Intragroup Reorganisations: Legal and Tax Steps

Intragroup reorganisations in Germany: aligning corporate and tax steps

Intragroup reorganisations are among the most frequent corporate projects in Germany: groups simplify holding structures after acquisitions, create sub-holdings for divisions, prepare carve-outs and disposals, merge loss-making and profitable entities, or move businesses into the legal form that suits a new financing or governance model.

The legal mechanics come mainly from the Transformation Act (UmwG) and general civil law, while the tax consequences depend on the Reorganisation Tax Act (Umwandlungssteuergesetz, UmwStG), the Real Estate Transfer Tax Act (GrEStG) and the loss forfeiture rules of the Corporate Income Tax Act. The key to successful intragroup reorganisations is to design the corporate steps so that they fit the conditions for tax neutrality, and to sequence them correctly.

This briefing covers the main building blocks: hive-downs, upstream and sidestream mergers, intra-group share transfers and contributions, and the tax and legal checks that come with each.

The building blocks

Each building block has its own legal procedure, explained in our briefing on UmwG mergers and spin-offs, and its own tax conditions. A reorganisation plan for a mid-sized group often combines several of them, for example a hive-down followed by a sale of the new subsidiary's shares to a sister company.

Tax neutrality under the UmwStG

The starting point of the UmwStG is taxation at fair market value: in a merger of corporations, the transferring company must in principle recognise the transferred assets at fair value in its tax closing balance sheet (§ 11(1) UmwStG), which would realise hidden reserves. On application, book values can be carried forward if the assets remain subject to German corporate income tax, Germany's right to tax gains is not excluded or restricted, and no consideration other than shares is granted (§ 11(2) UmwStG). Equivalent rules apply to the acquiring company and the shareholders.

Divisions are more demanding. A spin-off or split-up of a corporation is tax-neutral only if a partial business (Teilbetrieb) is transferred and, in a spin-off, a partial business remains with the transferring company (§ 15(1) UmwStG). A 100% shareholding in a corporation counts as a partial business. Anti-abuse rules deny book value treatment where the division prepares a sale to outside persons, and assets assembled into a partial business shortly before the division do not qualify.

Contributions of a business, a partial business or a partnership interest into a corporation against new shares can be made at book value on application (§ 20(2) UmwStG). If the contributing party sells the new shares within seven years, the contribution gain is taxed retroactively, reduced by one seventh for each full year that has passed (§ 22(1) UmwStG). This holding period is crucial when a hive-down is followed by a disposal; in that case, a share deal shortly after the hive-down can trigger tax on most of the hidden reserves.

For tax purposes, reorganisations can be backdated to the date of the balance sheet on which they are based (§ 2(1) UmwStG), which can be up to eight months before the register application. This retroactive effect does not apply for all purposes, for example not for employment relationships or for transactions with third parties.

Real estate transfer tax and tax losses

Real estate transfer tax (RETT) is a frequent obstacle to intragroup reorganisations. Transfers of real estate by universal succession, and transfers of shares in property-holding companies that cross the 90% thresholds, are in principle taxable. The group clause in § 6a GrEStG provides relief for transformations under the UmwG, contributions and certain other transactions, but only if exclusively a controlling company and companies dependent on it are involved, and the controlling company holds at least 95% of the dependent companies continuously for five years before and five years after the transaction. These holding periods restrict later disposals and must be monitored.

Tax losses are the second key issue. Under § 8c KStG, losses of a corporation are forfeited if more than 50% of its shares are transferred within five years to one acquirer. An intra-group exception applies where the same person holds 100% directly or indirectly in both the transferring and the receiving entity, or in comparable constellations listed in the statute. Mergers and other transformations can also lead to the loss of carryforwards of the transferring entity, which cannot be transferred to the acquiring entity under the UmwStG. Loss-making entities should therefore be acquiring rather than transferring entities where possible.

