Supreme Tax Court: A deferred item must be dissolved if within a tax group the controlling company sells its shares of the subsidiary company

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contained in section R 63(3) of the Corporate Tax Guidelines (Körperschaftsteuerrichtlinien; hereinafter “KStR”) is no longer applicable. Tax payers will be glad to rely on this decision in case the tax authorities tend to follow their old (and now outdated) rules.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.