German Taxation of Migrations and Cross-Border Transformations
On July 12, 2006, the German government approved the draft of the SEStEG (a bill regarding tax measures accompanying the introduction of the European company). In particular, the draft bill implements the tax framework for a European company set forth in the amended EU Merger Directive as of February 17, 2005, the EU directive as of October 26, 2005 on cross-border mergers of limited liability companies, and the European Court of Justice (ECJ) SEVIC Systems decision of December 13, 2005. However, it is doubtful whether these proposals fully comply with European law. The draft basically provides an instant taxation of built-in gains if the German right to tax these gains is limited or excluded. Among other things, these proposals substantially affect the taxation of companies migrating from Germany as well as cross-border mergers. If these changes become effective, U.S. groups with German investments planning a reorganization—e.g., the implementation of a European holding structure—need to carefully review the proposed changes.
Migration from Germany
The draft bill imposes a general exit tax on companies migrating from Germany. According to this, an instant realization of the built-in gains in business assets will be assumed if the German authorities lose the right to tax hidden reserves, i.e., an exit tax is imposed on a migrating company if the business assets do not remain in a permanent establishment in Germany. Contrary to current law, a realization is assumed even if the assets are transferred to a permanent establishment in a country to which Germany applies the tax credit method. The tax credit method does not exclude the German right to impose taxes on the built-in gains of the transferred assets as the gains are still being taxed upon realization abroad. The foreign tax is granted as tax credit on the German tax.
However, although the German taxation rights are not excluded, an instant exit taxation would occur. If such a taxable event arises, the business assets would be valued at their fair market value on the relevant transfer date, not the going concern value. The taxable gain or loss would be calculated as the difference between the fair market value and the tax basis of the business assets.
This exit taxation would apply not only to German corporate forms (limited liability company, GmbH, or stock corporation, AG) but also to a migrating European company (Societas Europaea, SE) and to migrating foreign corporate forms, such as a UK limited which has had its effective place of management in Germany.
It is questionable whether the exit tax on emigrating companies complies with European law. For the reverse case of an immi-grating company it is widely undisputed that the EU freedom of establishment requires Germany to accept that corporation, i.e., the transfer of the effective place of management and/or registered office may not trigger any corporate or tax con-sequences. Several landmark ECJ decisions have prompted Germany to do so (Centros, Überseering, Inspire Art). As a result, approximately 15,000 UK limited companies have their effective seats of management in Germany.
Instant taxation at the moment of migration also raises questions of EU law compatibility regarding the exit taxation clause and its timing. Following the ECJ de Lasteyrie du Saillant decision, the draft bill defers taxes for individuals migrating to another EU Member State or European Economic Area (EEA) country until the capital gains are actually realized. As the ECJ regards a deferred taxation as less incriminatory than an instant one, this differentiation between migrating companies and individuals might violate the EU freedom of establishment.
According to the draft bill, the Transformation Tax Code would expand to apply to European legal forms in general. The previously planned “globalization” of the code has been abandoned. Currently its applicability is basically limited
to German legal forms.
For non-German investors, the following changes could be of major practical relevance:
As a general principle, the shareholder can elect to avoid an immediate taxation of gains arising from a corporate-to-corporate reorganization (e.g., merger, de-merger or spin-off), provided that the German right to tax the hidden reserves is neither excluded nor limited. The aforementioned taxation of migrations from Germany follows this same principle. Technically, the shareholder of the transferring corporation has sold the shares in the transferring corporation at the fair market value and has acquired the shares in the receiving corporation at the same value. The assessment of a group of assets that is required in corporate transactions includes the goodwill of the firm.
At the shareholder level, the gain resulting from the technical sale of the shares is split up into a “capital-gain part” and “dividend part.” It is assumed that the corporation has distributed its open reserves. On this “dividend part,” withholding tax on capital would be imposed.
The shareholder may roll over the former book values of shares in the transferring corporation to shares in the recipient corporation to avoid instant taxation. However, this roll over is only permissible if the German right to tax the built-in gains in the shares is neither lost nor limited by the transaction.
The transferring corporation can avoid a capital gain taxation with regard to the assets that are transferred to the recipient corporation by a valuation of the assets at their book value in the final balance sheet. However, this is only permissible if the built-in gains are later taxable in Germany at the level of the recipient corporation. A transfer at fair market value or at any intermediate value between book value and fair market value is permitted as well.
