The following article is adapted and reprinted from the M&A Tax Report, Vol. 9, No. 1, August 2000, Panel Publishers, New York, NY.


By Robert W. Wood

Some months ago, we noted the important trends bubbling to the surface of the German tax system that would probably affect M&A activity. (See Wood, "Tax Law Effect on Deals? You Bet!," Vol. 8, No. 7, The M&A Tax Report (Feb. 2000) p. 1.) As the year wears on, we have been waiting (and not too patiently) for just what would occur. The investment community has been waiting, too, and nearly everyone has been figuring that momentous transactions were in the works (not without cause).

Of course, that's because everyone has been assuming for some time that big tax differences are about to happen. See Klebnikov, "Auf Wiedersehen to Germany Inc," Forbes, May 1, 2000, p. 162. One major discussion point has been over Deutsche Bank AG and a deal involving for more than a billion euros. In fact, the deal was so big that Deutsche Bank is apparently avoiding paying more than a billion euros in taxes on its sale of some of its holdings in Allianz AG.

The Deutsche Bank/Allianz AG disposition is one of the first, but there will be many more. See Walker, "Deutsche Bank Gets Tax Ruling, Speeding German Restructuring," Wall Street Journal, June 8, 2000, p. A20. As we noted previously, large German banks and insurance companies have long held significant stakes in each other (true cross fertilization) as well as in German industrial companies. Part of the reason for this interlocking share holdings is because the German capital gains tax has always made selling the shares highly unattractive. But all this is about to change.

Tax Bill Passes

Literally as we go to press, the German tax bill has passed, in a sweeping tax reform that the financial and political press is calling Gerhardt Schröder's biggest political victory yet. See Munschau, "Germany Takes a Small Step in the Right Direction," Financial Times (London), July 17, 2000, p. 13. The sweeping tax plan has a number of features, and just so you don't think it was easy for the Germans to make the change, we at The M&A Tax Report have already rewritten this article three times to account for the changing German developments!

But now the bill has passed (whew!). Of perhaps greatest concern to M&A professionals is the whopping 50% capital gains tax levied on German companies that sell shares in other companies. That tax, though highly controversial at various points during the debate of the bill, has now been repealed. True, this particular part of the German tax plan is not scheduled to kick in until 2002. Perhaps that means there will be plenty of time for investment banks and other dealmakers to move in on Germany (those who haven't already) to line up deals. See Rhoads, "New Tax Law Will Transform Germany Inc.," Wall Street Journal, July 17, 2000, p. A29.

On the other hand, the fact that the repeal of the German capital gains tax will take effect in 2002 may unleash a wave of divestitures, spinoffs and acquisitions now. Many companies are expected to go ahead with their transactions now, using various financial moves to sell businesses (and stakes in businesses) this year and next, but booking taxable profits later. After all, that was essentially the gimmick that Deutsche Bank AG used in June 2000 when it sold part of its interest in Allianz AG (the Munich insurer).

But paused as we are on the brink of the German reforms, now that the onerous capital gain on intercompany shareholdings has been (prospectively) repealed, no one is quite sure just how huge the changes will be. Still, it is safe to say that the effect will be enormous on the German corporate landscape, potentially on both domestic and foreign takeovers. Indeed, immediately after the news of the bill's passage, the financial press is trumpeting the change as being of worldwide proportions. See Pretzlik, "German Companies Ready for Wholesale Restructuring," Financial Times (London), July 15/16, 2000, p. 2.

Although the effects of this whopping change are likely to ripple through German finance and industry, the largest holders of stakes in German industrial companies are the insurance companies and banks. For example, Deutsche Bank holds huge chunks of DaimlerChrysler, Heidelberger Zement and Metallgesellschaft.

What's for Sale?

The German insurance company, Allianz AG, sometimes dubbed as the "kingpin" of the restructuring story, also has a huge asset portfolio. These companies, apart from their past successes, are likely to be key players in a number of German transactions that will happen over the next two years. See Pretzlik, "German Companies Ready for Wholesale Restructuring," Financial Times (London), July 15/16, 2000, p. 2.

What perhaps has not been focused on too much is that not only will it enable the German companies to voluntarily dump their shares (on a tax favored basis, at least after January 2002), but it makes them simultaneously vulnerable to outside takeovers. Surely this isn't missed on the seasoned M&A professionals, who perhaps for the first time can now look at German companies with a new and clear set of glasses (or would those be rose-colored lenses?). Id.

