Germany tax: Court adopts stricter interpretation of compensation payments to minority shareholders in fiscal unity

The German Federal Tax Court (BFH) recently issued a decision that sets limits on compensation payments to minority shareholders in fiscal unity structures.

Under German law, if a German corporation establishes a fiscal unity with its majority shareholder, a compensation payment must be made to the minority shareholder(s). The BFH has clarified that a compensation payment that comprises both a fixed and a variable portion that, taken together, correspond to the profit share the minority shareholder would have received in the absence of a fiscal unity is contrary to the conditions that apply for a fiscal unity to be accepted for tax purposes. Therefore, the BFH disregarded the fiscal unity in the case, with the result that both entities were taxed on a stand-alone basis.

The BFH is adopting a stricter position than the German tax authorities. The latter have taken the position that the combination of a fixed and a variable compensation payment to minority shareholders does not violate the validity of a fiscal unity. According to the BFH, the fiscal unity requirement that there be a transfer of the entire profit from the subsidiary to the parent in a fiscal unity is not satisfied (at least in cases such as the one decided) where the variable portion of the compensation payment is structured so that the entire compensation adds up to the profit share the minority shareholder would have been entitled to in the absence of the fiscal unity.

In its decision, the BFH confirmed the prevailing opinion in the professional literature that where the (direct) minority shareholder is, for example, the parent of the (direct) majority shareholder of the fiscal unity subsidiary (i.e. an indirect shareholder in the fiscal unity subsidiary), no compensation payment is necessary from a legal perspective. Even though compensation payments are not required in such structures, this does not prevent the parties from agreeing on a compensation payment, which should also be recognized for tax purposes if the characteristics of a compensation payment pursuant to the law are properly reflected.

Taxpayers should review existing fiscal unity structures with minority shareholders to determine whether compensation payments have been stipulated in the profit and loss transfer agreement that might not be in accordance with the strict interpretation of the BFH and, if so, consult with their tax advisers to explore mitigation possibilities.