German Parliament Adopts Changes to the Loss Utilization Rules and the Interest Cap Rules

Blog Post

Corporate & Finance Alert

September 8, 2009

The German Bundestag (Lower House) passed two statutory amendments to the Business Tax Reform Act of 2008 as part of the Citizen Relief Act (Bürgerentlastungsgesetz) (the “Act”) on June 19, 2009. These amendments were approved by the Bundesrat (Upper House) on July 10, 2009 and became effective on July 22, 2009. The Act is a reaction to the global economic crisis and introduces a restructuring clause in Section 8(c) of the German Corporation Tax Act (“CTA”) which temporarily permits the utilization of loss carryovers in connection with the restructuring of loss corporations. In addition, the new Act temporarily increases the exempt threshold of the Interest Cap Rule (also named the “Earnings Stripping Rule” and “Interest Barrier Rule”) from € 1 million to € 3 million.

New Restructuring Clause in Section 8(c) of the CTA

Existing law

Under the existing rules, Section 8(c) of the CTA restricted the utilization of losses. Loss carryovers were subject to a pro rata forfeiture, if more than 25 percent but less than 50 percent of the shares in a loss-generating German corporation were transferred to one acquiror (or its affiliates) within a five-year period. If more than 50 percent of the shares were transferred, then the entire loss carryover is lost. In general, these rules apply to direct and indirect transfers of shares. It is without doubt that this rule did not attract investment in a restructuring of an insolvent or distressed corporation.

New law

Due to the current economic situation the German parliament decided to temporarily mitigate this obstacle by introducing a restructuring clause in Section 8(c) (1a) of the CTA. This restructuring clause allows corporations to maintain their loss carryovers in the event of a qualifying restructuring. Pursuant to Section 8(c) (1a) of the CTA, the new clause applies if shares are acquired with the purpose of restructuring the business of the corporation. The clause defines the restructuring purpose as any measure taken to prevent or overcome illiquidity, insolvency or over-indebtedness of the corporation while at the same time substantially preserving the characteristics of the corporation’s business structure. Pursuant to Section 8(c) (1a) of the CTA preservation of the main characteristics of the business structure requires at least one of the following requirements to be met:

  • The loss corporation must have an agreement with the German workers’ council securing jobs.
  • The total sum of the annual wages paid by the corporation during the five fiscal years following the share transfer does not drop below 400 percent of the aggregate wages paid in the year of the acquisition. This means that the corporation has to pay at least 80 percent of the original wages in a five year average.
  • The loss corporation receives substantial new business assets through a shareholder’s equity contribution. Section 8(c) (1a No. 3) CTA defines “substantial new business assets” as an introduction of new assets with a value of at least 25 percent of the existing business assets of the loss corporation within twelve month following the share transfer. Such contribution may also be received by way of debt waivers, if the debt is valid and recoverable. Any distribution made from January 1, 2009 through December 31, 2011, will reduce the value of the qualifying contribution to the business assets accordingly.

In order to avoid abuse, the restructuring clause sets forth that no restructuring is given under Section 8(c) (1a) CTA if, at the time of the share transfer, the corporation already ceased its business operations, or if it changed its line of business within a period of five years following the share acquisition. As a result, the restructuring clause will not be applicable for “shell company acquisitions” with the only purpose of allocating losses to future earnings.

In addition it should be noted that pursuant to the Lower House Finance Committee Explanations, a share acquisition for restructuring purposes requires proof that the corporation can be restructured at the time of the acquisition, and that the contemplated measures are suited to restructure the corporation in a foreseeable period of time. The Committee Explanations state that the creation of a formal restructuring plan could meet these requirements. However, the future success of the restructuring measures has no bearing on the application of the restructuring clause.

The new law will apply to all share transfers between December 31, 2007 and December 31, 2009.

Increase of Exempt Threshold of the Interest Cap Rule

Existing law

The Interest Cap Rule of Section 4(h) of the German Income Tax Act (“ITA”) and Section 8(a) CTA limits the full deductibility of interest expenses. As a general rule, Section 4(h) (1) ITA allows the deduction of interest expenses up to the amount of interest income in the same fiscal year. All interest expenses exceeding the interest income are deductible only up to 30 percent of the taxable earnings before interest, taxes, depreciation and amortization (EBITDA). The intent of the rule is to avoid the transfer of gains and profits to low-tax countries while using interest expenses to reduce the profits taxable in Germany. However, this rule is subject to several exceptions. Among other things, the interest cap rule does not apply if the interest expenses exceed the interest income by no more than € 1 million per year.

New law

In order to allow small and middle sized companies to benefit from the full deductibility of interest expenses, the German parliament temporarily increased the € 1 million threshold to € 3 million. The Act addresses these companies’ increased financing needs by ensuring that they remain outside the scope of the Interest Cap Rule. Based on an interest rate of 5 percent, the overall budget that is exempted from the Interest Cap Rule increases up to € 60 million.

However, the increase of the threshold is only temporary and is applicable for fiscal years beginning after May 25, 2007 through the fiscal year ending on or before December 31, 2009.


The new amendments bring needed changes for companies battling with the current financial crisis. However, since the new amendments are limited to the end of 2009, the relief will be only for a short-term. The German parliament announced that it is contemplating further tax reforms; however, due to the upcoming elections to the Bundestag in September 2009, such reforms will not be discussed until after the elections.

The authors would like to thank Tim Holthaus, a Referendar with Gibbons P.C. (while in the process of taking the German Bar Examination) at the time this article was authored, for his assistance with preparing this article.