228. Clarification Of Loss Utilisation Directive

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1. Introductory

The Frankfurt Regional Tax Office has issued an administrative order dated 3 July 2000 (S†2745 A - 22 - St†II 13 (S); DB 2000, 1541) clarifying the application of certain aspects of the 1999 Loss Utilisation Directive, on which we reported in article no.†176. The Loss Utilisation Directive (hereinafter: "the 1999 directive") deals with the application of ߆8 (4) KStG (denying loss carryforwards to a corporation where it is not "economically identical" to the corporation that sustained the losses) and ߆12 (3) UmwStG (making the survival of loss carryforwards in merger situations contingent upon the continued operation of the business that caused the loss).

The administrative order was issued on the basis of discussions between the Federal Ministry of Finance and the central tax authorities of the German states (Oberste Finanzbehˆrden der L‰nder). Hence, the Federal tax authorities and the tax authorities in the other German states are in agreement with the terms of the order.

2. Corporate Recovery Exception

Under ߆8 (4) KStG, a corporation loses its economic identity inter alia when more than half of its shares are transferred and the corporation continues or recommences its business with predominantly new assets (primary loss forfeiture situation).

By way of exception, the statute provides that injection of predominantly new assets solely for the purpose of rehabilitating a failing business (restoring it to economic viability) is not damaging provided the business continues to operate on a comparable scale for a period of five years (corporate recovery exception). Marginal no.†14 of the 1999 directive limits the injection of new assets under the corporate recovery exception to what is "necessary for the continued existence of the enterprise." The injection of assets in excess of what is necessary to restore the corporation to economic viability (so-called "over-rehabilitation" - ‹bersanierung) will cause the corporation to forfeit the protection of the exception and lose its economic identity.

The administrative order states that, once five years have passed since the time of the share transfer, the injection of new assets can no longer lead to a loss of economic identity by reason of "over-rehabilitation." The administrative order thus makes clear that the five year period created by marginal no.†12 of the...