GLG News by Peter Dehnen

Implications: EU Internal Market Commissioner Charlie McCreevy announced that he wants to take Germany to the European Court of Justice (ECJ) since in his view, Germany has failed to amend the so-called “VW Law” properly and in line with European legislation. The ECJ held last year that the VW law was in breach of European rules on the free flow of capital across borders within the EU. The German car maker Porsche, which is Volkswagen’s major shareholder, currently owning 30 %, has already won permission from the European Commission (EC) to acquire control of VW and is about to do this step by step within the next few months. The German state of Lower Saxony, VW's second-largest shareholder with just slightly over 20 % of the ordinary shares, wants to keep its stake and the blocking minority provided by the VW Law.

Analysis: Yesterday, September 9, 2008, EU Internal Market Commissioner Charlie McCreevy announced that he wants to take Germany to the European Court of Justice (ECJ) since in his view, Germany has failed to amend the so-called “VW Law” properly and in line with European legislation. The VW Law, originally dating from 1960, shields Volkswagen from takeover. The ECJ held last year that the VW law was in breach of European rules on the free flow of capital across borders within the EU. Political Parties in Germany disagree about the future of the VW Law. Especially within the Christian Democrats (CDU) and the Liberal Party (FDP) the national party line diverges from the interests of the persons acting in Lower Saxony, which are also members of the VW supervisory board. While particularly the Liberal Democrats stand for a more liberal approach in economy, which means a pullback of the state from private companies, the Prime Minister of Lower Saxony Christian Wulff (CDU) and his minister of Economics Walter Hirche are in favour of the VW Law, as it protects the jobs of their voters at VW in Lower Saxony. The policy of the German Federal Government remains unclear with regard to the VW Law. It seems that the government plays out. Even now after the announcement of Market Commissioner Charlie McCreevy the government appeases the public that – so far – no claim was handed in at the ECJ. The German government had added a special note to the governmental draft of the revised VW Law, allowing the deletion of the blocking minority rule in the case of a challenge by the EC, which is now expected. Thereby the government is able to act last minute in the case of a final warning. On the other hand, the Federal State of Lower Saxony has already made share purchases to secure the blocking minority, since this blocking minority was at risk due to the issuing of employee shares. Therefore Lower Saxony might also buy up another 5 % of VW shares to reach 25 %, which is the ordinary blocking minority allowed for German stock companies. Lower Saxony might get that money from the sale of shares held in other private companies. Volkswagen has not commented on the EC decision since it sees itself as an object rather than as a player in this issue. Porsche welcomed the decision and said that it is to be expected that the EC will file another lawsuit against Germany in this case. The upcoming election campaign for 2009 hovers above all and might give political developments in Germany another drive.

Implications: Siemens announced that the Supervisory Board has approved recommendations of its law firm to claim damages from executive board members in charge between 2003 and 2006. It will be the first time in German history that a chief executive of a company listed on the German blue-chip stock index DAX has been sued for damages by his former employer.

Analysis:  Siemens announced on 29 July 2008 that the Supervisory Board has approved recommendations of its law firm to claim damages from almost all executive board members in charge between 2003 and 2006. Claims will be made against the former Siemens CEOs Heinrich von Pierer and Klaus Kleinfeld as well as against former top managers Johannes Feldmayer, Thomas Ganswindt, Edward Krubasik, Rudi Lamprecht, Heinz-Joachim Neubürger, Jürgen Radomski, Uriel Sharef, Günter Wilhelm and Klaus Wucherer. Siemens told Financial Times Germany that the managers had "breached their organizational and supervisory responsibilities" by failing to stop illegal practices and wide-ranging bribery in the company. It will be the first time in German history that a chief executive of a company listed on the German blue-chip stock index DAX has been sued for damages by his former employer. Both Heinrich von Pierer and Klaus Kleinfeld have consistently denied any wrongdoing. Michael Hendricks, an expert in directors & officers (D&O) insurance stated in the 29 July 2008 issue of the German Business Daily Handelsblatt that the justifications for the damage claims are “crystal clear“ and the chances of success are “very good”. Since D&O insurance policies do not pay in the case of intentional acts, the private assets of the managers are seriously at risk should they be found liable. Siemens, on the other hand, would be glad if it could recover the amount of around EUR 200 Million (approx. USD 290 million) calculated by Mr. Hendricks as the potential available damages. Experts estimate that a settlement of the issue could take 4-5 years as reported by the Handelsblatt in its 29 July 2008 issue. In addition to the civil damage claims, prosecutors in Munich, where the Siemens headquarters is situated, are still conducting investigations against more than 300 suspects in the scandal in which Simens allegedly bribed clients and customers around the world in order to win infrastructure contracts, using slush funds and sham companies to make the illegal payments. On Monday 28 July 2008, sentence was handed down in the first criminal proceeding of the Siemens probe with the Munich District Court giving Reinhard Siekaczek, a former middle-ranking manager, a two-year suspended sentence and imposing a remarkable fine of EUR 108,000 (approx. USD 157,000). The sentence is widely expected to have a signal effect for other criminal cases which could follow. While Daniela Bergdolt of a German lobby organization for the protection of shareholder rights (Deutsche Schutzvereinigung für Wertpapierbesitz) called the decision “absolutely correct”, Peter von Blomberg, head of Transparency International Germany, called the decision “very mild” citing the fact that the accused cooperated with the court and supported the entire investigation process. The current criminal proceedings as well as the damage claims against Siemens managers are unprecedented and the Siemens case has increased attention to corporate compliance and risk management issues at German companies of all sizes and in all branches.

