the economic situation within the eurozone. That being said, economic stability would support a level of optimism, and there are numerous medium to large transactions that are already known to be under preparation for 2013. At some point, we expect the wave of exits linked to fundraising activities and maturing debt capital structures, but this still seems some way off. Until then it seems like we are in for more of the same, with 2013 likely to mirror the experiences of 2012.

Because of the upcoming elections in September 2013, the two chambers of Parliament, Bundestag and Bundesrat, were unable to reach an agreement in 2012 on the package of Bills proposing changes to the tax acts for 2013. But a partial compromise was reached by a mediation committee of the two chambers leading to a modified Bill for the revision and simplification of corporate taxation and the tax law on travel cost and acceptance of a modest increase in the basic personal allowance for income tax. The Bundestag has now passed both Bills and forwarded them to the Bundesrat which has confirmed part of the Bills in February 2013. Especially, the changes to the German tax group rules should positively affect tax risk evaluations within M&A transactions. The main changes are as follows:

At present, a tax group subsidiary must be both registered in and managed from Germany. This dual tie to Germany appeared to be an excessive restriction on the freedom of establishment to the European Commission and the government has responded with its proposal to require any tax group subsidiary to be managed from Germany, provided its seat (registered office) is in an EU/EEA member state. This amendment is to apply to all open cases.

Partly in reaction to a Supreme Tax Court judgment on the non-discrimination of foreign shareholders, the Bill provides that the holding in a tax group subsidiary must be attributable to the German permanent establishment of the parent, regardless of its seat or place of management. There is also a condition to the effect that the income attributed to that permanent establishment must be taxable in Germany under both domestic law and the relevant double taxation treaty. The intention is to close a loophole potentially attributing German taxable income to a foreign parent without its own German tax liability, although the consequences may well be far reaching. The change is to apply to the 2012 year of assessment.

Present law denies relief for the losses of a tax group parent that can also be claimed abroad. Cutting the dual tie by allowing foreign subsidiaries to join a tax group if they are managed from Germany (see above) requires extension of the denial of loss relief to the tax group subsidiary. So, losses of a tax group parent or subsidiary are to be excluded from German relief if they are offset abroad by the parent, the subsidiary or by any other entity. This change is to apply to all open cases.

At present, a tax group is invalidated where the accounts on which the profit transfer or loss consummation under the profit pooling agreement was based are later found to be in error (considered as lack of actual enforcement). Typically, the error is found by the tax auditors long after the following year's financial statements have been resolved. The Bill would protect companies from this collapse of their tax group, provided:

• The shareholders had validly adopted the accounts under company law;

• The error was not necessarily apparent to management applying acceptable standards of commercial prudence (this is the case, for example, if the accounts were audited); and

• The error is corrected in the accounts for the year following its discovery and an appropriate adjusting payment made to the correct amount of profit transfer or loss consumption.

This change also applies to all open cases.

The profit pooling agreement of a GmbH must now make an explicit and unqualified reference to section 302 of the Aktiengesetz (Public Companies Act), the provision governing the loss consummation of public companies by their controlling parents. This is to ensure that any changes to the Public Companies Act in this regard automatically apply to GmbHs in a similar position. Any necessary alteration to the profit pooling agreement must be resolved and registered by December 31 2014, unless the tax group terminates on or before that date. Such alteration is not to be regarded as a new agreement.

From 2014, the procedures for taxing a tax group parent will become fully dependent on the tax position of the subsidiary. This will avoid the discrepancy occasionally experienced from retrospective changes to a subsidiary's results (say on tax audit) that cannot be taken up by the parent, whose assessment for that year has already become final and binding.

The maximum loss carry back from 2013 is to be increased from €511,500 ($670,500) to €1 million

The following changes relevant for M&A deals are likely to be introduced during March 2013:

The European Court of Justice had decided that the German corporate taxation of dividends would constitute a breach of EU law because the German dividend withholding tax would be credited or refunded for German corporate recipients, whereas non-German EU corporate recipients would suffer definitive withholding tax if they held less than 10% in a German corporation (as of 10% shareholding, the exemption under the EU Parent-Subsidiary Directive would apply).

A special working group has now issued its proposal of a political compromise to mitigate the breach of EU law, and it is likely that such proposal will be agreed by the legislative bodies in the course of March 2013. Under such compromise, the current 95% dividend exemption will be abolished for dividends that German or non-German corporations would receive from minority shareholdings (less than 10%) unless such dividends have been paid before March 1 2013 (in which case the German withholding tax would be refunded upon application).

The good news from the political compromise of the special working group mentioned above with regard to M&A or private equity deals would be that capital gains from the disposition of such minority shareholdings remain entitled to the 95% exemption. In practice, such 95% exemption for capital gains would be important for non-treaty protected (offshore) investors in German deals which hold (indirectly through a German or non-German tax-transparent private equity fund) a shareholding of 1% or more in a German corporation. But such offshore investors should be aware that the German tax administration may request tax returns and tends to apply an increasingly restrictive interpretation of the 95% capital gains tax exemption in practice.

M&A deals are often structured through Benelux acquisition or holding companies which use to issue hybrid instruments such as (convertible) preferred equity certificates – (C)PECs. Under current tax reform proposals, German-resident recipients of dividends from hybrid instruments would not qualify for any dividend tax exemption if such payments are deductible from income of such acquisition/holding companies in the other state. Private equity funds using Benelux acquisition companies may have to revisit the tax position of their German corporate and individual investors.

