German Federal Fiscal Court Clarifies Standards for Proper Performance of Profit and Loss Transfer Agreements

– Judgment of 5 November 2025, I R 37/22 –

In its ruling of 5 November 2025 (I R 37/22), the German Federal Fiscal Court (Bundesfinanzhof – BFH) provided important guidance on the requirements for the proper performance of a profit and loss transfer agreement (PLTA) in the context of a German corporate income tax group (Organschaft). The ruling addresses, in particular, (i) the timing within which claims arising under a PLTA must be settled and (ii) the permissibility of settlement through intercompany settlement accounts.

A. Background

For a corporate income tax group to be recognized under German tax law, a PLTA must be concluded for a minimum term of five years and must be properly performed throughout its entire duration (Section 14 (1), sentence 1, no. 3, sentence 1 of the German Corporate Income Tax Act). While the statute imposes the requirement of “proper performance,” it does not define the specific actions necessary to satisfy that standard.

Under prior case law, a PLTA was considered properly performed if it was implemented in accordance with its contractual terms and the profits or losses determined under the agreement were in fact transferred between the controlling entity and the controlled subsidiary. However, the BFH had not previously clarified the time frame within which such performance must occur.

B. Key Holdings of the Federal Fiscal Court

The BFH articulated a two-pronged test for determining whether a PLTA is properly performed:

1. Recognition in the Financial Accounts: Receivables and liabilities arising under the PLTA must be accurately reflected in the annual financial accounts of both the controlling company and the controlled subsidiary.
2. Civil-Law Fulfillment of the Claims: In addition, the relevant claims must be validly satisfied under civil law.

With respect to financial statement recognition, the court held that it is sufficient for PLTA-related receivables and liabilities to be included in an aggregated balance sheet line item (e.g., “liabilities to shareholders”), provided that the underlying accounting clearly demonstrates that such amounts relate to PLTA claims. However, financial statement recognition alone is not sufficient; the claims must also be effectively settled.

C. Timing Requirements for Proper Performance

The BFH emphasized that proper performance requires timely settlement of PLTA claims. As a general rule, settlement within 12 months after the claims become due is regarded to be sufficient. The court derived this benchmark by analogy to the annual balancing requirement applicable to current account relationships under Section 355(2) of the German Commercial Code.

Regarding the determination of the due date, the following distinction must be made in accordance with case law and the prevailing view:

• Claims for the transfer of profits to the controlling company become due upon adoption of the controlled subsidiary’s annual financial accounts.
• Claims for the assumption of losses by the controlling company become due as of the end of the controlled subsidiary’s fiscal year.

These principles are likewise applicable for tax purposes. The BFH further held that settlement occurring significantly later than 12 months after the due date, or only upon termination of the tax group, does not satisfy the proper performance requirement. If the 12-month period is exceeded, the PLTA is deemed not to have been properly performed for the relevant year; within the initial five-year minimum term, such a failure may result in the retroactive disqualification of the tax group.

D. Permissible Methods of Settlement

The BFH reaffirmed that PLTA claims need not be settled exclusively through cash payment. In reviewing the use of intercompany settlement accounts, the court drew an important distinction:

• “Non-genuine” settlement accounts: Where an account merely accumulates PLTA claims without recording offsetting counterclaims and without regular balancing, the BFH does not regard this as valid settlement.
• “Genuine” settlement accounts: By contrast, where PLTA claims and counterclaims are offset against one another, or where the account is regularly balanced, valid settlement is achieved.

In principle, the settlement of PLTA claims through set-off and novation – i.e., conversion into a loan – is also recognized; the BFH appears to share this view in its new ruling, as it refers to a “set-off equivalent to payment” or conversion “into a loan”. Specifically:

• Set-off is generally accepted as a form of proper performance, including under the tax authorities’ administrative guidance (Federal Finance Ministry, decree of 25 August 2006, IV B 7-S 2770/12/06).
• Novation is also recognized in principle – albeit not by the supreme court yet – (Tax Court of Hamburg, judgment of 30 June 2022, 6 K 182/20); however, in the case of novation of loss assumption claims, careful consideration must be given to the corporate law debate regarding its validity (against validity: Higher Regional Court of Munich dated 20.10.2022, 7 U 1785/18), as well as any attendant insolvency law implications.

Case law and legal commentary suggest that, for set-off or novation to be effective for corporate and tax purposes, the counterclaim or novated claim must be economically “valuable” – the BFH has not yet address this issue. Accordingly, where settlement methods other than cash payment are contemplated, a thorough legal and tax analysis remains advisable.

In all cases, the BFH made clear that any permissible form of settlement must be completed within the 12-month period in order to satisfy the proper performance requirement.

E. Practical Implications

The BFH’s ruling significantly tightens and clarifies the standards for the ongoing proper performance of PLTAs. For existing and future tax groups, taxpayers should ensure in particular that:

• PLTA-related receivables and liabilities are clearly and consistently reflected in the financial accounts, and
• PLTA claims are validly settled under civil law within 12 months of their respective due dates.

In this context, existing settlement account arrangements, cash pooling structures, and intercompany financing frameworks should be carefully reviewed to confirm compliance with the BFH’s requirements.

F. Conclusion

With its decision in I R 37/22, the BFH has, for the first time, provided concrete guidance on the timing of settlement of claims arising under a PLTA. While the ruling enhances legal certainty, it simultaneously imposes strict temporal limits on acceptable proper performance. It remains to be seen how the German tax authorities will apply these principles in practice, particularly with respect to prior years and ongoing tax groups.