Implications: Porsche recently purchased shares outright corresponding to a 4.92 % share of VW’s common stock. The European Commission announced the postponement, of its decision in regard to the request submitted by Porsche for approval of its planned shareholding. Meanwhile, in order to ensure that its share of VW remains at the important mark of 20%, Lower Saxony recently purchased 500,000 additional VW shares. In a 2007 decision, the ECJ struck down various provisions of the so-called “VW Law” which contained a minority blocking provision as well as a voting rights cap to protect the interests of the German State of Lower Saxony. In reaction to the ECJ’s decision, the German Ministry of Justice drafted a “new” VW Law which retained the 20 % blocking minority provision of the old law based on Lower Saxony’s interpretation of the ECJ ruling.

Analysis: Porsche wants majority interest in VW
It is no secret that Porsche intends to increase its interest in Volkswagen from currently 31 % to a planned 50 %. However, Porsche seems to have changed its tactics somewhat. While Porsche has so far generally relied on the purchase of stock options, it recently purchased shares outright corresponding to a 4.92 % share of VW’s common stock. The purchases will not, however, become effective until the antitrust authorities give green light for the merger.

European Commission postpones decision on Porsche-VW issue
The European Commission (EC) recently announced the postponement, to 23 July 2008, of its decision in regard to the request submitted by Porsche for approval of its planned shareholding increase after Porsche withdrew its original request and submitted a new one. Despite the EC’s announcement, Porsche continues to believe that the EC’s decision is a mere formality and that it will receive approval in the end. Porsche has already received approval from the US antitrust authorities and is also awaiting approval from the authorities of 15 other, non-European countries.

Lower Saxony purchases half a million extra shares
Meanwhile, in order to ensure that its share of VW remains at the important mark of 20%, the German State of Lower Saxony recently purchased 500,000 additional VW shares. This move was necessary, according to Lower Saxony’s Finance Minister, in order to prevent a dilution of its interest which could have arisen if and when the 3 million share options granted to employees are exercised. While the Finance Minister did not publish the purchase price of the additional shares, considering the current VW stock price it must have amounted to around EUR 9 million (approximately USD 13.2 million).

EU Launches Legal Action against Germany over “New” VW Law
In a 2007 decision, the European Court of Justice (ECJ) struck down various provisions of the so-called “VW Law” which contained a minority blocking provision as well as a voting rights cap to protect the interests of the German State of Lower Saxony. In reaction to the ECJ’s decision, the German Ministry of Justice drafted a “new” VW Law which retained the 20 % blocking minority provision of the old law based on Lower Saxony’s interpretation of the ambiguous ECJ ruling. As a result, the new VW law continues to shield VW, Europe's largest car maker, from takeovers by granting 20 % minority blocking rights to its shareholders although German law generally only allows a blocking minority of 25%. In effect, the new VW Law gives the German State of Lower Saxony, with its 20% interest, the ability to block actions desired by Porsche, the other main shareholder, which holds an interest of 31%. On 5 June 2008, the EC increased pressure on Germany over this so-called ”new VW Law” with an EC spokesman declaring that “special rights granted to the German authorities are not acceptable or compatible with basic (EU) treaty provisions such as the freedom of capital flows". The EC gave the German government a two-month deadline in which to react to concerns about the law and said failure to provide answers would result in the case being transferred back to the ECJ. Although Germany partly implemented the ECJ decision into the new VW Law, the EC believes that Germany’s interpretation of the ECJ ruling does not go far enough to ensure European rights and warned that new legal action could follow.    

Commentary
The currently running antitrust suits are just another major step in Porsche’s apparently unavoidable VW takeover. However the crucial point will not be when and how Porsche reaches the 50 % mark, but if, when and how the Federal State of Lower Saxony and the German Federal Government will lose their influence as a major shareholder of Volkswagen. While it seems more and more likely that the EC will force Germany to abolish the new VW Law, this will not clear the way for Porsche’s merger plans. The prime minister of Lower Saxony, Christian Wulff has already pulled out another joker: a 50-year-old letter of comfort signed by the German Federal Government, granting a “minimum state influence” at Volkswagen which could potentially force the Federal Government to purchase a 5 % stake in Volkswagen if and when the 20 % blocking minority provisions is abolished. In this case, a special VW Law would no longer be needed since the 25% blocking minority is common in German stock corporation law and also in line with European provisions. Therefore, while Porsche is well prepared for the merger it is not yet master of the situation. As long as Germany and Lower Saxony maintain their positions, Porsche will remain stuck in the back seat regardless of its actual ownership interest. Lower Saxony is not just a shareholder with a blocking minority, but also a shareholder who is not necessarily acting in the company’s best interests. The main goals of Lower Saxony are the protection of jobs at Volkswagen and consequently its suppliers and the protection and preference of VW factories in Lower Saxony (even over other factories in Germany). Monetary fines, procedural costs and purchase prices for supplemental shares can be brought up without considering its efficiency. There are also voices among German politicians calling for a sale of Lower Saxony’s shares in Volkswagen which would generate gains of around EUR 15 billion (approx. USD 22 billion) and would allow Lower Saxony to reduce its annual debt burden of EUR 700 million (approx. USD 1 billion). However, these voices are not yet drowning out the contrary voices. There is no doubt that Porsche will and should merger with Volkswagen one day. But so far, there is no master plan as to how this should be achieved.