Unlike the current law, the draft bill fully bans any transfer of a loss carry forward (NOL) from the transferor corporation to the transferee corporation. Presumably, this is to prevent the import of foreign losses into Germany in cases of an inbound cross-border merger of foreign loss companies. To avoid potential violation of the EU freedom of establishment, NOL transfers are not allowed in purely German mergers, divisions and spin-offs.
Following Article 11 of the EU merger-directive, a specific anti-avoidance clause is being proposed.
By Dr. Martin Kock
After 15 years of discussion, the EU Takeover Directive 2004/25/EC finally was adopted on April 21, 2004. The objec-tives of the Directive are to harmonize European takeover laws and to create a “level playing field” for European takeovers. Each Member State was required to implement the directive by May 20, 2006. The necessary amendments to various laws (most notably the German Takeover Act) came into effect in Germany on July 14, 2006.
Under the Directive, directors are not allowed to take defense measures against hostile bids. Contrary to this general rule, only the following measures are allowed. Directors may:
take measures authorized by shareholders after publication of the hostile bid
continue the ordinary course of business
continue measures outside the ordinary course of business provided that such measures were authorized prior to the hostile bid
search for competing offers
Certain measures allowed under German law are not legal under the Directive. For example, under the Directive directors cannot act upon supervisory board consent or upon a broad “shelf” shareholder consent that is not in connection with the hostile bid.
The Directive provides for breakthrough rules according to which:
contradictory by-laws or shareholder agreements (e.g., regarding share transfer or voting) do not bind the bidder during the offer phase
“golden shares” and pools do not apply in shareholders’ meetings during the offer phase (with the exception of golden shares based on laws)
golden shares have only one vote in the first shareholders’ meeting after the offer phase if the bidder has acquired at least 75 percent of the shares (facilitating new by-laws or appointment of board members)
Opting-Out and Opting-In
The German lawmakers decided to make the aforementioned provisions voluntary for German companies (Germany “opted-out”). However, the new law allows individual companies to apply certain provisions of the Directive. Companies could therefore “opt-in” by including certain rules of the Directive in their charter documents. The advantage for a company to opt-in is that any target it may want to takeover will also be bound by this standard as long as it also has opted-in (reciprocity principle). However, German targets which in principle are subject to strict neutrality (because they opted in) may take extended defense measures if the (German or foreign) hostile bidder is not subject to the stricter standards promulgated by the Directive.
It remains to be seen whether shareholders of German companies interested in higher shareholder value will apply the rules of stricter neutrality through charter amendments. If shareholders are resolving these amendments—a 75 percent majority is required—then they will prove to be more courageous in creating the “level playing field” intended by the European Directive than the German lawmakers.
Reforms of German Copyright Law Take Shape
By Dr. Wolfgang von Frentz
In March 2006 the German government proposed reforms to German copyright law. The proposed Act on the Mod-ernization of Copyright Law (Gesetz zur Modernisierung des Urheberrechts), or the so-called Second Basket of amendments (Zweiter Korb), aims to further update German copyright law.
The First Basket (Erster Korb) of amendments to the German Copyright Act went into effect in September 2003. They implemented the EU Directive on the harmonization of certain aspects of copyright and related rights in the information society (2001/29/EC) into German law. The reforms now proposed target aspects not compulsorily regulated by the EU Directive. The key aspects of the reforms relate to file-sharing via the internet, copyright remuneration and licensing of copyrights for unknown forms of utilization.
File-Sharing via the Internet
File-sharing via the internet is one of the main concerns of the reform. Under the proposal, copying protected works for private use (one form of fair use under German copyright law) will be inadmissible not only if the copied material was apparently produced illegally but also if it is apparent that the material is made available to the public illegally. For example, a block-buster movie offered online by the owner of a legal copy of the movie on a file-sharing platform may not be copied for private use any longer.
Copying for private use is a hot topic and will continue to face other obstacles. Many have argued that users should be allowed to circumvent technological protection measures if necessary to copy a work for private use. However, the reform plans do not provide for such a circumvention right. Rather, the reform plans confirm the message of the First Basket reforms: the law acknowledges if a copyright holder decides to use technological protection measures, and thus the law limits the right of copying for private use.