Most German states have increased the real estate transfer tax (RETT) from 3.5% to 4.5% or even 5%. A technique to avoid German RETT for the purchaser has often been the interposition of a RETT blocker which aims to prevent a transfer of the legal ownership of 95% of the shares in a property holding company. But the political compromise has now been settled to look through such RETT blocker to aggregate all direct and indirect shareholdings in calculating the 95% threshold, and the Bundesrat has addressed this in the proposed revised light Tax Bill 2013. If 95% of the beneficial ownership as defined under the new look-through rules has been changed after December 31 2012, the RETT would become due now.

Note: Some have questioned whether the retroactive effect of the Tax Bill 2013 is constitutional.

The Authorised OECD Approach (AOA) to taxing permanent establishments as though they were separate legal entities is also likely to be implemented in the course of the fiscal year 2013.

The top three predicted effects of the Alternative Investment Fund Managers Directive (AIFMD) on funds have proven to be true with increased costs in the management company, recruitment of staff to handle compliance issues and restrictions of fundraising activities cited as the top effects in practice. The German legislature has already issued draft bills for the implementation of the regulatory and tax consequences.

• One highlight of the regulatory draft legislation is the proposal under which private equity funds would be obliged to notify the German Supervisory Authority (BaFin), the board of directors, as well as the council of the employees about the acquisition of a controlling stake in a non-listed portfolio company. In addition, subject to certain conditions, information about leverage may have to be filed at the BaFin.

• Another German peculiarity has been suggested by the draft tax legislation under which the taxation of funds would be divided into three categories: Investments funds would enjoy tax transparency under the beneficial rules of the draft Investment Tax Act, however, limited partnerships would be subject to the ordinary taxation rules, including German controlled foreign company (CFC) rules, and all other funds (including corporate funds like SICAVs or others like FCPs, FCPRs) would be subject to some kind of semi-transparent taxation with the aim to introduce taxation of retained earnings.

• An interesting question is whether the consequences of the AIFMD could be mitigated through certificate or bond structures. But the Bundesrat has requested to check the suitability of anti-avoidance rules.

The EU Commission has issued its proposal for a directive on the new financial transaction tax (FTT) to be introduced as of January 1 2014. M&A deals involve a series of instruments (securities both equity and debt, hybrid instruments), which may become subject to the new FTT.

With regard to the Foreign Account Tax Compliance Act (FATCA), the majority of funds believe that compliance with FATCA will have no impact on either fund structures or portfolio companies.

Several German states have requested to abolish the beneficial tax regime (40% tax exemption) for carried interest received through funds structured as non-trading partnerships. The outcome should mainly depend on political discussions which may also include the developments of similar disputes in the US and the UK. Funds may have to revisit their carried interest structures.

The level of importance attributed to sustainability or environmental, social and governance issues will also remain high.

The German tax legislature is to introduce some changes which will definitely help, like the newly introduced tax group rules, but also creates additional complexity such as the taxation of hybrid instruments, the proposed abolishment of RETT blocker structures or the effects from AIFMD. In addition, the discussion on base erosion and profit shifting (BEPS) and aggressive tax planning (ATP) by the OECD, which may also have effects for M&A transactions, will remain on the agenda for 2013.

Generally, as last year, flexibility and creativity remain the key factors to deal-making in 2013, potentially including a greater willingness by many funds to non-control positions. Primary situations will continue to be less abundant than secondary/tertiary opportunities, meaning that creating a new equity story will be crucial to driving investment decisions and consequently deal activity levels within the private equity space.

Unsurprisingly, funds continue to see the main potential being in the traditional German Mittelstand heartland of engineering and industrial innovation. Healthcare and related services continue to be supported by the shifting demographics in Western Europe and the relative protection offered from the economic environment; but the political and reputational dynamics that need to be assessed in this sector remain a key consideration.

Although there are strong fears that Germany may enter recession in Q1 of 2013, it remains the economic powerhouse and safe haven of the eurozone. The fundamental dynamics of the economy are still intact, and growth is still forecast for 2013 as a whole. While numerous challenges clearly remain, Germany is still a highly attractive territory for private equity investors. Any upturn in deal activity levels will continue to depend upon deal flow and valuation expectations; however, with a stability achieved over recent years in terms of both completed deals and availability of credit, the optimism may well have some foundation should the eurozone turn the corner, as we all hope that it will.

Klaus Schmidt
		PricewaterhouseCoopers Tel: +49 (0)89 5790 6706 Fax: +49 (0)89 5790 5731 Email: klaus.schmidt@de.pwc.com Klaus Schmidt leads the German M&A tax team at PwC. He is based in the Munich office and has more than 12 years of experience in international M&A. He is an attorney at law and a certified German tax adviser (Steuerberater). Klaus has gained extensive experience in international M&A transactions, joint ventures, reorganisations, international tax structuring and due diligence. He is providing M&A advice to a number of private equity clients as well as corporate clients from the US and Europe.

André Gloede
		PricewaterhouseCoopers Tel: +49 (0)69 9585 6014 Fax: +49 (0)69 9585 971405 Email: andre.gloede@de.pwc.com André is a certified German lawyer and holds a PhD from the international tax institute in Hamburg. He has deep experiences from structuring German and international aspects of pan-European private equity funds. This includes tax and regulatory aspects. André also advises institutional investors (insurance companies) on their investments in private equity funds. In addition, he is structuring infrastructure funds and renewable energy funds.