Implications: Volkswagen’s two major shareholders – Porsche and the State of Lower Saxony - are on course for a showdown at the company’s upcoming annual general meeting (AGM) to be held on 24 April 2008. Porsche’s fight with Lower Saxony stems from the so-called “VW law,” parts of which were struck down last year by the European Court of Justice (ECJ).

Analysis: Both Porsche and Lower Saxony agreed on Friday that provisions in the law capping voting rights at 20 % and giving the state the automatic right to two supervisory board seats – both of which were also written into VW’s articles of associations – should be scrapped. However, the shareholders have disagreed as to whether the current 20 % blocking minority provision should be retained or increased to the general limit of 25 % set by German law.

Porsche calls for changes in VW Articles

Under the VW law, therefore, while Porsche holds a 31 % interest in VW, which it is planning to increase to at least 50 % in the near future, it has little control over VW since its voting rights are limited to 20 % and the State of Lower Saxony with its 20% interest can block any of Porsche’s proposals which it deems unattractive. Therefore, Porsche’s calls for amendments to the VW articles of association which would increase its shareholder rights will likely have little chance of success at the upcoming AGM.

Election of Lower Saxony representatives

As noted above, another provision of the draft amended VW law would suspend a current provision which grants two automatic supervisory board seats to the German State of Lower Saxony. The current state members of the board, Minister President Christian Wulff and his Minister of Economy Walter Hirche, will stand for re-election at the AGM and while their re-election is said to be certain, the legal basis for the election is not. VW wants to have them elected in an ordinary manner in order to prevent any later legal dispute which could arise if the automatic right to two board seats is abolished in the new VW Law.

The new draft “VW –Law”

It is unclear whether Porsche would file a legal challenge to try to change the articles of association if it fails to push through its proposals at the AGM and it is also unclear whether such a claim would be successful. This arises from the ambiguity of the ECJ decision which stated that it was the combination of the 20 % voting cap and the 20 % blocking minority provisions which was considered contrary to EU law. Legal experts say it is unclear whether the removal of the voting cap alone would allow the retention of the blocking minority provision. However, this is exactly what the German Ministry of Justice, which is currently preparing a draft of the amended VW Law, intends to do. Lower Saxony and VW workers are hoping the a new VW law will be enacted which would retain the blocking minority and certain other of the law’s provisions which the ECJ did not clearly reject. This would give employees an effective veto over factory closures in Germany and particularly in Lower Saxony. Furthermore, the draft of the new VW Law, which would basically maintain the rights of Lower Saxony, might not even get beyond the draft status. Currently the draft is being discussed between the relevant ministries, and the German Federal Economics Minister Michael Glos, has announced his intent to reject the draft bill, without, however, having yet provided any reasons for his position.

Is Porsche preparing a take-over?

Porsche recently denied media reports regarding a possible takeover of VW, with Porsche raising its VW stake to 75 %, declaring that this is merely “analyst and investor fantasies”. Although the Supervisory Board has recently allowed Porsche to increase its share to 50 percent, this would not give Porsche any additional rights given the current legal situation.

New ECJ proceedings

A spokesman for the European Commission stated at a regular briefing that “It is up to the German authorities ... to do whatever they find necessary to change the German system to comply with the [ECJ’s] ruling.” A recent article in the German news weekly “Focus” claiming that the EC Commissioner for Competition, Neelie Kroes, is preparing another lawsuit against Germany with respect to the VW Law, elicited no comments from Ms. Kroes’ spokesperson.

Conclusion

The year 2008 will bring remarkable changes to VW, regardless of the outcome of the current shareholder discussions and disputes. The next steps will be decided at the AGM on 24 April 2008.

Implications: More than USD 42 billion was invested by foreign government investors in Germany in 2007 and more than 2.2 million German employees work for companies owned by non-resident government and private funds. In regard to foreign investment funds, a German draft bill would allow the German government to prohibit the acquisition of a stake greater than 25% in a company located in Germany by a non-resident investor. Although the draft bill aims primarily at government-owned funds, the law would equally apply to any investor, whether privately or publicly owned, in order to allow blockage of controlling foreign interests in German companies. The President of the European Commission, Jose Manuel Barroso, has argued for a “European approach”, which need not automatically mean a European law, but which should avoid national solo attempts at restrictions.

Analysis: Germany seeks to protect its companies against foreign government funds  

More than USD 42 billion was invested by foreign government investors in Germany in 2007 – an increase of 20% over 2005 -- and more than 2.2 million German employees work for companies owned by non-resident government and private funds.   Government-owned funds of East Asia and the Gulf Region have invested USD 20.6 billion in foreign ventures since the beginning of this year, which represents one third of last year’s entire investment amount and government-owned funds own about USD two trillion worldwide. The idea behind such funds is not a new one – they have existed for decades and 41 countries have set up such funds. For example, the Kuwaiti government fund has been holding Daimler shares since 1969. However, the world has become increasingly concerned since Russia and China set up their own government funds although there has, to date, never been a case of trouble or political influence.   Impressed by these developments and the latest news in world financial markets, the German Federal Government has announced a draft bill which would protect German companies from takeovers by foreign funds whether privately owned or run by a foreign government.

