Loss carryforward and change of shareholders

The key points in brief

• In the case of corporations (Kapitalgesellschaften), a change of shareholders (Gesellschafterwechsel) may cause loss carryforwards (Verlustvorträge) for corporation tax and trade tax purposes to lapse in part or in full where certain shareholding thresholds are exceeded.
• The decisive question is whether more than 50% of the shares or voting rights are transferred within five years to a single acquirer or to a group of acquirers with aligned interests – in which case there is a „harmful acquisition of a shareholding“ (schädlicher Beteiligungserwerb).
• Loss carryforwards can be preserved, for example by means of the built-in gains clause (Stille-Reserven-Klausel), the group clause (Konzernklausel) or the continuation-bound loss carryforward (fortführungsgebundener Verlustvortrag) under § 8d KStG.
• Partnerships (Personengesellschaften) are not directly covered by the restriction on loss deduction in § 8c KStG; different rules apply there to the use of losses and to changes of partners.

What effect does a change of shareholders have on the loss carryforward of a corporation?

A change of shareholders (Gesellschafterwechsel) may result in existing loss carryforwards (Verlustvorträge) for corporation tax and trade tax purposes being lost entirely where the statutory shareholding thresholds are exceeded.

The central provision is § 8c of the Corporation Tax Act (Körperschaftsteuergesetz, KStG) („Loss deduction for corporate bodies“). It provides that, in the event of what is known as a harmful acquisition of a shareholding (schädlicher Beteiligungserwerb), unused losses of the corporation are no longer deductible. A harmful acquisition of a shareholding exists where, within five years, more than 50% of the subscribed capital, of the membership rights, of the participation rights or of the voting rights are transferred to one acquirer or to persons related to that acquirer, or where a comparable set of circumstances is present.

The consequences at a glance: if more than 50% of the shares are transferred, the losses not used up to that point lapse in full (complete forfeiture).

A group of acquirers with aligned interests also qualifies as an acquirer; several acquirers can therefore jointly exceed the 50% threshold. A capital increase is treated in the same way as a transfer of shares to the extent that it alters the shareholding ratios.

The restriction on loss deduction applies not only to current-year (interim) losses, but also covers loss carryforwards from earlier years that have already been assessed. The tax courts have made it clear that, in the event of a harmful acquisition of a shareholding, assessed trade tax loss carryforwards likewise fall within § 10a sentence 10 of the Trade Tax Act (Gewerbesteuergesetz, GewStG) in conjunction with § 8c KStG. A change of shareholders can therefore take effect on both the corporation tax and the trade tax side.

What is the purpose of the forfeiture of losses on a change of shareholders?

The forfeiture of losses is intended to prevent the loss carryforwards of a corporation from effectively being „sold“ and new shareholders using another party's historic losses to reduce their own tax burden.

The Federal Constitutional Court has confirmed the legislature's wide margin of discretion, but has at the same time pointed out that § 8c para. 1 sentence 1 KStG in its original version captures situations that are not necessarily abusive (for example purely strategic acquisitions of shareholdings without any trade in losses). It was in response to this criticism that additions such as the built-in gains clause (Stille-Reserven-Klausel) and the continuation-bound loss carryforward (§ 8d KStG) were introduced, in order to mitigate the excessive harshness of standardised rules.

Under what specific conditions does the loss carryforward lapse for tax purposes?

The forfeiture of losses is triggered solely by the statutorily defined shareholding thresholds being exceeded within a five-year period; the legislation does not require any additional element such as an intention to abuse.

The constituent conditions of § 8c para. 1 KStG can be structured as follows:

• Five-year period: a rolling period of five years is considered. All relevant acquisition transactions within this period are aggregated.
• Shareholding thresholds: if more than 50% of the shares are transferred, the losses not used up to that point lapse in full (complete forfeiture).
• Circle of acquirers: one acquirer, persons related to that acquirer, or a group of acquirers with aligned interests; this group-based approach allows several individual transactions to be added together.

The tax courts emphasise that § 8c KStG is deliberately designed as a „simpler and broadly framed“ restriction on loss deduction. A narrow interpretation confined to abusive shell-company purchase arrangements (Mantelkaufgestaltungen) is therefore not permissible; the wording contains no requirement of abuse and displays no unintended gap.

Important in practice:

• The forfeiture of losses also occurs in the case of multi-tier or indirect acquisitions of shareholdings, in so far as the relevant shareholding thresholds are exceeded at the level of the loss-making company.
• The same applies to trade tax: § 10a sentence 10 GewStG expressly refers to § 8c KStG, with the result that, in the event of a harmful acquisition of a shareholding, a GmbH's trade tax loss available for carryforward may lapse under the same threshold rules.
• Under the case law of the Federal Fiscal Court (BFH), a loss carryforward that has already been separately assessed may still be used on a pro rata basis in so far as positive income was generated in the period up to the harmful acquisition of the shareholding; thereafter the restriction on loss deduction applies to the remaining losses.

A change of shareholders close to the 50% threshold is therefore highly sensitive from a tax perspective: a few percentage points alone can determine whether loss carryforwards running into millions are preserved or lapse without compensation.

