Mer­gers & Acqui­si­ti­on and Taxes

Igno­ran­ce of tax laws does not exempt from the obli­ga­ti­on to pay tax. But often the know­ledge.”
Mey­er A. Roth­schild, Ban­ker (1744–1812)

The tax law is so com­pli­ca­ted and obscu­re as fog with visi­bi­li­ty in 50 m.”
Hein­rich List, for­mer Pre­si­dent of the BFH (Federal Finan­ce Court, Ger­ma­ny)

Busi­ness Sel­ler and Buy­er, both par­ties have an inte­rest to opti­mi­ze their taxes, becau­se, as for­mer Ger­man Chan­cellor Hel­mut Schmidt said: “Who has the duty to pay taxes, also has the right to save taxes”

The inte­rests of both par­ties shape the tech­nic of M&A and its opti­mi­za­ti­on of taxes. For a suc­cess­ful Deal, the M&A Con­sul­tants will access the tax situa­ti­ons of sel­ler and buy­er and inte­gra­te the demands into a satis­fac­to­ry for both side, via­ble tran­sac­tion con­cept, appro­ved by the tax advi­sers of both par­ties. This also means tax advan­ta­ges and dis­ad­van­ta­ges in terms of pos­si­ble step-up volu­me to be weig­hed and inte­gra­ted in an over­all pri­ce, terms and war­ran­ty model.

The fol­lo­wing state­ments about taxes, can only be a first rudi­men­ta­ry infor­ma­ti­on. Legal form, com­pa­ny legal histo­ry, sha­re or asset deal, tax figu­res, the per­so­nal inte­rests and the tax situa­ti­on of the share­hol­ders have among others a signi­fi­cant influ­ence on an opti­mal tran­sac­tion struc­tu­re and tax design which should be che­cked by a tax expert.

1. Taxes sel­ler side

Depen­ding on the legal form of the sel­ling com­pa­ny and accord­ing to the legal form of the Share­hol­der the­re are dif­fe­rent tax regimes to be obser­ved. On the issue of the tre­at­ment of dis­po­sal los­ses should not be dealt with here.

1.1 Sale of a pri­va­te com­pa­ny or indi­vi­du­al com­pa­ny

Pri­va­te com­pa­nies and natu­ral per­sons are to be trea­ted simi­lar­ly for taxa­ti­on. Part­nerships, as a mer­ger of several natu­ral per­sons, the inco­me of tho­se Part­nerships the is deter­mi­ned in the frame­work of a sepa­ra­te and uni­form pro­fit state­ment and attri­bu­t­ed to the share­hol­ders accord­ing to their respec­tive sha­re. Depen­ding on the legal form of the share­hol­der, dif­fe­ren­ces ari­se in the tax assess­ment.

1.1.2 Share­hol­der is a natu­ral per­son

If the ent­i­re sha­res of a share­hol­der in a com­pa­ny are sold, this is sub­ject to a redu­ced tax rate. In this case, no com­mer­ci­al tax will ari­se. Are howe­ver only parts of a co-entrepreneur’s sha­re sold, this is regar­ded as con­ti­nuous inco­me from tra­de or busi­ness, with the result of the full inco­me and com­mer­ci­al tax.

The redu­ced rate of taxa­ti­on can be the 1/5 rule (i.e. the capi­tal gain is dis­tri­bu­t­ed fac­tious­ly over 5 years, the then cal­cu­la­ted tax amount is taken by 5, in this way top tax rates should be com­pen­sa­ted for). The other pos­si­bi­li­ty is, when the tax­able per­son has pas­sed the age of 55 years or he/she is per­man­ent­ly unab­le to work, he once in the life has the right to a redu­ced tax rate of 56% of the average tax rate for capi­tal gains, ins­tead of the 1/5 rule. This app­lies to capi­tal gains up to € 5 mil­li­on. Fur­ther the­re is a tax exemp­ti­on of 45.000,00 € which mel­ts away by the amount that exceeds € 136.000,00 of capi­tal gains.

1.1.3 Share­hol­ders is a coope­ra­ti­on

In case a coope­ra­ti­on (e.g. pri­va­te-law cor­po­ra­ti­ons: GmbH, UG, AG, e.V, coope­ra­ti­ve) is share­hol­der of a Part­nership, the gains on dis­po­sal is in regards cor­po­ra­te and com­mer­ci­al tax ful­ly tax­able. (Cur­r­ent­ly cor­po­ra­te tax is 15% as well as appro­xi­mate­ly 14% tra­de tax at a com­mu­ni­ty mul­ti­plier of 400). The com­mer­ci­al tax is app­lied to Part­nership. Tax debtor is in this case the Part­nership, not the coope­ra­ti­on.