Germany wants to remain an investor-friendly country

The German Secretary of Economics, Michael Glos, told the Financial Times Germany that while freedom of investment remains a strong guideline for the German government’s investment policy, particularly since foreign investors contribute considerably to the national GDP, the government must nevertheless address the concerns created by recent developments. “It cannot be ruled out that individual investors might also follow political interests, which might influence the public security of the state invested in”, Glos stated recently in Financial Times Germany.

The European influence on the bill

The President of the European Commission, Jose Manuel Barroso, has argued for a “European approach”, which need not automatically mean a European law, but which should avoid national solo attempts at restrictions. An initial draft of the German bill was already corrected to bring the German approach into line with European law by at least avoiding limitations on the fundamental freedom of the movement of capital within the EU. Furthermore, investors situated in the European Union or the EEA will be excluded from the law’s application. Since Germany grants US companies treatment equal to European companies in such matters on the basis of a bilateral agreement, this treatment will also apply to US investment funds.

The draft bill

In regard to foreign investment funds, the draft bill would allow the German government to prohibit the acquisition of a stake greater than 25% in a company located in Germany by a non-resident investor. Although the draft bill aims primarily at government-owned funds, the law would equally apply to any investor, whether privately or publicly owned, in order to allow blockage of controlling foreign interests in German companies.   The question as to whether an acquisition would be prohibited would be determined on the basis of the acquisition’s “danger to public security”, a vague and vast criteria which would leave a great deal of room for interpretation. In the case of a detected “danger to public security”, the draft bill grants the German Secretary of Economics the power to prohibit an acquisition or to make use of a veto right within three months following the announcement of such a transaction. This time limit is still in discussion, however, and the Christian Democrats (CDU), the main party in the governing grand coalition, have pleaded for a three-year veto period.   The bill also provides that potential funds will have the right to announce planned acquisitions in advance to the Ministry of Economics and to receive a decision on such transactions within one month of application. Furthermore, the draft bill would require foreign government funds to disclose their structures as well as their investment strategies.

Outlook

Currently, the draft provides for a complete investment prohibition only in regard to armaments companies. However, the German draft bill is still a light version of comparable bills existing, for example, in the United States, where the veto right is not limited to any specific time period.   Unavoidable loopholes in the draft bill and the upcoming law are already clear and arise from the fact that various investors, each holding less than the allowed 25% ownership level, could form an alliance or that an investor might use a European or US company as an investment vehicle to circumvent the law.   Critics already argue that the bill sets the wrong sign for investors who are both desired and needed in Germany. Despite the fact that practically all currently operating government funds are acting in a faultless manner, Germany intends to protect, in particular, its key industries from the two new players on the government fund field: Russia and China.

Implications: The Porsche AG founded a new corporate entity in the legal form of a Societas Europaea (SE), the Porsche Automobil Holding SE, which got registered in November. According to Porsche CEO Wendelin Wiedeking the registration of the Porsche Automobil Holding SE was a prerequisite for Porsche to enhance the stake in Volkswagen. Another hurdle taken…

Analysis: Back in March, Porsche CEO Wendelin Wiedeking denied any ambition to gain control of Volkswagen. But recent statements which the CEO made in interviews have led to speculations regarding the fate of the German vehicle manufacturer.

In March, when Porsche was about to increase its ownership of the group from 27.3 % to 30.9 % the luxury carmaker said it did not plan to acquire Volkswagen outright but rather to shield the Lower Saxon company from the possibility of a foreign takeover attempt. This made perfect sense given that the European Union is going after the Volkswagen law providing that no shareholder can have more than 20 % voting rights regardless of the economic stake actually taken.

On October 23 the ECJ ruled against the Volkswagen law, upholding a European Commission claim that Germany has prevented the free movement of capital. Germany is now obliged to abolish the law or amend it respectively.

According to media reports in Germany, the sports car manufacturer Porsche is already buying options that would enable it to boost its stake in Volkswagen from 30.9 % to over 50.0 %. After the completed bidding process which increased its stake to over the 30 % mark, Porsche will only be required to again publicise the extent of its stake in Volkswagen if an when it crosses the 50 % mark. Brokers said they expect Porsche to cross that line early next near. But even if Porsche acquires enough options this year already this doesn’t mean that Porsche is going to enhance its stake in Volkswagen straight away. Experts expect the increase of the shares held by Porsche not before the coming election of the state parliament in Lower Saxony scheduled for January 27.

Under German law Porsche is not required to publish another mandatory offer when increasing its stake in Volkswagen over the 50% threshold and thus acquiring the control of Volkswagen AG.

Implications: Leo Kirch, whose media group collapsed in 2002 in Germany’s then largest bankruptcy, has made a surprising comeback. The media entrepreneur bought the rights to German league soccer on October 9, thereby guaranteeing higher revenues for the league’s various clubs. The deal with Kirch was reportedly controversial among soccer clubs because his empire’s collapse led to significant financial difficulties for some of them.

