Tax exemption of restructuring income: BFH specifies requirements

The German Federal Fiscal Court’s (“BFH”) decision X B 94/23 of August 9, 2024 raises new questions regarding the practical implementation of the tax exemption of restructuring income. Our “Corporate Tax” practice group is monitoring developments and is available for further advice.

Background: What is restructuring income?

Restructuring income regularly arises from debt relief granted in order to rescue a company in crisis. The elimination of a liability generally leads to taxable income. Art. 3a EStG provides a legal basis for the tax exemption of restructuring income for company-related restructurings.

A company-related restructuring exists if it can be proven that the following criteria are met at the time of debt relief:

1. need for restructuring,
2. ability to be restructured,
3. debt relief’s suitability to serve as recapitalization measure, and
4. the creditors’ intention to restructure.

The case: Dispute over a debt waiver’s tax exemption

The BFH’s aforementioned decision was based on the following simplified facts:

The plaintiff, the sole shareholder of a limited partnership (KG) that operated several gas stations, had been in financial difficulties since 2003. A restructuring concept had been discussed with a supplier in 2010, but not implemented. It was not until 2014 that the plaintiff and a supplier agreed on a settlement. As part of this settlement, the supplier received a settlement amount of EUR 50,000 and in return waived a claim of EUR 3.7 million.

According to the supplier, the settlement was agreed in order to secure a partial amount of the receivables and save the existing business relationships. The plaintiff deregistered his business in 2020, classified this debt relief as tax-free and applied for the retroactive application of Art. 3a EStG and Art. 7b GewStG (German Trade Tax Act) (Art. 52 (4a) sentence 3 EStG).

The tax office and tax court rejected a tax exemption for the restructuring income in the amount of EUR 3.65 million due to the plaintiff's inability to be restructured and the creditor's lack of intention to restructure. The tax court did not allow an appeal against its decision. The plaintiff lodged an appeal against denial of leave to appeal.

BFH decision: Important clarifications

The BFH deemed the appeal against denial of leave to appeal to be unfounded and clarified the following in its decision dated August 9, 2024:

• Old legal basis still relevant: For the interpretation of the elements contained in Art. 3a (2) EStG, reference must be made to the case law guidelines issued on Art. 3 No. 66 EStG old version.
• No mandatory restructuring concept required: The law does not contain any fixed rules of evidence for the required determination as to whether a debt relief is suitable for serving as a recapitalization measure. A written restructuring concept is not a necessary prerequisite for the application of Art. 3a EStG. However, the existence of a restructuring concept can be used as an essential indication for the debt relief’s suitability to serve as a recapitalization measure. A further significant indication for the debt relief’s suitability to serve as a recapitalization measure can also be the actual success of the restructuring.
• Intention to restructure must be demonstrable: The presumption that there is always an intention to restructure is clearly incorrect. In any case, the intention to restructure requires proof that the creditor issued the debt relief with the aim of recapitalizing the debtor company. Exclusively self-serving motives are not sufficient in this respect.

Significance of decision X B 94/23

The decision was only (subsequently) designated for official publication on January 9, 2025. This indicates that the BFH wanted to provide guidelines on the interpretation of a debt relief’s suitability to serve as a recapitalization measure and the creditor's intention to restructure outside of appeal proceedings.

Conclusion

The BFH confirms the high requirements for the tax exemption of restructuring income. In particular, the creditor's intention to restructure must be carefully proven. A viable restructuring concept can be important in order to avoid subsequent tax disadvantages.

If you have any questions in connection herewith, please feel free to contact us at any time.