Corporate taxation in Germany is based mainly on the Income Tax Act (Einkommensteuergesetz, hereinafter: EStG) and the KStG. §10d(2) EStG allows losses incurred in a tax year to be carried forward, i.e. according to the ability-to-pay principle, taxable income in future tax years may be reduced by setting off the losses up to a maximum of EUR 1 million each year. Under §8(1) KStG, this possibility to carry forward losses also applies to entities subject to corporate income tax.

The possibility of carry-forward of losses resulted in trade in empty-shell companies (Mantelgesellschaften), which had long ceased any economic activity but still retained losses that had been carried forward.

1. (a)

   a corporate entity is not economically identical if more than half of its shares are transferred and if the entity then continues its economic activity or starts it again with predominantly new assets;

2. (b)

   a corporate entity is economically identical, however, if the injection of new assets is solely for the purpose of restructuring the loss-making entity and if the activity which gave rise to the unrelieved loss carry-forward continues on a comparable scale for the following five years;

3. (c)

   a corporate entity is also economically identical if, rather than injecting new assets, the acquiring entity covers the losses that have accrued at the loss-making entity.

The last two examples were commonly referred to as the ‘Sanierungsklausel’ (clause allowing for restructuring of companies in difficulty).

§8(4) KStG was repealed with effect from 1 January 2008 by the Business Taxation Reform Act 2008 (Unternehmensteuerreformgesetz).

1. (a)

   unused losses are forfeited entirely if more than 50 % of the share capital, membership rights, ownership rights or voting rights is transferred to an acquirer;

2. (b)

   if, within a period of five years, more than 25 % but not more than 50 % of the share capital, membership rights, ownership rights or voting rights is transferred, unused losses are forfeited on a pro rata basis.

Initially the new rule did not provide any exception for companies in the process of restructuring and at the same time subject to a significant change in ownership.

1. (a)
   the acquisition serves the purpose of restructuring the corporate entity7;
2. (b)
   the company is, or is likely to be, insolvent or over-indebted at the time of the acquisition8;
3. (c)

   the company’s fundamental business structures are preserved, which requires:

   • the corporate entity to honour an agreement between management and works council (Betriebsvereinbarung) on the preservation of jobs, or

   • preservation of 80 % of the jobs (in terms of the average annual wage bill) for the first five years following the acquisition, or

   • injections of significant business assets or write-off of debts which still have an economic value within 12 months; business assets are significant if they represent at least 25 % of the assets of the previous financial year; any transfer back to the acquiring entity within the first three years are deducted;

4. (d)

   the company does not change sector of activity during the five years following the acquisition;

5. (e)

   the company had not ceased operation at the time of the acquisition.

§8c(1a) KStG entered into force on 10 July 2009 and applies retroactively from 1 January 2008.

It should be noted that the losses carried forward can be offset only against the profits of the company that is being restructured. The acquiring company cannot offset the losses against its own profits.

However, under German corporate tax law such losses are not forfeited; they are merely ‘frozen’ at the level of the entity and may be used only once the company is no longer consolidated. There is no time limit for the carry-forward of these ‘frozen’ losses.

The acquiring company benefits indirectly from §8c(1a) KStG because, once the restructuring process has been successfully completed, the tax burden of the restructured entity is reduced. Furthermore, the acquiring company may of course merge part or all of its activities into the acquired company and hence use the losses carried forward.

The new rule in §8c(1a) KStG differs from the preceding rule, the repealed §8(4) KStG, in one important aspect which is crucial for the assessment for State aid purposes.

Under §8c(1) KStG, a company forfeits its loss carry-forward where more than half of the shares are transferred, unless the Sanierungsklausel is applicable. Thus, the general rule is the forfeiture of loss carry-forwards on significant changes in ownership. The existing Sanierungsklausel therefore is the exception to the general rule.

Under the earlier §8(4) KStG, the general rule was continuation of loss carry-forwards in the case of significant changes in ownership, provided that the company was economically identical. This exception was intended to prevent abuse, for example in the form of trading in shell companies.