Even for those who are not prepared to step into the German marketplace looking for a controlling interest in the company, heaps of noncore shareholdings are going to be available. Examples include Schering AG, a German pharmaceutical company which is 10% owned by Allianz AG. That would be a nice foothold. Similarly, MAN AG, a truckmaker, is 1/3rd owned by CommerzBank AG, Munich Re and Allianz AG. These and other stakes in companies will surely be up for grabs. See Rhoads, "New Tax Law Will Transform Germany Inc.," Wall Street Journal, July 17, 2000, p. A29.

Something for Everyone

Although understandably M&A practitioners are focusing on the repeal of the capital gain tax (again, not scheduled to occur until January 1, 2002), there are a number of other provisions in the German tax law that are awfully important. Perhaps the German law should be likened to earlier tax reform efforts in this country (say the landmark Economic Recovery Tax Act of 1981 pushed through in the Reagan administration). Highlights of the new German tax law include:

Stock Market Effect?

It is not surprising that in the wake of this bill being passed the German stock market looks much more attractive. Long-term effects are uncertain. But short-term gains seem inevitable. See Sims and Steinborn, "Germany's Stocks Are Looking More Attractive After Legislators Pass Sweeping Tax Reform," Wall Street Journal, July 17, 2000, p. C12. See also "Tax Vote Sends Frankfurt Financials Soaring," Financial Times (London), July 15/16, 2000, p. 11.

Other Tax Reforms?

Some have already speculated that the pressure of this massive German tax reform (again, something on the scale of some of the prior U.S. tax reform ventures), may spur other European nations to follow suit. On the heels of the German tax act's passage, both Italian and French officials have responded to interviews that they intend to ask for tax reform as well. See Rhoads, "New Tax Law Will Transform Germany Inc.," Wall Street Journal, July 17, 2000, p. A29.

No Foregone Conclusion

The much trumpeted proposal (which actually came at Christmas time last year) did face a number of significant hurdles before it was enacted. Debate on the tax package only began June 9, 2000 in the Bundesrat, Germany's opposition-controlled upper house of parliament. Although all came out rosy in the end, the proposal came under fierce attack by the opposition, both Christian Democrats and Christian Socialists.

The main complaint was about the wholesale elimination of the tax on corporate capital gains. Predictably, the gripe was that this change will benefit only big corporations, not the thousands of smaller unincorporated businesses. The latter will have to continue to pay taxes on capital gains based on individual income tax rates. The result was a compromise (with individual tax cuts, too). Yet, even at the compromised rates, there are complaints that the act still favors big companies. See Rhoads, "Prospects Brighten for German Tax Plan," Wall Street Journal, July 14, 2000, p. A12.

Even for the smaller businesses, the picture still has to look attractive considering the significant rate cuts. On the heels of the jubilant behavior that prevailed around Christmas and New Years about the likely abolition of the German tax, any compromise looked like it would be would be much less than a victory. But now that the bill is passed, the jubilance seems to be even greater. Clearly, M&A activity will flourish.

Before 2002

I'm still not clear exactly how Deutsche Bank AG is managing to avoid paying more that $1 billion euros ($961.5 million) in capital gains taxes on the sale of part of its interest in the insurance giant Allianz AG. Apparently, the plan employed a set of complicated derivative trades. For details, see Rhoads, "Gains-Tax Repeal Faces Fierce Fight In Germany," Wall Street Journal, June 9, 2000, p. A16.

Among all the jockying for position, and given the capital gain tax repeal (or other significant tax rate modification), European buyout activity is still rising at a steady clip. Indeed, not only is the shear number of transactions exploding, but the so-called mega buyouts have now already arrived. Some takeover bids are $2 billion or more, dwarfing previous European acquisition activity, and even many US transaction. See Portanger, "Mega Buyouts Nave Arrived for Europeans," Wall Street Journal, June 30, 2000 p. C1.

One reason is the junk bond market, the health of which is robust in Germany (and Europe in general), much more so than in the US. Interestingly, since we the M&A Tax Report are often tend to focus on spin offs with myopic predisposition, much of the European buyout activity has thus far centered on bidding for assets that were at one time spun off by European conglomerates. Yet, competition is now becoming heated.

Now that the long awaited tax reform in Germany has come about, all of the frenetic activity is expected to increase by many times.

Massive German Tax Overhaul, Vol. 9, No. 1, The M&A Tax Report (August 2000), p. 1.