Legal checks beyond tax

Intragroup reorganisations also raise legal issues that are easy to overlook when the focus is on tax:

• Capital maintenance. Upstream transfers of assets or shares below market value, and upstream guarantees, may breach the prohibition on repaying share capital (§ 30 GmbHG) or the stricter rules for stock corporations (§ 57 AktG), exposing managing directors to liability.
• Employees. Transfers of businesses trigger § 613a BGB and works council rights. Co-determination thresholds may be crossed or fall away, changing supervisory board requirements.
• Financing. Facility agreements and bonds usually restrict reorganisations, require new obligors to accede and require security to be re-granted.
• Contracts and permits. Change-of-control clauses, non-assignable licences and public-law permits may need attention even where universal succession applies.
• Profit transfer agreements. Mergers and share transfers can terminate or affect domination and profit transfer agreements and the fiscal unity they support. See our briefing on domination and profit transfer agreements.
• Data protection and IT. Transfers of customer and employee data between group entities need a legal basis and documentation.

Typical scenarios

Most intragroup reorganisations follow one of a handful of patterns, each with its own priorities:

• Post-acquisition integration. After buying a German group, the acquirer merges the acquisition vehicle with the target to align debt and operating income, a so-called debt push-down. Interest deductibility, the interest barrier rules, the forfeiture of the target's losses and the lenders' security package are the main issues.
• Creating a German sub-holding. International groups bundle their German subsidiaries under one holding company to establish a fiscal unity, simplify cash pooling and reduce the number of reporting lines. Share contributions under § 21 UmwStG and the RETT group clause are central.
• Preparing a disposal. A business unit is hived down into a new company that is later sold. The seven-year holding period under § 22 UmwStG, the alternative of selling assets directly and the employee transfer rules determine the route.
• Legal-form changes. A GmbH becomes a GmbH & Co. KG to obtain tax transparency for family shareholders, or a GmbH becomes an AG before an IPO. Co-determination, governance and tax on the change of form need to be assessed together.
• Simplification. Dormant or small entities are merged to save administrative costs, often combined with the termination of profit transfer agreements and the consolidation of contracts.

Illustration: a hypothetical US group holds three German GmbHs directly. It wants a German holding company to form a fiscal unity and to prepare the later sale of one GmbH. Contributing all three shareholdings into a new holding GmbH can be tax-neutral, but contributing the GmbH that is to be sold starts a seven-year holding period. The group therefore considers keeping that GmbH outside the holding and checks whether any of the GmbHs owns German real estate, which would make the RETT position decisive.

Governance and documentation

Intragroup reorganisations are often treated as formalities, but each step requires proper corporate approvals. Managing directors must assess whether the step is in the interest of their own company, not only of the group, particularly where a subsidiary gives up assets or assumes liabilities. Supervisory boards may have approval rights under the articles or rules of procedure. Where minority shareholders exist, their rights to information, cash compensation and appraisal proceedings must be respected.

Documentation should include board resolutions with reasons, valuation evidence for transfers at book value or below market value, and confirmations that capital maintenance rules are observed. Tax authorities in later audits, insolvency administrators and buyers in due diligence will review these records, so they should be complete, dated and consistent with the step plan and with the filings made.

Sequencing intragroup reorganisations

The order of steps matters. Merging two companies before a share transfer may preserve losses that would otherwise be forfeited; a hive-down before a sale triggers different consequences from a sale of assets; and the date of each register entry can determine whether holding periods are met. Groups therefore often obtain binding rulings from the tax authorities for complex intragroup reorganisations, which requires a detailed description of the planned steps and usually takes several months.

Timing is also driven by the eight-month rule for the balance sheet used in UmwG transformations, works council periods, notarisation and register review. A typical intra-group reorganisation of several steps takes three to six months from planning to the last register entry. More information on related transactions is in our briefing on carve out transactions and on our corporate and transaction tax page.

How TRW & Co helps

We plan and implement intragroup reorganisations for German and international groups. We prepare step plans with tax advisers, draft the corporate documents, organise notarisation and register filings, handle works council information and employee transfers, coordinate lender consents and check capital maintenance and profit transfer agreements. Our corporate team works on one timetable with tax, employment and finance colleagues. Contact us to discuss a planned reorganisation.