Germany takes the view that §8c(1a) KStG is a general measure, since it may be used by all undertakings, regardless of their region, sector and size. Germany points out that any undertaking could potentially find itself in financial difficulties outside its control and be a candidate for application of the rule.

Germany takes the view that these considerations were of particular importance for tax incentives for research and development, but also for environmental protection, training and employment. In the view of the German authorities, tax rules that favour undertakings making particular efforts in these areas are not selective, since they are open to all undertakings, even if de facto they are of greater benefit to undertakings active in certain sectors than others. In Germany’s view, the same reasoning should also apply to tax rules that favour undertakings in difficulty which are acquired in order to be restructured.

The German authorities argue that, unlike the measures in DMT and HAMSA, §8c(1a) KStG does not provide for discretionary decisions by public bodies, but that its application flows automatically from the law. Therefore, applying the a contrario argument, §8c(1a) KStG is not selective.

Germany also takes the view that §8c(1a) KStG forms part of the body of rules under German insolvency law. In particular, the eligibility of an undertaking is based on the notions of insolvency, risk of insolvency and over-indebtedness, which are defined in the InsO and which provide grounds for the opening of insolvency procedures.

On the question of selectivity, Germany concludes that the Commission’s view would mean that any tax reduction constituted State aid, even if it were generally applicable, and that such a position was in breach of the TFEU.

Germany asserts that the exemption created by §8c(1a) KStG is justified by the nature and overall structure of the German corporate tax system. It claims that there is an objective difference between undertakings in difficulty which are in need of restructuring and other undertakings, and that this objective difference justifies different treatment of undertakings in difficulty which are acquired in view of restructuring. The German authorities base their argument on three considerations.

Firstly, whereas financially sound undertakings have a choice between seeking finance on the capital markets and looking for an undertaking to acquire them, undertakings in difficulty only have the latter option, as they will not be able to raise debt on the capital market or obtain a bank loan. As a result, undertakings in difficulty will systematically forfeit the possibility of carrying forward their losses, whereas healthy undertakings always have the choice between debt financing and looking for a buyer.

Secondly, the ratio legis of §8c(1) KStG, i.e. preventing trade in empty-shell companies with accumulated losses, does not require the exclusion of loss carry-forward in situations where the acquisition is for the purpose of restructuring rather than simply tax optimisation. Without the restriction of §8c(1a) KStG to acquisitions of undertakings in financial difficulty in view of restructuring, i.e. if other acquisitions were also included, the ratio legis could no longer be maintained.

Thirdly, the purpose of §8c(1) KStG is to ensure that the sale price of stakes in undertakings is based solely on the economic value of the undertaking and that the value of accumulated losses for tax optimisation does not affect the sale price. In the case of the acquisition of an undertaking in difficulty in view of restructuring, however, the possible value of accumulated losses plays no particular role. To substantiate this argument, Germany points out that accountants do not attach any value, in commercial group accounts, to potential carried-forward losses of an ailing undertaking.

For these three reasons taken together, Germany considers that, even if §8c(1a) KStG were prima facie selective, it is in any event justified by the nature and overall structure of the German corporate tax system.

Germany observes that, with effect from 1 January 2008, §8c KStG replaced a similar rule that was repealed at the same time, namely §8(4) KStG. Both rules pursue the same objective, i.e. the prevention of trade in empty-shell companies with accumulated losses.

Germany notes that the Commission had never expressed any concerns with regard to §8(4) KStG, and that it therefore appears that this rule did not constitute State aid.

Germany therefore regards the Commission’s position in this regard as incoherent.

Germany has pointed out that many other Member States have comparable rules to §8c(1a) KStG. Examples are Austria, Belgium, Finland, Italy, Luxembourg and the Netherlands. It notes that the Commission has not taken any action under the State aid rules against these Member States, despite the great similarities between the systems.

In relation to paragraph 34 of the opening decision, which sets out the action the Commission has taken with respect to the French system, Germany stresses that the German system differs from the French system, which is limited to certain sectors of the economy and provides a complete exemption from corporate income tax.

