No prohibition on deduction for futile due diligence expenses

– BFH dated 1/9/2013 – I R 72/11, DB, 2013, p. 673, DStR, 2013, 581 –

Profits or dividends in conjunction with affiliated companies remain tax exempt in accordance with § 8b Para.1 and Para.2 of the KStG (Corporation Taxes Act). Losses in conjunction are correspondingly excluded from deduction in accordance with § 8b Para.3 of the KStG. The BFH was asked whether the expenses for a due diligence process which are to be capitalized, in principle, in the event of a successful acquisition, as supplemental acquisition costs of the participation, are excluded from deduction if the acquisition fails. Opinions for and against a prohibition on deduction were discussed in the literature.

The BFH decided in a decision dated 1/9/2013 that futile due diligence expenses are not excluded from deduction. Therefore, even if due diligence expenses have been capitalized, the derecognition resulting from the failed acquisition should be taken into consideration as reducing the profit. The opinion of the respondent tax office that there should be no prohibition of deduction as the prerequisite for the prohibition on deduction in accordance with § 8b Para.3 p.3 of the KStG is the existence of a share. Since the parties interested in purchasing could not be legally or economically ascribed shares in the target company at any time due to the failed acquisition, the prohibition on deduction as per § 8b Para.3 of the KStG is not relevant. Only this opinion, according to the BFH, correlates with the meaning and purpose of the deduction exclusion, for establishing a correspondence to the tax exemption for the sales profits for the deduction page. Since tax exemptions, with regards to the shares that were not acquired, cannot apply, there is also no room for a prohibition on deduction.

A good decision for company buyers who thus need not fear having to finance the expenses of a failed acquisition without tax effects.

Minimum value rule and group valuation

The deterioration of the inheritance-tax related alleviation regulations to be expected through a decision of the German Federal Constitutional Court has motivated several medium-sized companies to implement planned order of succession. In this connection, the company to be transferred must be assessed for tax purposes. In doing so, the minimum value regulation based on the net asset value introduced in 01/01/2009 by the legislator and the inheritance tax reform law must be observed. In practice, increased problems concerning the application of this minimum value regulation in accordance with Article 11 para. 2 p. 3 of the BewG [German Fiscal Law] were mainly observed in companies in group structures. The question to be answered is:

“Does the minimum value regulation in corporations have to be applied at Group company level or does the comparison take place between the capitalised value and/or discounted cash-flow value and the net asset value at group level?”

The solution presented by Wollny in DStR 42/2014 leads to a comparison at group level. The first approach that was presented refers to Article 2 BewG and deduces the Group as a subject of valuation from its scope of provisions on the economic unit. The second approach that was presented, explains the logical contradictions which resulted from an observation at Group company level and proves this by using the “sale of a business” course of action by supporting the approach of net asset values. The understanding of the minimum value regulation demonstrated by the second solution is directly applicable to evaluation processes according to civil law.