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Tax & Legal

Write-downs to fair market value resulting from foreign exchange rate differences on investment units are to be added back off-balance sheet


Where a company, which has acquired investment units in US dollar denominated equity funds, writes down the value of the investment units to their fair market value following an unfavourable development in the foreign currency exchange rate, the company must add the write down back off-balance sheet.

 

Background

The question before the tax courts was whether foreign currency exchange losses arising from the valuation of investment units could be recognised in calculating the income for corporation tax purposes. The plaintiff (a German limited company – GmbH) had valued the investment units at their lower fair market value as at the balance sheet dates. (This was a permissible treatment.) The company sold the investment units and made a profit in US dollar terms. However, due to the fall in the foreign currency exchange rate, a loss was incurred in Euro terms. The tax office recognised the loss as such, but added it back off-balance sheet according to Section 8b (3) 3rd Sentence Corporation Tax Act. This treatment was confirmed by both the tax court and the Supreme Tax Court.

 

Reduction of profits arising from write-downs to fair market value are to be neutralised off-balance sheet.

According to Section 8 (2) of the Investment Tax Act the investor’s gain arising from the shares during the time of ownership (i.e. the difference between the gain on the shares as at the valuation date and the gain as at the date of acquisition – “pro rata temporis gain”) is relevant for the determination of the level of the off-balance sheet add-back. According to the Supreme Tax Court such pro rata temporis loss had been incurred on the shares. Such a reduction in value does not only occur where the stock market price of the shares held by the investment fund goes down, but also where the value of the shares at the balance sheet date has sunk because of a fall in the foreign currency exchange rate. For tax purposes no differentiation is to be made between losses incurred through changes in the stock market price and losses incurred through changes in the foreign currency exchange rates. According to the Supreme Tax Court the purpose of the Investment Tax Act is – following the so-called investment tax law transparency principle – to put investors in funds on a par with direct investors. This should also apply to investments in equity funds. Thus an off-balance sheet add back is also required where the investor decides to write down the value of a fund unit due to a foreign currency exchange loss to ensure an equal tax treatment with direct investors.

 

Existing symmetry of the rules excludes a breach of EU law

The Supreme Tax Court took the view that the off balance sheet add-back did not amount to a restriction of the EU basic freedoms. The add-back did indeed mean that, ultimately, the foreign currency exchange rate loss was not recognised for tax purposes. However, in the opposite case of an exchange rate gain, which is reflected through a pro rata temporis gain, the law provides for a tax exemption (Section 8 (1) and (3) of the Investment Tax Act and Section 8b (2) Corporation Tax Act).

 

Reference

Supreme Tax Court decision ( I R 63/15) of 21 September 2016, published on 15 February 2017

 

Amendment of tax loss utilisation rules for corporations


Under certain conditions, changes in shareholders and the admission of new investors will in future be possible without giving rise to a forfeiture of losses carried-forward. On 23 December 2016 the Act for the Further Development of Tax Loss Utilisation for Corporations was published after having been adopted by the German Parliament (Bundestag and Bundesrat) on 20 December 2016.

 

The new rules represent a significant change for corporations in the tax treatment of loss utilisation. Previously a corporation’s unutilised losses could be subject to (partial) forfeiture, where there was a change in the shareholder ownership above certain levels (“harmful change of ownership”). A new provision has now been introduced into the Corporation Tax Act, according to which it is possible to apply for relief from the forfeiture of tax losses after such a harmful change in ownership.

 

Strict conditions for the application of the rule

An application under the new provision can only be successful, to the extent that the corporation has maintained exclusively the same business since the corporation was established or at least has maintained exclusively the same business in the last three periods of assessment before the period of assessment in which the harmful change of ownership arose. Furthermore during this period the corporation cannot have been a controlling enterprise in a tax consolidation group (“Organträger”) nor can it have held an interest in a commercial partnership.

In addition to the above, the provision lists a number of harmful events; where any of these harmful events have occurred in the above mentioned three year period, the corporation will not be entitled to the relief.

The relief from tax loss forfeiture does not apply to losses which were incurred in a period prior to a previous discontinuance or dormancy of the business. This would apply, in particular, to situations where the corporation had discontinued its business in the past and then started a new business.

The corporation must apply for application of the relief in its tax return for the period of assessment in which the harmful change of ownership occurred.

Earmarked loss carry-forward

The whole of the loss carry-forward available at the end of the period of assessment in which the harmful change of ownership occurred, will become an earmarked loss carry-forward. It may be set off against profits arising in future years subject to the rules of minimum taxation.

Harmful events

Any earmarked loss carry-forward which has not already been utilised will be forfeit if the business is discontinued or if any of the harmful events listed in the provision occur. In such a case, the corporation will be able to retain the earmarked loss carry-forward to the extent that the corporation has hidden reserves. This only applies however to hidden reserves which existed at the end of the period of assessment, which preceded the period of assessment in which the harmful change of ownership occurred.

Other important conditions

  • The earmarked loss carry-forward must be separately declared and assessed.
  • The provision will apply to harmful changes of ownership, which occur after 31 December 2015.
  • No application for non-forfeiture may be made for “old” losses incurred in periods prior to a discontinuance or dormancy of the business. In the case of a discontinuance or dormancy occurring prior to 1 January 2016, it may not be possible to allocate the losses properly as these events may have occurred far back in the past. Accordingly an application for non-forfeiture is completely excluded in these cases.
  • The provision also applies accordingly to any interest carry-forward and to any loss carry forward for trade tax purposes.

Bundesrat gives its assent to the packet of measures against profit reduction and profit shifting.


In its last session of the year, the Federal Assembly (Bundesrat) gave its assent today to the Act to Implement the Amendments to the EU Mutual Assistance Directive and to Introduce Further Measures to Combat Profit Reduction and Profit Shifting

This packet of measures, which will come into effect on 1 January 2017, will give almost € 25 billion worth of relief to taxpayers. In particular low earners, families and lone parents will benefit.

The Bundesrat also gave its assent to the law amending the rules regarding the utilisation of losses upon change of control. (See our Blog:  http://blogs.pwc.de/german-tax-and-legal-news/2016/12/06/bundesrat-set-to-approve-draft-for-relief-from-curtailment-of-loss-utilization)