A measure must be financed through State resources, and the use of State resources must be imputable to the State. A loss of tax revenue is equivalent to consumption of State resources in the form of fiscal expenditure. By allowing companies to reduce their corporate tax burden through loss carry-forward, Germany is foregoing revenue, which constitutes State aid. Germany has informed the Commission that implementation of the measure could lead to a tax revenue shortfall of EUR 900 million every year. Since the measure implies a loss of State resources, it is therefore granted through State resources. The aid is granted by a law, and is therefore imputable to the State.

Pursuant to §8c(1) KStG, certain changes in the ownership structure of an undertaking mean the partial or complete forfeiture of the possibility of carrying forward past losses for tax purposes.

§8c(1a) KStG creates an exception to that rule where the change in ownership concerns an undertaking in difficulty and takes place for the purpose of restructuring.

§8c(1a) KStG could therefore grant a selective advantage to companies fulfilling those conditions, since it enables them to set off past losses against future profits for the purpose of calculating their taxable income.

1. (a)

   §8c(1a) KStG complies with the private market creditor principle (5.2.1);

2. (b)

   §8c(1a) KStG is not prima facie selective (5.2.2);

3. (c)

   §8c(1a) KStG is justified by the nature and the overall structure of the German tax system (5.2.3).

Germany also points out the similarities between §8c(1a) KStG and its predecessor, §8(4) KStG (see 5.2.4) and that other Member States have similar rules (see 5.2.5).

The measure must be liable to affect intra-Union trade and distort or threaten to distort competition. §8c(1a) KStG is not sector-specific, i.e. all sectors can benefit from it. Virtually all sectors of the German economy are active on markets open to competition and intra-Union trade. Hence, the measure is liable to affect intra-Union trade and to distort or threaten to distort competition.

Therefore, as all the requirements laid down in Article 107(1) TFEU are met, the Commission takes the view that the scheme on the tax carry-forward of losses in the case of restructuring of companies in difficulty constitutes State aid within the meaning of that article.

Since §8c(1a) KStG was introduced in order to tackle the problems resulting from the financial and economic crisis, the Commission examined whether it could be declared compatible under Article 107(3)(b) TFEU, as interpreted by the Temporary Framework.

In the light of the current financial and economic crisis and its impact on the overall economy of the Member States, the Commission considers that certain categories of State aid are justified, for a limited period, to remedy this crisis and they can be declared compatible with the internal market under Article 107(3)(b) TFEU. The Temporary Framework sets out the conditions under which the Commission will declare such aid schemes compatible.

However, §8c(1a) KStG does not fall under any of the measures set out in the Temporary Framework because it concerns tax breaks for companies in difficulty. However, the Temporary Framework does not provide for State aid in the form of tax breaks.

The Commission therefore takes the view that §8c(1a) KStG does not meet the requirements for being declared compatible under Article 107(3)(b) TFEU, as interpreted by the Temporary Framework.

Since §8c(1a) KStG concerns tax advantages for ailing companies, the Commission examined its compatibility under the Rescue and Restructuring Guidelines. Under these Guidelines, only companies in difficulty are eligible for aid. Whereas an insolvent or over-indebted company can be considered as being in difficulty within the meaning of the Guidelines, paragraph 13 of the Rescue and Restructuring Guidelines provides that a firm belonging to or being taken over by a larger business group is not normally eligible for rescue or restructuring aid. One of the requirements of §8c(1a) KStG is a change in shareholding. After such a change, the target company might belong to a group. In this case, it would normally be for the group to assist the target company in difficulty, which would then not be eligible for aid under the Rescue and Restructuring Guidelines.

In addition, even for the beneficiaries eligible for aid under the Rescue and Restructuring Guidelines, other requirements of these Guidelines are not met.

Under paragraph 25(a) of the Rescue and Restructuring Guidelines, rescue aid can only take the form of loans or loan guarantees. Hence, the tax advantage in question cannot be considered to be rescue aid.