Modified Remuneration System
Another key aspect of the reforms is the modification of the current copyright holder remuneration system. An important element in German copyright law is the author’s right to fair remuneration from the sale of certain technical devices and storage media. Current German copyright law raises fixed levies on technical devices and storage media designed to enable copying. So-called collecting societies (also known as Verwertungsgesellschaften) collect the levy and pay it to the copyright holder. These levies are justified as a form of compensation for the copying of works without the copyright holder’s approval. According to one part of the reform plan, the levy may be raised in the future if technical devices or storage media are used for copying to an appreciable extent and not only as today if they were designed to enable copying.
Currently, copyright holders may rely on a wide array of content protections and technical copy restrictions. A remuneration scheme based on digital rights management systems, or DRM, could potentially restrain illegal copying and enable individ-ualized distribution. Therefore, it was discussed whether the levy system for technical devices and storage media should be conveyed into a more individualized remuneration system.
Despite the benefits of DRM, the German government concluded that the right to make private copies from digital sources requires a levy system. As a compromise, however, the reform plans envisage that the levy amount will no longer be fixed in the German Copyright Act. Rather, the collecting societies and the associations of the respective manufacturers would negotiate to determine the amount.
According to the reform plans, only the criteria for the deter-mination of a fair remuneration will be fixed by statute. The actual payment will be calculated according to the extentof use. Higher usage rates will incite higher levies, which will result in higher revenue for copyright holders. Consequently, there will be no or a very small levy on devices that use copy protection or Digital Rights Management Systems to impede private copying.
The proposed criteria state that the levy will have to be appropriate in relation to the price level of the devices or the storage media, and it is limited to 5 percent of the selling price. If the parties cannot agree on appropriate remuneration, the bill provides for arbitration proceedings. If the parties do not accept the settlement recommendation, the dispute can be brought in front of the Appellate Court (Oberlandesgericht).
All in all, the new copyright bill introduces more flexibility but nonetheless upholds the levy system.
Unknown Forms of Utilization
The third key aspect of the reform relates to unknown forms of utilization. Broadcasting houses’ and publishers’ archives contain a substantial array of works, which at the moment cannot be easily digitalized or offered online. According to a provision in the current German Copyright Act, copyright owners cannot transfer in advance rights to unknown forms of utilization. As a result, if a licensee wishes to use a work in a form pre-viously unknown, the licensee has to go back to the copyright owner and obtain the necessary rights through a new agreement.
The reforms lift this hurdle: rights to still unknown forms of use could be effectively transferred in advance. This also affects existing contracts through which only rights to forms of known utilization were transferred. The respective licensee is entitled to use the work in digital form if the copyright holder does not object within a certain timeframe. In exchange, the copyright owner receives fair remuneration. If enacted, the reform would allow for archived existing works to be used in new media.
Taken as a whole, the Second Basket could bring some long-needed flexibility to German copyright law. It remains to be seen, however, whether the reforms will remain in tact through Parliamentary review and what ultimate effect they will have in practice.
Fewer Restrictions on Cross-Border Mergers
The German Ministry of Justice recently proposed several amendments to the German Law Regulating Transformation of Companies (UmwG) to facilitate cross-border mergers of German corporations.
According to Brigitte Zypries, the German Minister of Justice, smaller and medium-sized companies will primarily benefit from the proposed amendments and will be able to merge across EU Member State borders much easier than before. Due to high transaction costs, currently only large companies can afford cross-border mergers. In addition, the bill intends to provide more flexibility to German medium-sized companies to encour-age their competitiveness both within the single European market as well as worldwide.
According to the proposed law, a German Gesellschaft mit beschränkter Haftung (GmbH) will be easily able to mergewith a French société à responsabilité limitée (S.a.r.l.) or a British private company limited by shares (Ltd.). Under the current law, in order to realize a cross-border merger, a mutual merger schedule, a merger report and a merger review are required. The GmbH then has to consider the protection rules regarding minority shareholders and creditors. Once it meets these conditions, a German corporation can file for a mergers’ certification with the appropriate registration office. It then provides the German mergers’ certification to the registration office, it is listed in the external commercial register and the merger is realized.
The proposed bill will implement into German law the corporate part of the EU Directive 2005/56/EG regarding the merger of corporations from EU Member States. Once the amendments are implemented, the German Law Regulating Transformation of Companies will apply to German mergers as well as to cross-border mergers. However single amendments still need to be implemented to address the special character of cross-border mergers.