How can a loss carryforward be saved on a change of shareholders?

Loss carryforwards can be preserved by means of the exceptions and arrangements provided for by law, where the specific conditions are carefully met and documented. The most important instruments are the built-in gains clause, the group clause (Konzernklausel) and the continuation-bound loss carryforward under § 8d KStG.

• Built-in gains clause (§ 8c para. 1 sentences 6–8 KStG)
  The legislature has introduced a counter-exception: unused losses are preserved to the extent that they are covered by built-in gains (stille Reserven) in the business assets that are taxable in Germany. This is intended to capture cases in which the corporate body does in economic terms have substantial assets whose increases in value are capable of offsetting the loss carryforwards. Where equity is negative, application is limited; the provision has been supplemented by a special rule ensuring that only genuine built-in gains are taken into account.
• Group clause (§ 8c para. 1 sentence 5 KStG)
  A counter-exception applies to intra-group transfers of shares: despite an acquisition that would in itself be harmful, shortfalls available for carryforward are preserved on intra-group transfers where the statutory group conditions are met. The group clause is intended to exempt typical restructurings within a group from the destruction of losses, for instance where subsidiaries are moved within a tax group (Organkreis).
• Continuation-bound loss carryforward (§ 8d KStG)
  A corporate body may, upon application, establish a „continuation-bound loss carryforward“ under § 8d KStG. This is no longer linked primarily to the change of shareholders, but to the continuation of the same business operation. The loss carryforward is preserved where exclusively the same business operation is continued; this is intended to curb the overreaching effect of § 8c KStG. A subsequent change of sector or a material alteration of the business operation may in turn jeopardise this continuation-bound loss carryforward, so that the arrangement must be examined carefully in advance.

In advisory practice, arrangements are frequently combined: in group restructurings, for example, the group clause may be used and, in parallel, it may be examined whether an application under § 8d KStG is advisable in order to safeguard the loss carryforwards in the event of further acquisitions of shareholdings at a later date. Early structural planning ahead of the change of shareholders is decisive.

How are loss carryforwards of partnerships affected by changes of partners?

Partnerships are in principle not covered by § 8c KStG; separate rules on loss deduction and on the partner structure apply here, in particular § 10a GewStG as well as the provisions on losses of a limited partner (Kommanditist) under §§ 15a, 15b EStG. Exceptions apply only to partnerships that have opted to be taxed as a corporation.

Loss carryforwards of partnerships are in principle used at the level of the partners or of the partnership in accordance with special rules:

• Trade tax shortfalls of a co-entrepreneurship (Mitunternehmerschaft) are separately assessed under § 10a GewStG and may in principle be used by the partnership in later years; requirements as to partner-related identity follow from the case law on identity of the business and on a harmful change of partners.
• In the case of limited partners, loss carryforwards are deductible under § 15a EStG only to the extent that they are covered by the liability contribution (Hafteinlage); where there are changes in the body of partners, both current losses and loss carryforwards may be affected.

The BFH has made it clear that § 8c KStG is, according to its regulatory purpose, tailored to losses of corporate bodies; losses of partnerships are subject to that provision only in so far as a corporate body participates as a co-entrepreneur and the losses, after offsetting against other income, become negative income of the corporate body. Different standards therefore apply to classic partnerships without a corporate co-entrepreneur than to a GmbH or an AG.

In practice this means: on a change of partners in a partnership, trade tax and income tax loss deductions are indeed at risk, but not by virtue of § 8c KStG – rather by virtue of the special rules on identity of the business and identity of the co-entrepreneur. The typical forfeitures of losses linked to the 50% threshold apply directly only to corporate bodies; in partnerships the transitions are often more flexible, but are likewise narrowly confined by the case law on identity of the business.

What is a loss carryforward – and how does it actually reduce the tax burden?

A loss carryforward is the tax mechanism by which negative income of one year can be carried forward to later years and offset there against positive income, so that the tax burden is smoothed over time.

In the case of corporate bodies, the loss deduction is made under § 10d of the Income Tax Act (Einkommensteuergesetz, EStG) in conjunction with the special provisions of the Corporation Tax Act. Historic losses are separately assessed as at the relevant reporting date and deducted from taxable income in subsequent years, provided that no restriction on loss deduction such as § 8c KStG applies.

In practical terms, the loss carryforward operates as follows:

• It reduces the total amount of income in the year of deduction and thus directly the basis of assessment for corporation tax and – via § 10a GewStG – for trade tax as well.
• In the absence of a harmful acquisition of a shareholding, a loss-making company can offset profits of later years in full or in part against the assessed loss carryforwards until those are used up.
• Where, by contrast, the use of losses is blocked by § 8c KStG, the unused losses are definitively „forfeited“: they can no longer be claimed in the year of deduction and no longer reduce the tax burden.

For companies in crisis and for high-growth companies with more volatile results, the loss carryforward is therefore a decisive factor in liquidity planning. An ill-considered change of shareholders can permanently destroy this resource – depending on the size of the loss carryforward, six- or seven-figure tax amounts are frequently at stake. Precautionary structuring ahead of transactions is for that reason a decisive building block of any tax-planned restructuring.