In the case of restructuring aid, the Rescue and Restructuring Guidelines require the submission of a realistic restructuring plan to restore the viability of the company. The aid must be limited to the minimum necessary. In this context, the beneficiary has to make a contribution to the restructuring costs. Finally, to avoid undue distortions of competition, the Rescue and Restructuring Guidelines provide for compensatory measures.

Not all of these conditions are fulfilled by §8c(1a) KStG. While the explanatory memorandum indicates that the target company has to provide a reorganisation plan with a positive business outlook, there is no indication that such a plan would meet the requirements of the Rescue and Restructuring Guidelines, nor that the amount of the aid is limited to the minimum necessary. The amount of aid depends on the losses that a company incurred in the past. Moreover, §8c(1a) KStG does not provide for a contribution by the beneficiary or compensatory measures.

Finally, rescue and restructuring aid to large enterprises must be notified individually. It cannot be granted as part of a scheme. §8c(1a) KStG does not distinguish between large companies and SMEs.

Even for SMEs, where rescue and restructuring aid can in principle take the form of a scheme, the Commission notes that the particular requirements for such a scheme set out in paragraph 82 of the Rescue and Restructuring Guidelines are not met, for the same reasons set out above in recital 117.

Therefore, the Commission takes the view that §8c(1a) KStG is not compatible with the internal market as restructuring aid.

§8c(1a) KStG must also be examined in the light of the Regional Aid Guidelines.

Potential beneficiaries of regional aid must be located in a German region eligible for regional aid. Under §8c(1a) KStG, this is not necessarily the case, because the provision applies to companies located throughout Germany.

Furthermore, the Regional Aid Guidelines exclude from their scope undertakings in difficulty within the meaning of the Rescue and Restructuring Guidelines (see paragraph 9). Therefore, even aid for undertakings located in eligible regions cannot be declared compatible on the basis of the Regional Aid Guidelines.

The Commission therefore takes the view that the measure is not compatible with the internal market as regional aid.

Finally, §8c(1a) KStG must be examined in the light of the Environmental Aid Guidelines.

The primary objective of the Environmental Aid Guidelines is to ensure that State aid measures will result in a higher level of environmental protection than would occur without the aid and to ensure that the positive effects of the aid outweigh its negative effects in terms of distortions of competition, taking account of the polluter pays principle (hereafter ‘PPP’) established by Article 191 TFEU.

This objective is not fulfilled by §8c(1a) KStG. The explanatory memorandum does not refer to any objective within the meaning of the Environmental Aid Guidelines.

As paragraph 20 of the Rescue and Restructuring Guidelines states, a firm in difficulty, given that its very existence is in danger, cannot be considered an appropriate vehicle for promoting other public policy objectives until such time as its viability is assured. Since all potential beneficiaries of §8c(1a) KStG are companies in difficulty within the meaning of paragraph 10(c) of the Rescue and Restructuring Guidelines, the Commission is of the opinion that §8c(1a) KStG is not compatible as environmental aid.

The Commission notes that the notified measure falls within the scope of both the Temporary Framework and the Rescue and Restructuring Guidelines. Therefore, when exercising its discretion under Article 107(3)(b) and (c) TFEU, it is bound by these two texts, for the reasons set out above in recital 109 et seq.

In this case, Germany has not presented any arguments that the aid is compatible with the internal market directly under Article 107(3)(b) or (c) TFEU.

The Commission notes that, due to the design of the aid measure, the amount of aid depends on the losses which the beneficiary has recorded in the past. Therefore, there is no link between the amount of aid received by an undertaking and the objective pursued by the aid scheme, i.e. the removal of barriers to restructuring and support for undertakings in difficulty during the economic and financial crisis. The Commission therefore concludes that the aid scheme is not limited to what is necessary to achieve its objective. As a consequence, it distorts competition in the internal market to an extent contrary to the common interest.

The Commission therefore concludes that the measure cannot be declared compatible based directly on Article 107(3)(b) or (c) TFEU.