Following a period of weakness that started in 2008, the M&A market in Germany now appears to be making a strong recovery.

In the meantime, the tax environment for M&A transactions in Germany has been affected by several legislative acts, the most important of which have probably been the Business Tax Reform Act and the Growth Acceleration Act, which came into effect in 2008 and 2010, respectively. While auction processes are being revived and debt financing seems to be becoming easier, it is always worth remembering that the attractiveness of a potential transaction generally depends on the return expected after taxes. Therefore, it is important to consider the main tax aspects when structuring the acquisition of a German company.

In terms of tax planning, the objectives pursued by a purchaser are various. They including stepping up book values of the target's assets, pushing down the interest on the acquisition financing to the target company, preserving existing loss carryforwards and repatriating the proceeds from a later exit in a tax-efficient way.

A key issue is whether the transaction is structured as a share deal or as an asset deal. From a mere tax perspective, the purchaser will often be in favor of an asset deal because it allows for a step-up of the acquired assets, and if the target company was part of a fiscal unity, then only an asset-deal structure avoids secondary liability risks resulting from such fiscal unity. However, the acquisition of shares is more frequent, not least because the capital gain realized by a seller that is a corporation itself is effectively 95% tax-exempt.

A major challenge in terms of tax planning consists in making the interest on the acquisition financing usable as far as possible for the reduction of taxable profits at the target level. Debt push-down is typically achieved by establishing a fiscal unity between the acquisition vehicle and the target, or by merging the two companies upstream or downstream. However, the debt capacity of a typical target has been limited by the interest barrier, or Zinsschranke, which was introduced as part of the Business Tax Reform Act in 2008. Under the interest barrier rule, net interest paid can in principle be deducted only to a maximum of 30% of the Ebitda.

The three exceptions provided for by the law can hardly be used precisely by larger companies. However, as the applicability of the interest barrier rule is limited to remunerations that qualify as interest for tax purposes, the use of alternative financial instruments, for example of atypisch stille Beteiligungen, or atypical silent partnerships, may serve as a workaround. In addition, it can be worthwhile transferring financial liabilities to foreign group companies with unused debt capacities.

Loss carryforwards are extinguished in principle if a purchaser acquires more than 50% of the shares in the target company. Since 2010, however, an exemption rule applies, according to which unused loss carryforwards can be saved insofar as they fall on hidden reserves in assets whose realization would be taxable in Germany. In practice, a frequent problem is that the hidden reserves and the loss carryforwards are located in different group companies. It must also be noted that the financial authorities apply the exemption rule restrictively if the loss company shows negative equity. In many cases, however, both problems can be remedied by a preclosing reorganization of the target group.

If at the time of acquisition the buyer has already decided to aim at an exit after several years, then special attention should be paid that later exit proceeds can be repatriated in a tax-efficient manner. For this reason, the German acquisition vehicle is often held via a holding company resident in another European Union state (for example, Luxembourg or the Netherlands), which for its part has an advantageous network of double taxation treaties and allows -- for example, by taking advantage of qualification conflicts -- for a tax-neutral payout of the capital gains received via the holding company to the foreign investor.

Even if it will not in every case be possible to realize all tax-planning objectives to the same extent (in some cases, certain objectives may even be mutually exclusive), the examples sketched out above show that in many cases returns from purchasing a company in Germany can be considerably increased by thoroughly planning the tax structure.

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Johann Wagner is an associated partner in the tax practice of Gleiss Lutz Hootz Hirsch.