German tax law permitting loss carryforward following restructuring of failing companies is not State aid, EU court rules

By Konstantin Sakuth, Linklaters LLP, Munich

The long-running debate regarding whether German laws that provide for the carryforward of tax losses in the case of restructuring of companies in financial difficulty are State aid has finally come to an end.

In a welcome decision, the Court of Justice of the European Union concluded June 28 that the German “restructuring clause” does not constitute illegal State aid.

Restructuring clause

German tax legislation provides that, generally, tax loss carryforwards of a corporation can be offset with future profits taking into account rules on minimum taxation. However, tax loss carryforwards are forfeited upon a harmful change in control.

Under the “restructuring clause,” enacted in 2009 as a result of the financial crisis, though, losses are not forfeited if the company in question is in financial difficulty and the change in control takes place to restructure this company.

Whether the restructuring clause applies depends on the facts and circumstances of the individual case. Hence, it was common practice to ensure the applicability of the exception by way of a binding ruling from the tax authorities.

The State aid discussion

Soon after the introduction of the restructuring clause, doubts were raised about whether it was in line with EU law or whether it constitutes State aid pursuant to Art. 107 TFEU. The latter would be the case if the provision was selective by favoring certain undertakings.

The starting point of the dispute was the Commission Decision (2011/527/EU), dated 26 January 2011, on State aid C 7/10 (ex CP 250/09 and NN 5/10) implemented by Germany.

The European Commission held that the restructuring clause constituted State aid and Germany was compelled to provide the European Commission with a list of all companies which had benefitted from the restructuring clause and to recover the aid granted.

This affected, amongst others, Heitkamp Bauholding GmbH and GFKL Financial Services AG, which brought actions against the Commission Decision before the General Court but without success (4 February 2016, T-287/11 and T-620/11).

The General Court confirmed the view of the European Commission, stating that the restructuring clause is selective. The European Commission, as well as the General Court, argued that the forfeiture of tax loss carryforwards represents the relevant general rule. The restructuring clause would deviate from the general rule and, thus, favor companies in difficulty.

The legal proceedings continued since both companies brought actions before the Court of Justice of the European Union.

Reference framework

Taxpayers had good reasons to be more optimistic after the Advocate General Wahl delivered his Opinion on 20 December 2017. In his view, the European Commission and the General Court erred when choosing the reference framework to determine the selectivity of the restructuring clause.

The future use of tax loss carryforwards, not the forfeiture of tax loss carryforwards, represents the general rule which must be used as the reference framework, the Advocate General said. The forfeiture of tax loss carryforwards is an exception to this general rule and the restructuring clause is an exception to this exception, which again leads back to the general rule.

ECJ decision

The June 28 ECJ decision follows the Opinion of Advocate General Wahl. The decisive question is the reference framework, which ought to be used to determine whether the restructuring clause is selective and, thus, constitutes State aid or not.

The ECJ concluded that it is not the forfeiture of tax loss carryforwards but the future utilization of tax loss carryforwards which must be used as the reference framework.

As such, the ECJ puts the European Commission in its place and clarifies that the restructuring clause does not constitute State aid. This judgement is welcome from the point of view of Germany and the taxpayer.

As a consequence of the ECJ judgements in Dirk Andres (acting as liquidator in the insolvency of Heitkamp BauHolding GmbH) v European Commission (C-203/16 P), Federal Republic of Germany v European Commission (C-208/16 P), Federal Republic of Germany v European Commission (C-209/16 P) and Lowell Financial Services GmbH v European Commission (C-219/16 P), previous judgements of the General Court and the Commission Decision are annulled.

Also, other proceedings pending before the ECJ concerning the restructuring clause are expected to be decided similarly.

However, the ultimate practical relevance of the ECJ decisions will also depend on whether the rule on forfeiture of tax loss carryforwards upon a harmful change in control is deemed unconstitutional or not.

This question is currently pending before the German Federal Constitutional Court.

—Konstantin Sakuth is an Associate with the tax team of Linklaters LLP in Munich. Konstantin holds an LL.M. in International Tax Law from WU Vienna.