Germany tax: Local tax court rules on validity of profit and loss pooling agreements

In a recently published decision, the local Tax Court of Cologne challenged the long-standing case law of the German Federal Tax Court (BFH) regarding the content of profit and loss pooling agreements (PLPA).

One of the conditions to form a valid tax consolidation under German tax law is that the controlling parent and the subsidiary conclude a PLPA that obliges the parent to compensate the subsidiary for any losses incurred. This loss compensation obligation is stipulated by section 302 of the Stock Corporation Act (SCA), and both the BFH and the Ministry of Finance (BMF) interpret the tax law in a way that the loss compensation obligation under section 302 SCA must be specifically agreed upon in the PLPA if the subsidiary is a GmbH. As a result, a tax consolidation with a GmbH as a controlled entity has been disallowed in cases where the loss compensation obligation is not specifically included in a PLPA.

In the case at issue, the Tax Court of Cologne did not follow existing BFH case law, but instead confirmed the validity of a tax consolidation with a GmbH in a situation where the loss compensation obligation was not included in the PLPA until the agreement was amended with retroactive effect. According to the court, the BFH's strict interpretation is excessive because section 302 SCA should be directly applicable to GmbHs for civil law purposes and the BFH's interpretation may violate the equality principle in the constitution. The tax court did not see any legal or economic difference in including or not including the section 302 SCA language in a PLPA with a GmbH. The court therefore held it was not necessary to specifically include a loss compensation obligation according to section 302 in a PLPA with a GmbH as a controlled subsidiary.

The case is now pending before the BFH. Until the BFH has decided on the appeal, taxpayers should ensure they comply with the BHF's interpretation of the rules and not rely on the tax court's decision.