The capi­tal gain or loss is on cor­po­ra­te inco­me tax level sett­led with the los­ses or pro­fits of the cor­po­ra­ti­on, while in respect of the com­mer­ci­al tax this is done on the level the Part­nership.

1.2 Sale of a cor­po­ra­ti­on

For capi­tal gains from sha­res in a cor­po­ra­ti­on it is for taxa­ti­on decisi­ve whe­ther the sha­res are held by a cor­po­ra­ti­on or a natu­ral per­son. In the case, they are held by a natu­ral per­son, it is necessa­ry to cla­ri­fy whe­ther the sha­res belong to the pri­va­te or busi­ness assets. If the sha­res are held as pri­va­te assets, the ques­ti­on of the par­ti­ci­pa­ti­on level of the last 5 years is of signi­fi­can­ce.

1.2.1 The sel­ler is a natu­ral per­son and holds the sha­res in the pri­va­te assets

The par­ti­ci­pa­ti­on was direc­t­ly and indi­rec­t­ly in the last 5 years never 1% of the capi­tal of the com­pa­ny, in this case the gains on dis­po­sal are taxed with with­hol­ding tax (25%) plus the soli­da­ri­ty surch­ar­ge as well as any church tax, if app­li­ca­ble. Deduc­tible on capi­tal gains are howe­ver only costs direc­t­ly lin­ked to the sale of busi­ness.

The capi­tal sha­re was grea­ter than or equal to 1% in the last five years, the gains on dis­po­sal are sub­ject to taxa­ti­on of inco­me from tra­de or busi­ness and thus to the par­ti­al inco­me sys­tem (Teil­ein­künf­te­ver­fah­ren). They are not sub­ject to com­mer­ci­al tax.

The par­ti­al inco­me sys­tem (Teil­ein­künf­te­ver­fah­ren) means that the gains on dis­po­sal are redu­ced by 40%, that means only 60% of capi­tal gains are taxed with per­so­nal tax rate of the sel­ler. I.e. based on the maxi­mum tax rate (45%) this results in a load of approx. 27% plus soli­da­ri­ty surch­ar­ge and any church tax on the total capi­tal gains. In the rever­se case, expen­ses about the sha­re sale, only 60% are deduc­tible.

In addi­ti­on, a tax exemp­ti­on of 9060,00€ for a 100% share­hol­ding, is app­lied, but this tax exemp­ti­on mel­ts by the amount the gains on dis­po­sal exceed 36.100 Euro.

The § 6b of the Inco­me Tax Act allows indi­vi­du­al entre­pre­neurs and Part­nerships to trans­fer the capi­tal gains from the sale of a cor­po­ra­ti­on to 100% to new­ly purcha­sed sha­res of cor­po­ra­ti­ons and as far as the gains on dis­po­sal are not exempt from taxa­ti­on per § 3 No 40 sen­tence 1 in con­junc­tion with § 3c para. 2 of the EStG to new­ly purcha­sed buil­dings (not land) and mova­ble assets.

This achie­ves a qua­si-tax-free trans­fer of the capi­tal gains com­pa­ra­ble to the situa­ti­on of cor­po­ra­ti­ons, whe­re capi­tal gains are in accordance with § 8b in princip­le tax-free (restric­tion: § 8b para. 3 sen­tence 1 of the Ger­man Cor­po­ra­ti­on Tax Act (KStG).

1.2.2 The sel­ler is a natu­ral per­son and holds the sha­res in his busi­ness assets

In this case, the gains on dis­po­sal belong to the ongo­ing com­mer­ci­al inco­me and are sub­ject to the par­ti­al inco­me sys­tem (Teil­ein­künf­te­ver­fah­ren), i.e. 60% of the capi­tal gains less 60% of expen­ses are taxed. On com­mer­ci­al tax level also 60% of capi­tal gains less 60% of the expen­ses. Howe­ver, the­re is no addi­ti­on of tax-free inco­me in accordance with § 8 No. 5 GewStG. In the case of capi­tal gains a tax exemp­ti­on of € 24.50 0.00 is avail­ab­le. In the case that after this exemp­ti­on the­re is still a com­mer­ci­al tax, this com­mer­ci­al tax will be sett­led with per­so­nal inco­me tax (§35 EStG). As long as the com­mu­ni­ty mul­ti­plier don‘t exceeds 380% this will result to a full dischar­ge of com­mer­ci­al tax, mul­ti­pliers bey­ond 380% will result in a com­mer­ci­al tax bur­den.

