Contribution gain II through change of legal form

The gain from the contribution to a corporation is taxed retroactively in the fiscal year of the contribution as a so-called contribution gain II in accordance with Section 22 (2) sentence 1 of the German Reorganization Tax Act (UmwStG) in the event that shares contributed at a value below fair market value within the scope of a contribution in kind pursuant to Section 20 (1) UmwStG or a qualified share exchange pursuant to Section 21 (1) UmwStG are sold directly or indirectly by the acquiring corporation within seven years of the contribution and, to this extent, the capital gain would not have been tax-exempt for the contributor under Section 8b (2) of the German Corporation Tax Act (KStG). Against this background, such retroactive taxation is primarily relevant for natural persons as contributors.

A “sale” in this context refers in particular to the transfer of the contributed shares to another legal entity in return for payment. In addition, retroactive taxation pursuant to Section 22 (2) sentence 1 UmwStG may also be triggered if substitute conditions are met in the context of certain reorganization and contribution transactions. According to the German Federal Fiscal Court (BFH) ruling of November 18, 2020, Case No. I R 25/18, a contribution gain II arises if the acquiring corporation is converted into a partnership within the seven-year blocking period. In its ruling of November 27, 2024, Case No. X R 26/22, the BFH had to clarify whether a contribution gain II also arises if the change of legal form does not affect the acquiring corporation, but rather the company whose shares have been contributed to the acquiring corporation.

In the case in dispute, two natural persons held shares of 98 % and 2 % respectively in both XA-GmbH and X-GmbH. At a shareholders’ meeting of X-GmbH, a resolution was passed to increase the share capital of this company. To this end, the shareholders transferred their respective shares in XA-GmbH to X-GmbH at book value as part of a so-called qualified share exchange pursuant to Section 21 (1) sentence 2 UmwStG. Subsequently, it was resolved to change the legal form of XA-GmbH to XA-KG at book value. In the opinion of the tax office, this constituted a sale of the shares in XA-GmbH by X-GmbH and thus led to the creation of a contribution gain II pursuant to Section 22 (2) sentence 1 UmwStG. The Fiscal Court of Münster and the BFH agreed with this view.

If a corporation (in the case in dispute: XA-GmbH) whose shares have been contributed to the acquiring company (in the case in dispute: X-GmbH) is reorganized into a partnership, this constitutes a sale of these shares by the acquiring company within the meaning of Section 22 (2) sentence 1 UmwStG. The civil law character of the change of legal form, which preserves identity (Section 202 (1) No. 1 of the German Transformation Act (UmwG)), does not preclude this, as the income tax law term of sale is to be understood in accordance with established BFH case law as specific to transaction tax and therefore the change of legal form of a corporation into a partnership is also to be regarded as a transfer of assets (“exchange-like transfer of legal entity for consideration”).

From the BFH’s point of view, a so-called teleological reduction, i.e., a restrictive interpretation of the provision, was also ruled out. Retroactive taxation pursuant to Section 22 (2) sentence 1 UmwStG is intended to ensure that the hidden reserves in the contributed shares at the time of the qualified share exchange, which were subject to tax in the hands of the contributor in accordance with the general income tax regulations, continue to be subject to taxation if the acquiring company sells them within seven years. However, this was precluded in the case in dispute by the fact that the conversion of XA-GmbH into a partnership resulted in the hidden reserves of this company being mixed with those of X-GmbH. Before the change of legal form, the hidden reserves of XA-GmbH and its sole shareholder since the share exchange, X-GmbH, were separate for income tax purposes. However, due to the change in legal form, the separation principle was then replaced by the transparency principle characteristic of partnerships. The spheres of X-GmbH and XA-KG were therefore no longer separate from each other. Rather, the assets of XA-KG and thus also its hidden reserves were to be allocated to X-GmbH on a pro rata basis for income tax purposes.

With regard to a possible teleological reduction, it should also be noted that, after the change of legal form, the shares in XA-GmbH could not revert to the tax status they had before the share exchange, either formally or in terms of the possible tax burden. If X-GmbH were to sell its shares in the now XA-KG, this would still be significantly more attractive than if the natural persons as shareholders had sold their shares in XA-GmbH before the share exchange, in which case the progressive income tax rate of up to 45 % would have been applied to 60 % of the capital gain.

It is irrelevant whether, in the specific case, a tax-neutral implementation of the restructuring objective could have been achieved by changing the order of the individual restructuring steps (first change of legal form, then contribution of shares). The legal assessment is always based on the facts of the case and the applicable legal provisions.

Since it was not clear in the case in dispute whether a 2 % share sale had taken place shortly before the change of legal form, the matter was referred back to the Fiscal Court of Münster for further hearing and decision.