Hidden and therefore as yet untaxed reserves can be contained in particular in business properties. The acquisition or construction often dates back decades, buildings are almost fully depreciated, and the interim increases in property values mean that current market values and tax book values diverge considerably. Selling these business properties inevitably leads to the disclosure and hence taxation of hidden reserves.
Section 6b of the Income Tax Act (EStG) permits the tax-free transfer of hidden reserves on the disposal of certain fixed assets. The purpose of the provision is to enable economically sensible restructuring that would otherwise fail due to the resulting tax burden.
Example: Mr Muller owns a business property with a warehouse building in Gronau, acquired in 1980. The building has been fully depreciated. The land is carried in the balance sheet at a book value of 20,000 euros as at 31.12.2015. In 2016, Mr Muller sells the property for 1,000,000 euros. In the same year, a more conveniently located plot in Gronau is acquired and a larger, more modern warehouse is built on it. Acquisition costs amount to 2,000,000 euros: 1,000,000 euros can be financed by a bank loan, and 1,000,000 euros comes from the sale of the old property. Without Section 6b EStG, Mr Muller would have to pay approximately 490,000 euros in tax on the disposal gain (1,000,000 euros - 20,000 euros = 980,000 euros) and would to that extent be unable to use the amount for reinvestment. Section 6b EStG enables him to transfer the entire disclosed hidden reserve to the new investment, so that no tax at all arises.
The condition is that the disposed assets must have formed part of the fixed assets of a domestic permanent establishment without interruption for at least six years at the time of disposal, and that the acquired or constructed assets must form part of the fixed assets of a domestic permanent establishment. According to the wording of the EStG, this means in the above example that reinvestment in Germany (here: Gronau) is privileged, whereas an investment in, for example, Enschede (Netherlands) is not.
However, this tax provision is contrary to EU law, as it infringes the principle of freedom of establishment. Following the judgment of the Lower Saxony Fiscal Court of 01.12.2011 (case reference 6 K 435/09), reinvestment in other EU member states is also tax-privileged. The Federal Fiscal Court (Bundesfinanzhof) considers the legal position to be so clear that it did not admit an appeal on points of law (BFH of 20.08.2012, I R 3/12(NV)). The Munich Fiscal Court confirmed this case law in its judgment of 7.7.2014 (case reference 5 K 1206/14). This means you have the option of disclosing hidden reserves in Germany and carrying those hidden reserves over to other EU countries.
In the meantime, the legislature responded via the Tax Amendment Act 2015 (Steueranderungsgesetz 2015) by creating a new Section 6b(2) EStG. This provision permits the tax on the disposal gain to be paid in five equal annual instalments where reinvestment takes place in another EU member state. This represents an improvement over the previous legal position. However, it is highly contentious whether the new rule actually eliminates the incompatibility of Section 6b EStG with EU law, since, for example, the reinvestment of a disposal gain derived from property sales in other EU member states is still discriminated against. For the EU scenario there is a five-year instalment arrangement. In the domestic scenario, in the case of land there is, in extreme cases, an indefinite deferral of tax, and in the case of buildings held as business assets there is at least a deferral of tax spread over the useful life, which is typically 33 years.
We will advise you on how best to navigate this uncertain legal position.