1.2.3 The sel­ler is a cor­po­ra­ti­on

The inco­me from the sale of a cor­po­ra­ti­on is in the dive­s­ting cor­po­ra­ti­on to 95% tax free. I.e. 5% of the gains on dis­po­sal will be con­si­de­red non-deduc­tible ope­ra­ting expen­ses and trea­ted with 15% cor­po­ra­ti­on tax plus soli­da­ri­ty surch­ar­ge tax. The same app­lies in the case of the com­mer­ci­al tax. This does not app­ly to credit and finan­ci­al ser­vices insti­tu­ti­ons.

1.2.4 Sel­ler is a part­nership

In this case the legal form of the share­hol­ders of the part­nership rules the taxa­ti­on, sin­ce the part­nership is trans­pa­rent and only in regards to the com­mer­ci­al tax a tax sub­ject. In so far the state­ments in regards to natu­ral per­sons and cor­po­ra­ti­ons app­ly accord­in­gly.

In regards to the com­mer­ci­al tax the part­nership is tax sub­ject. Is the share­hol­der of the sel­ling part­nership a cor­po­ra­ti­on, 5% (non­de­duc­tible ope­ra­ting expen­ses) of the capi­tal gains are sub­ject to the com­mer­ci­al taxes. Is the share­hol­ders of the sel­ling part­nership a natu­ral per­son, 60 % of the dis­po­sal gain is sub­ject to com­mer­ci­al taxes. If the share­hol­ders are natu­ral per­sons and corporation’s taxa­ti­on is deter­mi­ned by the respec­tive share­hol­dings.

This only brief­ly mar­ked tax topics, on the seller’s side, which can be, depen­ding on the per­so­nal as well as ope­ra­ting situa­ti­on, as com­plex as you wish, are con­se­quent­ly oppo­sed by the inte­rests of a poten­ti­al acqui­rer.

2. Tax assess­ment acqui­rer

For a suc­cess­ful deal, always both sides are to be obser­ved. In most cases the acqui­rer has an inte­rest to trans­form the purcha­se pri­ce as com­ple­te­ly as pos­si­ble in tax-redu­cing depre­cia­ti­on poten­ti­al. Essen­ti­al­ly the inte­rests of the acqui­rer sum­ma­ri­ze as fol­lows:

  1. Tax opti­mi­zed dis­tri­bu­ti­on of the purcha­se pri­ce to the acqui­red assets, inclu­ding good­will
  2. Tax effec­tive detec­tion of hid­den reser­ves by rest­ruc­tu­ring mea­su­res after clo­sing
  3. Tax opti­mal finan­cing of the purcha­se pri­ce
  4. Avo­id­ance of addi­tio­nal bur­dens cau­sed by tran­sac­tion taxes and pro­per­ty acqui­si­ti­on tax
  5. As far as pos­si­ble use of acqui­red loss car­ry­for­wards

The pos­si­bi­li­ty to trans­form the purcha­se pri­ce into tax opti­mi­zing depre­cia­ti­on poten­ti­al, exist for a sha­re deal only for the purcha­se of part­nership sha­res, while this pos­si­bi­li­ty is lar­ge­ly not pos­si­ble for the purcha­se of sha­res of cor­po­ra­ti­on. An Asset Deal, which trans­forms the purcha­se pri­ce in depre­cia­ti­on poten­ti­al, is stron­gly depen­ding on the sta­tus of the com­pa­ny and may but also may not make sen­se. Espe­ci­al­ly the impact on the sel­ler side needs to be con­si­de­red.

Cur­r­ent­ly, only with an Asset Deal the purcha­se pri­ce for a cor­po­ra­ti­on can be unpro­ble­ma­ti­cal­ly trans­for­med into depre­cia­ti­on poten­ti­al. The various models to trans­form the purcha­se pri­ce of cor­po­ra­ti­on into depre­cia­ti­on poten­ti­al, like down­stream mer­ger, com­bi­na­ti­on model, trans­for­ma­ti­on model, part­ner model, have been ruled out by legis­la­tor during the last years. Inso­far the­se models are not sub­ject of this arti­cle.

