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Tax losses
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The tax law of most industrialized countries is designed to determine profits based on a financial year and then use the result as the basis for taxation. The financial year of a company is usually a 12-month period, but is not necessarily identical to the calendar year. Profits and tax losses during the year are automatically offset against each other in the individual months of the financial year.

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When tax losses arise in the company

Problems arise when, due to economic development or solely due to tax regulations, profits have to be reported in one year and tax losses arise in the other year. At a purely national level, states then allow losses to be carried back in whole or in part, with the result that profits from earlier years are subsequently taxed at a lower rate or not at all. Losses that have not been carried back into the past can usually be offset against profits in subsequent years. What remains in any case is a liquidity problem. In most cases, however, profits and losses will not be completely balanced out.

In Germany, the results are determined in accordance with income tax and corporate tax regulations. These results are then used as a basis for trade tax in a second step. While there is loss carryback for income tax and corporation tax, this is excluded for trade tax. Losses in 2020 can therefore subsequently be offset against profits from 2019, but the trade tax set for 2019 remains the same.

Lump-sum loss carry-back in the course of Corona aid

If you have not yet submitted your 2019 tax return but have listed advance payments and work as a freelancer, trader or landlord, the tax office will allow a retroactive tax deduction of 15% of your income without further evidence. This means you will receive the corresponding advance payments back into your account. Anyone who requests a higher deduction must prove that Corona has placed a greater burden on them. As soon as profits are made again, the flat-rate loss carryback is compensated.

Convert tax losses into tax benefits through retrospective conversion

Under certain conditions, German law allows companies to change their legal form up to 8 months into the past. Due to the corona pandemic, the retroactive effect has been extended to a maximum of 12 months. This means, for example, that a GmbH that made profits in 2019 but only made losses in the first half of 2020 due to the lockdown can now be converted into a partnership with effect from November 30.11.2019, 30. This can determine the financial year differently from the calendar year, for example on June XNUMXth of a year.

In this way, the profits from December 2019 to March 2020 will be offset against the losses from the first half of 2020. As a result, the GmbH would only tax the profit of the first few months for 2019. Apart from the sales tax, the partnership does not have to submit a tax return for 2019. The tax return for 2020 then covers the period from the conversion to the end of the first financial year. In this way, 2020 can also end with zero taxation.

Since the GmbH expires without liquidation as a result of the conversion, the question does not arise in 2020 as to whether the company can still use its going concern balance sheet. The question of an obligation to file for insolvency due to excessive balance sheet debt no longer arises.

Conversion of losses into future depreciation

The Conversion Tax Act grants taxpayers extensive options when changing the legal form and also when transferring their company, a co-entrepreneur's share and also when transferring shares in a corporation into another company. This makes it possible to simply continue the previous book values. This does not result in any tax profits for the person making the contribution. The transferred assets are treated largely the same for tax purposes as before.

However, there is no obligation to transfer the assets at book value. Any value can be used up to the actual market value. The transferring legal entity then generates a capital gain equal to the difference between the stated value and the book value. However, this is only subject to income tax, not trade taxes.

The capital gains can be offset against losses from ongoing business activities for tax purposes. Since the freedom from valuation makes it possible to declare the capital gains in the exact amount of the tax losses, there is no tax burden resulting from the release of the hidden reserves.

The acquiring legal entity can also be a new company founded specifically for this purpose. This company records the transferred assets at the value that the transferor paid taxes on. This means that the company has higher book assets, which has a positive effect on equity and creditworthiness. From now on it deducts from this higher value. The depreciation then reduces the income or corporate tax as well as the trade tax.

Cross-border tax losses - loss offsetting

Companies that also operate abroad must determine and distribute their results according to national regulations. If there is a subsidiary abroad, the delivery and service relationships are subject to a critical review. The analysis of opportunities, risks and functions in the companies involved has the task of ensuring a fair allocation of the tax results. This is done via the documentation for structuring the transfer prices. A fictitious third-party comparison is used to determine how external third parties would have assessed and invoiced these deliveries and services.

This gives tax auditors a wide scope to increase their country's tax results. They are usually not at all interested in the fact that there would be less tax to be paid in the other country. In any case, the other country would not easily pay back taxes voluntarily. It is therefore important to organize the tax situation in all countries involved in parallel and keep it under control.