Analysis: The German Soccer League DFL and Kirch reached an agreement to market rights to German league soccer matches. DFL, eager to narrow the gap with richer competitors, including the English Premier League, will also jointly produce pay-TV soccer programming with Kirch with the hope of attracting a greater number of potential bidders.

Kirch has made headlines in recent years largely as a result of his relentless pursuit of Deutsche Bank regarding remarks made in early 2002 by Rolf Breuer, then Deutsche Bank chairman, which appeared to question Kirch’s creditworthiness – which Kirch blamed for the financial collapse of his group a few months later. The return of Kirch is all the more remarkable because most observers had written off his career. According to Kirch’s biographer, the media mogul had continued to work six days a week at his office in Munich whereas his legal action against Deutsche Bank didn’t seem like a full time job.

A herald of Kirch’s comeback in the sports media business was a side note in late September, when it emerged that he had purchased an 11.5 % stake in EM.Sports Media, the sports media group that runs the sports channel DSF, for example.

Even though it has been said in official statements that Kirch is only marketing the TV-rights on behalf of DFL and not purchasing them for himself one has to be aware of future moves. Kirch is obviously back in the business and owns (part of) DSF. After the surprising announcement in regard of the conclusion of the rights deal with DFL other unforeseen moves may follow…

Implications: The Transrapid railway system is an ambitious business project with high potential. Unfortunately the German developers were not able to see their modern train run in Germany or Europe as the concept was exported to China and the first track was build to link Shanghai with its airport. Now the high tech train system is coming to Germany.

Analysis:

The former Bavarian minister president Edmund Stoiber exited national politics and made himself a farewell present by paving the way for the development of Europe’s first commercial Transrapid track which is to be built by the state of Bavaria to connect Munich’s city centre and its airport.

The Transrapid railway system uses an electromagnetic system which enables the train to float above the tracks thereby eliminating the need for an onboard engine. This system allows for much higher speeds (top speed with passengers 450 km/h (250 mph)) than traditional rail services. The service, developed by the consortium Transrapid, which includes Siemens and ThyssenKrupp, is regarded as a symbol of German technological competence. So far the only regular working Transrapid service is located in Shanghai, China.

The project is estimated to cost 1.85 billion Euros, which has caused some difficulties in regard to the project’s financing. The Bavarian government has now stated that the financial issues have been solved but various critics of the project are not convinced. In any event, an agreement has been concluded between the Bavarian state government, the rail operator Deutsche Bahn and the Transrapid consortium.

Implications: The Siemens group is currently manoeuvring in troubled waters as the bribery scandal finally starts to enter the courtrooms in Germany and abroad. But the payment charges against Siemens are not limited to fines for the punishable misconduct or neglect. The figures for levies on illegally made profits and tax arrears resulting from the unlawful booking of the payments in question have the potential to exceed the regular fines by far and in the first case to be decided the actual fine was comparatively negligible. Nevertheless, the management seems to be prepared to cope with the big figures of (expected) fines, reimbursements and back duties.

Analysis:

Already in October the regional court of Munich ruled in the bribery scandal regarding Siemens’ telecommunications unit and sentenced the company to pay 201 million Euros which consists of a fine amounting to 1 million Euros and a levy on the profits achieved by the bribery of 200 million Euros. Siemens also agreed to pay 179 million Euros to the tax authorities – largely covered by a 168 million Euros charge it has already taken – to compensate for the 450 million Euros in non-deductible payments which it falsely booked in regard to the bribes. Siemens stated that it would not appeal the decision.

Siemens CEO Peter Löscher said the company would accept full responsibility in this matter knowing that the bribery case is still far from being settled. The mentioned payments only mark the end of the German investigation into bribery payments in the company’s telecommunications unit; German regional prosecutors are still investigating alleged bribery in its power generation unit as well as whether the group illegally helped finance a rival to its main trade union.

Authorities in the US, Italy, Switzerland and Liechtenstein are also investigating and Siemens faces antitrust probes in other countries. Although the German decision is important, the findings of the SEC and the US justice department will be crucial to the overall financial effect on Siemens. We expect the overall fine to exceed the amount of 1 billion Euros.

Implications: This article discusses a remarkable judgment by the highest German tax court. With its decision from February 7, 2007, the Supreme Tax Court contradicted the tax authority’s long standing approach and stated that the regulation contained in section R 63(3) of the Corporate Tax Guidelines (Körperschaftsteuerrichtlinien; hereinafter “KStR”) is no longer applicable. Tax payers will be glad to rely on this decision in case the tax authorities tend to follow their old (and now outdated) rules.

Analysis: The Court was called on to decide the case of a holding company H which held shares of a subsidiary company S which incurred losses from participation in another company. Since H and S formed a tax group for German tax purposes, the losses of S were attributed to the H’s taxable income and resulted in reducing the H’s tax burden. Since the losses were calculated differently for tax and commercial law purposes, H had to show a deferral in its balance sheet representing the resulting difference.

Since H sold the shares of S, the question arose as to how the deferred item should be treated. The tax authorities, referring to section R 63 (3) KStR, dissolved the deferral while simultaneously increasing H´s taxable income.

