Utilizing Loss Carryforwards at the Right Time

The principle of taxation based on economic capacity requires that losses from previous years be taken into account when assessing taxes. However, this so-called loss offsetting is not allowed without restrictions. In principle, losses from the seven years preceding the tax period can be deducted from the net profit, to the extent that they could not be considered in calculating the taxable net profit of those years.

This means that in the tax return for 2020, for example, only losses from the fiscal years 2013 to 2019 can be considered; losses from preceding tax years are forfeited. To utilize the losses for tax purposes despite the issue of temporal limitation, there are various solutions in practice, some of which are explained below.

Extension of the Loss Offset Period

In the case of restructuring, under certain conditions, payments can be offset against previous years' losses without temporal limitation. For this, a restructuring in the tax sense must take place within the company, meaning inflows must occur to eliminate or reduce a real deficit (= loss carryforward no longer covered by open or hidden reserves).

Only such genuine restructuring gains are tax-effective and can be offset with losses without temporal limitation. The extraordinary offsetting of losses with genuine restructuring gains must be claimed by the taxpayer in the tax return. Suitable documentation should be provided to the tax authorities to facilitate verification.

Realization of Hidden Reserves

Another way to offset losses is through the dissolution of hidden reserves. However, there are limits imposed by commercial law on upward revaluation, and this only results in offsetting with losses within the ordinary (seven-year) loss offset period. This is because it is not a tax-relevant restructuring but merely a balance sheet measure to eliminate loss carryforwards.

Furthermore, within a group, it's possible to realize hidden reserves by transferring an asset from one group company to another, which can be offset with existing loss carryforwards. The prerequisite is that the market value of the asset is greater than its book value. With the acquisition by the receiving company, new depreciation basis is created, thereby resulting, in a consolidated view, in a kind of deferral of the loss carryforward without tax disadvantages.

Merger

Finally, within a group, a profitable company can be merged with a loss-making one. Regarding the takeover of any loss carryforward in restructuring, tax law does not contain explicit provisions. Based on merger law, tax succession, and case law, the takeover of tax factors includes not only the recognition of positive but also negative results, whereby losses of the transferring company falling into the loss carryforward period must also be considered by the acquiring company (and vice versa).

The takeover of previous years' losses in the context of a merger requires a certain economic continuity, meaning there must be objective or business reasons for the restructuring. Simply creating potential for loss offsetting is generally not sufficient. It is advisable to definitively clarify the possibility of using loss carryforwards before the merger through a tax ruling, which is submitted to the relevant tax authority. Such a definitive clarification of the tax assessment of a situation with the tax authority may also be necessary for the aforementioned internal group transfer.