Determining the conditions for tax exemption of the reorganization income

According to Section 3a (1) sentence 1 of the German Income Tax Act, increases in business assets or business income from a debt waiver for the purpose of a company-related restructuring are tax-free. The regulation was introduced by law on June 27, 2017 after the so-called restructuring decree from 2003 was declared invalid by the German Federal Fiscal Court. In its decision of August 9, 2024 (case no. X B 94/23), which was subsequently intended for publication, the German Federal Fiscal Court had to clarify the legal question of whether the profit from a debt waiver granted by a creditor in the 2014 year of dispute fulfils the requirements for tax exemption in accordance with Section 3a of the German Income Tax Act.

The sole general partner and trustor of the sole limited partner of a Limited Partnership (KG), which operated petrol stations and purchased the majority of the fuel sold from a Public Limited Partnership (AG), was allocated all shares and income of the KG for tax purposes, so that the latter were determined and recognised directly as part of his income tax assessment without a uniform and separate assessment. Due to the financial difficulties of the petrol station business, the shareholder agreed with the AG in 2014 that the AG would waive all of its outstanding receivables in return for payment of EUR 50,000. The shareholder applied for tax exemption under Section 3a of the German Income Tax Act and Section 7b of the German Trade Tax Act for the resulting book profit of around EUR 3.7 million and applied for their retroactive application as provided for by law. However, the tax office treated the book profit from the debt waiver as taxable in the 2014 income tax and trade tax assessment notice. The Lower Saxony tax court dismissed the appeal against this at first instance, as neither the suitability of the debt waiver for restructuring nor the intention of the AG as a creditor to restructure had been sufficiently demonstrated. The German Federal Fiscal Court agreed with this in its decision on the appeal against denial of leave to appeal.

This is because the law does not contain a fixed rule of evidence in the form of a specific criterion from which the suitability for restructuring can be derived. However, key indicators for the existence of such suitability for reorganisation may lie in particular in the existence of a comprehensible and verifiable reorganisation concept or a retrospectively successful completion of the reorganisation. In the case in dispute, however, the settlement agreement concluded in 2014 no longer referred to a restructuring concept that was discussed in 2010 but ultimately not implemented. In addition, the restructuring was also not successful, as the KG sold further petrol stations due to financial difficulties and deregistered its business in 2020. No other indications of suitability for reorganisation were discernible in the case in question.

The legally standardised criterion of the ‘creditors’ intention to restructure’ also has independent relevance. The existence of the ‘intention to reorganise’ is not always to be assumed if an individual creditor waives a claim in full or in part in connection with a reorganisation. This would render this element of the offence meaningless.