The Federal Tax Court, on the other hand, was of the opinion that there is no legal basis for any treatment other than dissolution without any influence on taxable income. The Court noted that there is no legal justification for the fact that the tax authorities have acted according to the Corporate Tax Guidelines and that, since the regulation has been discussed among tax experts for many years without consensus, it cannot be regarded as a general principle. The Court held, therefore, that a deferred item must be dissolved without any effect on income if the shares of a subsidiary company are sold by the controlling company of a tax group.

Implications: The heading of this article is phrased as if there where no deduction of interest payments on loans used to finance the acquisition of shares possible under German jurisdiction. But that is not the full story. As it is often the case when it comes to German tax law, things appear to be tricky. That is also true in the case discussed in the article. It has to be admitted that there is a restriction on such but nevertheless under certain conditions interest payments on loans used to finance the acquisition of shares are deductible even after the shares moved into another corporation. This analysis discusses the courts ruling and identifies the necessary conditions.

Analysis: On March 27, 2007, Germany’s Supreme Tax Court (Bundesfinanzhof, BFH) heard a case regarding the deduction of interest payments as capital income-related expenses. In the case under consideration, a taxpayer originally held 50% of the shares of a corporation (GmbH 1). The taxpayer provided a guarantee for GmbH 1 which later drew on the guarantee. In order to finance the guarantee payment, the taxpayer took out a loan of 700,000 EUR.

The taxpayer was also shareholder of another corporation (GmbH 2), into which he contributed the shares of GmbH 1. In return for the contribution he received approximately 30,000 EUR which were charged against existing loans.

In his income tax return, the taxpayer claimed a deduction for the interest payments on the loan. The tax authorities denied the deduction arguing that there was no direct connection between the interest payments and any kind of income. The loan had originally been taken out in order to finance the guarantee for GmbH 1 but after contributing the shares of GmbH 1 to GmbH 2, the taxpayer no longer had direct income from it but rather this income flowed to GmbH 2.

The Supreme Tax Court basically agreed with the tax authorities but referred to prevailing case law stating that in the case of the sale of an asset which has been used to achieve taxable income, interest payments arising on the financing of the assets remain deductible if the sale profits are reinvested into another asset which also generates taxable income.

The new aspect of the case considered was that the shares were contributed to another GmbH rather than being sold. The Court regarded this process as comparable to an exchange and therefore as in return for payment stating that it made no difference that there was no cash payment but only the charging against loans.

According to the Court, however, the deduction of interest payments is restricted to the amount which corresponds to the reinvested profit. Since the taxpayer received only 30,000 EUR which he could reinvest, but paid interest on a loan of 700,000 EUR, the interest payment could only be deducted proportionately.

Implications: EON, Germany’s biggest power producer, has set up a joint venture in Siberia with Russian energy group STS which will assist the company in its goal of building up a strong position in one of Europe’s largest and fastest growing markets. Both partners own a 50 % stake in the new company with the name EON-STS Energia. This analysis provides background information on risks and chances of the announced enterprise.

Analysis: We learn from the article that Russia’s electricity market is one of Europe’s largest and fastest growing and that the upcoming liberalization of the country’s wholesale power sector will create an attractive business environment for investments in power generation. Russia experts warn, however, that expansion into that country is not risk-free since the Kremlin is quite sensitive regarding foreign businesses entering its key energy sector. This, of course, implies a risk to the joint venture and the investment. While the venture is EON’s first electricity operation in Russia, it does have extensive experience there through its gas wholesaling subsidiary EON Ruhrgas which is closely linked to Russian gas monopolist Gazprom. This experience may now prove helpful in EON’s move into the Russian electricity market.

Implications: This analysis provides an inside view on new aspects of the German tax law that might be of interest even for taxpayers not resident in Germany. Although the corporate tax system has been changed from the tax credit method to the half-income system in 2000/2001, many corporations have tax credits resulting from the old system. These enterprises should be aware of the modification of section 37 (4) Corporate Tax Code, which allows the payout of the tax credit, starting 2008.

Analysis: Payout of historical corporate tax funds by ten annual instalments Many German corporations have corporate tax credits resulting from the former corporate tax system that granted corporate tax credit in case of distribution. The tax credit existing at the moment of the change of the system in 2000/2001 from the tax credit method to half-income system was “frozen”. It had not to be shown in the balance sheet and was not allowed for payout.

Implications: “A marriage made in heaven” – that’s what the merger between Daimler and Chrysler was once called. Today we can read about their divorce and how they are looking around for potential new partners. This analysis gives a rough overview and comments on the future of the enterprise.

Analysis: On the paper DaimlerChrysler sold the biggest part of its share of the money-losing Chrysler to Cerberus Capital Management LP, a New York private-equity firm, for $ 7.4 billion, thereby backing out of a troubled 1998 takeover aimed at creating a global automotive powerhouse. In fact, the bill appears to be far different. The German automaker spent $37 billion to initially buy Chrysler in 1998 and had to invest billions more in order to keep it afloat. DaimlerChrysler said that it would essentially put up $677.7 million to shift 80.1% of Chrysler to the private-equity fund. Cerberus itself is putting up $7.4 billion in return for its stake, but most of that will be used to shore up the capital of Chrysler. In the end, Daimler is about to receive $1.4 billion, but it will retain Chrysler’s debts, leading to a net cash outflow. Chrysler, however, will retain its obligations for pensions and healthcare costs and be renamed Chrysler Holding.