Relocation to another EU country and Switzerland

A company is liable to tax in the country in which it has its registered office. Normally business decisions are also made in this country. However, if the day-to-day business decisions are made in another country, then one speaks of a so-called administrative headquarters in the other country. If there is a double taxation agreement (DTA), the right of taxation shifts to the country in which the administrative headquarters is located.

A problem arises if losses were incurred before the administrative headquarters were moved. Due to national laws and also according to the DTA, these can no longer be offset against future profits in the new state.

As far as states within the EU are concerned, this hinders the free choice of establishment and violates the fundamental right of freedom of establishment. The ECJ commented on this in its ruling of February 27.2.2020, XNUMX. The countries involved in the proceedings were the Netherlands and the Czech Republic; However, the judgment is analogous for all other transfers of headquarters within the EU and, in our firm opinion, also applies in relation to Switzerland due to the Free Movement of Persons Agreement (FZA).

The ECJ confirms that there could be a violation of the freedom of establishment. However, he sees no need to allow cross-border loss offsetting per se because, among other things, double use of losses cannot be ruled out due to the continued headquarters in the country of origin.

The jurisprudence on Use of final losses cannot be transferred to cases of relocation of the administrative headquarters. Something different therefore applies if the company actually moves its statutory headquarters to another country. then final losses in the country of origin must be taken into account in the new country of residence.

The ECJ ruling does not apply to final losses of an EU/EEA permanent establishment. In this respect, the principles of case law regarding final losses apply. Anyone who can no longer use the losses accumulated there for tax purposes due to the closure of a permanent establishment in a country can offset these losses against the taxable profits in the country in which the company is based.

Avoidance of double taxation

There are also instruments for this. All common agreements to avoid double taxation stipulate that supply and service relationships in affiliated companies must withstand a fictitious arm's length comparison. If this is not met, the tax result in both contracting states must be subsequently corrected.

If one of the companies involved generates profits but the other makes losses, then these cannot per se be offset against one another. However, it is worthwhile to subject supply and service relationships in affiliated companies to a risk and functionality check and, if necessary, to subsequently correct the transfer prices. In this way, you can often achieve at least partial loss compensation.

Final losses from foreign operations or subsidiaries in the EU

Tax law only allows offsetting of profits and losses at the national level. However, the European Court of Justice sees this as critical when it comes to losses from EU permanent establishments or from subsidiaries in the EU. If the taxpayer can demonstrate that he will never be able to offset losses suffered abroad against profits in that country, then the home state must, contrary to its national law, allow the foreign losses to be offset against domestic profits.

Proof can be provided by completely withdrawing from the other country and declaring that you will not do business there again. As a result, you can no longer make any profits in the other country, which means that the losses would no longer be taken into account for tax purposes, i.e. "finally". The ECJ sees this as a violation of the freedom of establishment and is forcing the member states to recognize these final losses.

The judgments of the ECJ open up scope for design. Finality can also be achieved by converting foreign EU permanent establishments into a capital company.

Problem: Foreign losses that have already lapsed cannot be subsequently revived due to the design. Timely action is therefore required. Even in purely domestic cases, every tax loss must be examined to see how it can be used from a global perspective, i.e. how it can be converted into liquidity.

Company acquisition with tax loss carryforwards

When purchasing shares in a corporation that has tax loss carryforwards, it must be checked whether the loss carryforwards will be eliminated in whole or in part due to the change in shareholders. The corresponding regulation in German law can be found in Section 8c KStG.

After that, it is less about the contractual regulations and more about the business content in the continued company. The loss carryforward is eliminated completely if more than 50% of the shares are transferred directly or indirectly to an acquirer or a group of acquirers within five years. If between 25% and 50% are transferred, there will be a pro rata or proportional loss. Transfers within a group are not subject to this restriction. The loss does not occur even if the transferred company has sufficient hidden reserves.

Jürgen Bächle
Jurgen Bachle

has been working as an independent tax consultant and expert in international tax law since 1989 and has been a member of the board of the German Association of Tax Consultants Baden-Württemberg, DSTVBW, for over 20 years.

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