In its judgement dated 11 March 2020, the Cologne Fiscal Court ruled that the allocation of shares in a third-party company based on a direct investment in a foreign corporation constitutes a preferential capital measure in accordance with Section 20 (4a) EStG and therefore does not result in a taxable distribution in kind for the shareholders. The tax authorities have lodged an appeal against this judgement, which means that the proceedings are now pending before the Federal Fiscal Court (case no. VIII R 14/20).
The judgement was based on the following, somewhat complex facts:
The investor held shares in G Group PLC in a securities account, which held an indirect interest of 100 % in G Ltd. until 2013. G Ltd. in turn held a direct interest in G Q. G Q indirectly held 45% of the shares in the US company A W. In the 2013 financial year, G Ltd. then sold its shareholding in G Q to A in return for cash and the transfer of shares in A. In addition to the announcement of this agreement, G Ltd. announced on the same day that it would sell its shares to A in the context of a so-called Return of value A shares and cash to the shareholders. As a result, "bonus shares" in A were entered in the investor's securities account. The custodian bank treated the allocation of the A shares as a taxable distribution in kind and withheld capital gains tax.
Capital income can include not only cash distributions but also distributions in kind, for example when a corporation transfers shares in another corporation to its shareholders. In this case, the shareholder must generally pay tax on the shares received at the fair market value at the time of receipt. An exception applies to such payments that originate from distributions for which amounts from the tax contribution account within the meaning of Section 27 KStG are deemed to have been utilised. § 27 KStG are deemed to have been utilised. A further exception exists if this is a capital measure within the meaning of Section 20 (4a) EStG, according to which a pro rata continuation of the acquisition costs is fictitious or the income and the acquisition costs are recognised at EUR 0 and therefore taxation only occurs at the time of the sale of the shares received.
Even if, in the opinion of the Cologne tax court, it does not appear clear and easily recognisable that this situation constitutes a taxable distribution in kind, the court found that the legislator created the return of value in connection with the sale of A W by G precisely for such cases.