DaimlerChrysler had implied it might seek a divorce from Chrysler in February when Chief Executive Dieter Zetsche said that “no option would be excluded in order to find the best solution for Chrysler Group and DaimlerChrysler.”

Pretty much like any divorce, the cancellation of the merger lasting for merely one decade was expensive. In the end, DaimlerChrysler actually had to pay to have somebody take Chrysler off of its hands.

Investment experts, however, regard the divorce as a new beginning and believe that the 80 % divestment will substantially improve earnings visibility for the stock and free up management capacity to focus on the remaining businesses.

Implications: This analysis provides an inside view on new aspects of the German tax law that might be of interest even for taxpayers not resident in Germany. The taxation of compensation payments for example again was the subject of a case decided by the Federal Tax Court.

Analysis:

Payments a Swiss employee receives in order to compensate disadvantages resulting from the cancelling of a promised employment in Germany can only be taxed in Switzerland. On September 12, 2006 the German Federal Tax Court had to decide another case regarding compensation payments to an employee, domiciled abroad. Different to previous cases this Swiss employee received the payment not as a compensation for the termination of the employment, but because the parties agreed to abstain from the promised employment.

Compensation payments have been subject of many cases decided by German and Swiss tax courts. Therefore both states already in 1992 agreed on principles how to treat such cases by a mutual agreement (published as a decree of the German Ministry of Finance in May 20, 1997).

Compensation payments in relation with German-Swiss employments that are provided for former employment can only be taxed in the state were the employment concerned has been performed. With this agreement Germany and Switzerland dissent from the regular principles of double taxation treaties following the OECD model convention. The model convention assumes that compensation payments are not made for already performed employment and therefore can only be taxed in the state were the employee is resident at the moment of payment.

The Federal German Tax Court in this case assigned the right of taxation to Switzerland, the resident state. It was of the opinion that the mutual agreement was only meant to regulate compensation payments made because of the termination of an employment. Therefore the general rule, laid down in the double taxation treaty between Germany and Switzerland, about the taxation of income from dependent income was applicable and granted Switzerland as residence state the right of taxation.

Implications: As the company struggles to improve an image tarnished by corruption the supervisory board of the German engineering conglomerate Siemens AG announced on May 20 already that it has tapped Peter Loescher as its new CEO. The announcement ended weeks of uncertainty over who would take over leadership of the company amid investigations in Europe and the United States into allegations that employees set up secret funds to pay off union leaders and bribe officials to win contracts.

Analysis: Austrian-born Loescher, 49, who was New Jersey-based Merck & Co’s president of Global Human Health at this time, succeeded Klaus Kleinfeld, who announced in April that he would not seek to renew his contract. The lacking backup by the prominent members of the supervisory board drove the former CEO to draw the line. Kleinfeld was not linked to any of the alleged wrongdoing at Siemens.

These wrongdoings are already subject to state prosecution and represent a severe burden to the company - and it’s CEO:

In the first related trial, two former Siemens officials were convicted last week of bribery and assisting bribery in regard to their involvement in multimillion-dollar payments to officials at an Italian utility. The Darmstadt state court also ordered Siemens to forfeit € 38 million in profits from deals with Enel in Italy, although both defendants asserted that it had not been Siemens’ idea to offer bribes to win contracts.

Loescher who took office on July 1, 2007 is the first CEO hired from outside the Munich-based company in its 160-year history. This rather revolutionary step in terms of the traditional company may be a first outside sign for deep inside changes the company is urged to undertake. That, at least, is the hope that accompanies the new CEO.

Chairman Gerhard Cromme was convinced that Mr. Loescher has what it takes to steer Siemens through its current difficulties and into a better future. The near future will show whether he was right with this.

Implications: The German government has been discussing necessary measures for a business tax reform for months. In February 2007 a draft was published summarizing the planned amendments. A lively discussion regarding the proposed changes ended in an amended draft which passed the Bundestag (Lower House of Parliament) on May 25, 2007. This analysis gives a summary of the most important measures of this bill which will become effective on January 1, 2008.

Analysis: German Bundestag finally passed a bill on the reform of German business following amendment in parliamentary proceedings. The following is a summary of the most important measures of this bill which will become effective on January 1, 2008:

• The corporate tax rate will be reduced to 15 %.
• Taxes will be reduced for sole proprietors and partners in business partnerships in regard to profits that are retained.
• The deduction of interest payments will be limited in that only interest payments which do not exceed 30 % of a company’s annual profit may be deducted in the year of payment. Any excessive amounts can be carried forward to the following years. Up to EUR 1 million of interest payments may be deducted without limitation.

Note: Unlike in the draft bill, under the bill passed, depreciation will not be considered for the purpose of calculating the 30 % annual profit base.

• Under the trade tax, the tax assessment factor (Steuermesszahl) will be reduced from 5% to 3.5%.

Note: The base for the calculation of trade tax will be increased by including 25 % of all interest payments (regardless of whether the payments are made in regard to long-term or short-term financing) as well as 25 % of a so-called “financing rate”, a fictitious financing portion of paid rental fees and royalties. An allowance of EUR 100,000 is intended to provide some relief for small and medium-sized businesses.