The inter­com­pa­ny grou­ping model crea­tes, in a sha­re deal still limi­ted depre­cia­ti­on poten­ti­al.

2.1 Inter­com­pa­ny grou­ping model

The sha­res of the tar­get com­pa­ny are acqui­red by a sub­si­dia­ry com­pa­ny foun­ded by the acqui­rer in the legal form of a GmbH & Co KG (with one or more natu­ral per­sons as limi­ted part­ners and wit­hout capi­tal par­ti­ci­pa­ti­on of the gene­ral part­ner). Bet­ween the GmbH & Co KG as the con­trol­ling com­pa­ny and the tar­get com­pa­ny as a sub­si­dia­ry com­pa­ny a fis­cal uni­on for cor­po­ra­te and com­mer­ci­al tax pur­po­ses is estab­lished. After­wards the assets with hid­den reser­ves of the tar­get com­pa­ny are sold in an inter­nal asset deal to the GmbH & Co KG. The resul­ting capi­tal gain is neu­tra­li­zed by a cur­rent value depre­cia­ti­on. The limi­ted partner’s sha­re and the sha­re in the gene­ral part­ner GmbH is after­wards sold to the acqui­rer. This pro­ce­du­re is limi­ted sin­ce § 3c para 3 sen­tence 2 EStG limits impairments of the sha­res of a con­trol­ling com­pa­ny to 60%. The­re­fo­re, also the inter­com­pa­ny grou­ping model is sub­stan­ti­al­ly impai­red.

2.2 Sel­ler con­ver­si­on model.

A fur­ther pos­si­bi­li­ty to crea­te depre­cia­ti­on poten­ti­al is the sel­ler con­ver­si­on model. The tar­get com­pa­ny is trans­for­med by the sel­ler pri­or to clo­sing in a part­nership, qui­te often a GmbH & Co KG. After­wards the sha­res are sold to the acqui­rer. The purcha­ser recei­ves in this way, on a secu­re legal basis, the desi­red tax-redu­cing depre­cia­ti­on poten­ti­al. This model results in a tax bur­den for the sel­ler and only makes sen­se if the sha­res are sha­res issue­din return for a con­tri­bu­ti­on in kind below fair mar­ket value­pur­suant to §§ 20, 23 UmwStG and are still wit­hin the blo­cking peri­od, which were ful­ly tax­able.  To note, the­re are still pos­si­b­ly adver­se tax con­se­quen­ces in the case of a pos­si­ble return of con­ver­si­on into a cor­po­ra­ti­on.

2.3 Sales Tax (VAT)

The acqui­si­ti­on of com­pa­ny sha­res is not sub­ject to the sales tax (VAT). The sales tax legal con­cept of the busi­ness unit is simi­lar to the inco­me tax con­cept of par­ti­al ope­ra­ti­on.

2.4 Real Esta­te trans­fer tax

Real Esta­te trans­fer tax ari­ses if wit­hin the assets of the acqui­red cor­po­ra­ti­on are pro­per­ties and in the con­trol of acqui­rer are 95% of the sha­res, direc­t­ly or indi­rec­t­ly. In the case of part­nerships with pro­per­ty assets, the real esta­te trans­fer tax is also trig­ge­red if wit­hin 5 years at least 95% of the sha­res in the hands of the acqui­rer. Also for pro­per­ty the­re are various tax opti­mi­za­ti­on models. Sin­ce tho­se models may influ­ence the inco­me tax sec­tor they need be clo­se­ly moni­to­red and coor­di­na­ted.

From the above-men­tio­ned state­ments, which refer only to tran­sac­tions in Ger­ma­ny. It beco­mes obvious that the sub­ject of taxa­ti­on has an signi­fi­cant influ­ence on tran­sac­tion design. The expe­ri­en­ced M&A Con­sul­tants, depen­ding on the situa­ti­on, the per­so­nal pre­fe­ren­ces of the cli­ent and the mar­ket needs and oppor­tu­nities will deve­lop a tran­sac­tion model, coor­di­na­ted with the respec­tive tax advi­sers, which will result in an opti­mum result for both par­ties.

This con­tri­bu­ti­on has been crea­ted with care. Any lia­bi­li­ty (for the cor­rec­t­ness of the infor­ma­ti­on) is exclu­ded. (as of Dec. 2016)