Background

• The PLTA is an instrument of German corporate law under which the tax group subsidiary undertakes to transfer its annual profit to the tax group parent and under which the tax group parent undertakes to compensate the tax group subsidiary for any annual loss. The profit transfer and/or loss compensation is technically achieved by recording the PLTA claims and obligations as receivables and payables in the annual accounts of the tax group subsidiary and the tax group parent and by subsequently settling the claims and obligations by cash payments or otherwise.
• The German tax grouping rules require that the PLTA is properly implemented in order for the tax group to take effect. Not actually implementing the PLTA properly for any year within the five-year minimum term principally results in a retroactive cancellation of the tax group from the beginning of the five-year term. After the five-year minimum term has expired, the tax group would only be disregarded for any year in which the PLTA is not actually implemented in a proper way.
• In recent months, there have been several decisions by German tax courts with respect to the requirements for proper implementation, which show that taxpayers should pay increased attention to this in practice. In the following, we have summarized the key aspects arising from the recent decisions for taxpayers operating a German tax group.

Proper implementation of PLTAs

The following key aspects have to be considered with respect to the proper implementation of PLTAs:

Determination of the correct amount of the profit transfer or loss compensation:

• The proper implementation of a PLTA, inter alia, requires that the amount of the annual profit transferred under the PLTA exactly matches the annual profit of the tax group subsidiary as correctly determined in the stand-alone German GAAP financial statements of the tax group subsidiary.
• The law provides certain exceptions under which the PLTA is deemed properly implemented even if the underlying annual financial statements of the tax group subsidiary were erroneous but are subsequently corrected, either "at source" or in a later financial year.
• In a recent decision, however, the Federal Tax Court ruled that a profit transfer based on incorrect annual financial statements of the tax group subsidiary is not sufficient for a proper implementation of the PLTA if the annual financial statements are not subsequently corrected, even if a correction is no longer possible because the tax group subsidiary has in the meantime been liquidated (decision I R 29/19 dated 2 November 2022).
• Similar issues can arise if the tax group subsidiary has been transferred to an unrelated party and the unrelated party declines to correct the subsidiary's pre-closing financial statements. For such situations, it is important to include in the share purchase agreement proper language on the duty to cooperate in order to ensure that a proper implementation can still be achieved even years after the divestment.

Recognition of profit transfer claims and obligations in the accounts:

• In another recent decision, the Federal Tax Court ruled that a PLTA is not properly implemented if, at the time when the obligations arising under the PLTA are settled, such obligations have not yet been properly booked as receivable/payable in the statutory financial statements of the tax group subsidiary and the tax group parent (decision I R 37/19 dated 2 November 2022).
• Moreover, the Federal Tax Court also held that in such a case it is not possible to remedy the lack of proper implementation by subsequently recording the corresponding receivables and liabilities as part of a correction to the annual financial statements. Insofar, the result is different from the situation where only the amount of the profit/loss transfer receivables/payables shown in the financial statements is incorrect: in the latter case, as outlined above, the statutory financial statements can still be corrected to achieve a proper implementation of the PLTA. 

Actual settlement of profit transfer claims:

• A proper implementation of a PLTA requires not only that the profit transfer claims (or, as the case may be, loss compensation claims) are shown in the accounts but that they are also actually settled (i.e., fulfilled), and settlement can generally occur in several ways, e.g.:
  • In cash by way of wire transfer from a bank account of the tax group subsidiary to a bank account of the tax group parent, or vice versa.
  • By way of set-off with reciprocal liabilities (cf. decision 6 K 182/20 of the Lower Tax Court of Hamburg dated 30 June 2022, and decision I B 77/15 of the Federal Tax Court dated 26 April 2016).
  • By way of novation, i.e., conversion of the profit transfer or loss compensation claims into a loan arrangement (cf. decision 6 K 182/20 of Lower Tax Court of Hamburg dated 30 June 2022). The novation should be properly documented with a written loan agreement and be properly reflected in the accounts of the tax group parent and of the tax group subsidiary.
• Apart from these settlement actions, further possibilities to settle the claims under a PLTA are used in practice which, however, have not yet been commented on by case law or official guidance from the German tax authorities, such as settlement by means of an intra-group cash pool or by clearing accounts. It is generally not sufficient to suspend the actual settlement of the claims, or to agree on an waiver of the claims under the PLTA.  

Timing of actual settlement:

• The question as to when profit transfer claims and/or loss compensation claims must be settled in order for the PLTA to still be properly implemented is unfortunately not regulated in the law and has not yet been clarified by case law of the German tax courts. However, two lower tax courts ruled that such claims have to be settled within an appropriate time period (innerhalb angemessener Zeit), without specifying the relevant time period in more detail (cf. decision 6 K 236/12 of Lower Tax Court of Hamburg dated 19 May 2015; and the more recent decision 10 K 1406/18 of Lower Tax Court of Cologne dated 21 June 2022, appeal pending before the Federal Tax Court under file no. I R 37/22).
• The decisions of the lower tax courts largely coincide with the view frequently taken by the German tax authorities in practice. Therefore, to mitigate the risk that the German tax authorities try to challenge the validity of the tax group, it is generally recommended to settle profit transfer and/or a loss compensation claims as soon as possible after the relevant financial statements have been established. A frequent position taken in academic literature is that the claims and obligations have to be settled within three months after they have become due and payable or after the relevant financial statements have been adopted, respectively. The appeal proceedings currently pending before the Federal Tax Court might provide more clarity on this aspect.

Key takeaways

• In summary, the proper implementation of a PLTA requires more than the mere recognition of profit transfer and/or loss compensation claims in the accounts of the tax group subsidiary and the tax group parent. Rather, the claims and obligations arising from the PLTA must in addition be actually settled, and this in a timely and proper manner.
• For the proper implementation of a PLTA, different settlement methods can be considered in practice, some of which have not yet been actively supported in case law and, therefore may have a higher risk of being challenged by the German tax authorities. In addition, lower German tax courts have emphasized in their recent decisions that for a proper PLTA settlement, the respective claims must be settled in a timely manner.
• In view of the fact that there have recently been several decisions by German tax courts on the requirements for "proper implementation", it is to be expected that the question of "proper implementation" will increasingly become a topic in German tax audits and that tax auditors will in particular examine whether proper implementation has taken place in a timely manner. Taxpayers are therefore advised to carefully examine whether their practice in implementing their PLTAs complies with the requirements of case law and of the German tax authorities, or whether the processes need to be adjusted, and whether still outstanding claims (if any) need to be settled promptly in order to mitigate the risk to the German tax group.