• The losses of a corporation acquired in a share purchase are only deductible by the new shareholders under strictly limited conditions. These conditions will be tightened by the business tax reform in that if between 25 % and 50 % of the shares are purchased, the losses may only be deducted on a pro-rata basis. If more than 50 % of the shares are purchased, the loss deduction will not be allowed at all.
• The declining balance method of depreciation will be abandoned.
• In regard to the depreciation of low-value assets, in the future only small or medium-sized enterprises will be allowed to depreciate assets up to EUR 410 in the year of purchase. For all other types of enterprises, only those assets costing up to EUR 150 may be directly depreciated (the first draft provided for a EUR 100 limit).
• Low-value assets with purchase prices between EUR 150 and EUR 1,000 must be accumulated in a “pool” and depreciated over 5 years. The pool will not change, even if an asset is sold or becomes obsolete during the 5-year period.
• Enterprises with working capital of up to EUR 235,000 (first draft: EUR 210,000) will be allowed to set aside pre-tax up to 40 % of planned investments (in movable assets only). The reserve must be liquidated and will increase the taxable profit of the year in question, if no investment is actually made prior to the end of a three-year period beginning with the creation of the reserve.
• Section 1 of the International Tax Relations Law (Aussensteuergesetz) will be amended in regard to the transfer of functions from or to Germany. In such cases, a “transfer packet” will be calculated including all hidden reserves resulting from tangible and intangible assets, such as international business opportunities. For foreign corporations which transfer functions to Germany this could be advantageous, since it would enable them to depreciate intangible assets.
• A uniform withholding tax of 25% on all types of capital income will be introduced starting January 1, 2009.

Note: The adopted draft provides that losses from the sale of shares may only be charged against profits from the sale of shares and not against any other type of income.

Implications: Porsche made an offer to buy the shares which it does not already own in Volkswagen AG at a price lower than the current stock exchange rate. This offer has not been successful – and Porsche is pleased with this result. This analysis shows, why that is.

Analysis: As expected, Porsche’s offer to buy the shares which it does not already own in Volkswagen AG at a price lower than the current stock exchange rate has not been successful. Porsche, which had maintained that it had no plans to acquire Europe’s biggest automaker, was obliged under law to make an offer for the remainder of the company after boosting its stake in March beyond 30 % in order to help shield the company from foreign takeovers. Under German law, Porsche is now free to acquire further shares in Volkswagen until it obtains a 50 % interest at which point it would need to make another takeover offer.

Implications: Plans to regulate hedge funds are on their way in Germany. This analysis focuses on the regulatory corner points actually discussed and their impact on the investors. The Federal Ministry of Finance (BMF) is planning a law for the delimitation of financial market risks which is to come into force parallel with the company tax reform on January 1, 2008. The Ministry is about to initiate a risk capital law and due to it a “risk delimitation law” in order to limit erroneous trends at the markets.

Analysis: The corner points actually discussed in the BMF are planning for enterprise participations starting at a value of 10% that they have to reveal from where the means for the financing of the interest have come and which strategy is pursued with it. Therefore, an investor who wants to use his voting rights on the general meeting and wants to come into the benefit of a dividend will have to prove in particular the possession of shares. It is also considered to strengthen the information rights of the staff of enterprises which are to be taken over by financial investors. Besides, in the draft the regulations could be concretized for the ban of arranged investment actions of several finance investors.

Implications: A CEO presents great financial figures – and has to step down. Unthinkable? Well, not really as you will find out while reading this analysis. Siemens, one of Europe’s largest engineering companies, has been hit by a series of corruption scandals in recent months revolving around the payment by some employees of bribes to help secure deals abroad. Now the corruption scandal has led to the resignation of the chairman of the supervisory board, Heinrich von Pierer. Pressure had been rising onvon Pierer for weeks because he was Siemens’ chief executive from 1992 to 2005, the years that a system of slush funds was established. The money, as much as 420 million euros, was allegedly used for bribes. He stepped down at the board meeting on April 25, saying he hoped his successor would be able to steer the scandal-plagued company “out of the headlines and into calmer waters”. Von Pierer is replaced by Gerhard Cromme, a board member and former head of heavy-industry giant ThyssenKrupp.

Analysis:

Also on April 25, CEO Klaus Kleinfeld announced that he would step down after his contract runs out on September 30, 2007. Kleinfeld, who during his two years at the helm of Siemens won plaudits from investors for his efforts to boost the company’s finances through large cuts in the company’s work force and a major acquisition drive, increasing the company’s profits by almost a third to 1.3 billion euros, finally failed to cling on to his position after being undermined by members of the company’s supervisory board. The board had hesitated in extending his contract and there had also been a number of media reports earlier in the week of his resignation that the search was already on for his successor. The lacking backup drove the CEO to draw the line. Thus Kleinfeld saw little choice but to give up after being at the helm for only two years, stating that the company “must have complete freedom of action” and needed “clarity about its leadership”. Klaus Kleinfeld was not personally implicated in the police investigations and for the time being there is no indication that he is or was connected to the corruption scandal.

His successor will be Austrian-born Peter Loescher, the head of global human health at Merck since April 2006. Chairman Gerhard Cromme felt confident with that choice and found that Peter Loescher is an exceptional individual for the office of president and CEO of Siemens AG. “I am convinced that Mr. Loescher has what it takes to steer Siemens through its current difficulties and into a better future," he said. Loescher will take office on July 1 already as Siemens announced in a press release.