Federal fiscal court (BFH): Allocation of revenue from debt waiver upon a change in partnership structure

If a partnership faces financial difficulties and its creditors’ claims are then waived, revenue in the amount of the waived claims accrues at the level of the restructuring partnership (Sanierungsgesellschaft). This revenue is thus fundamentally allocable among the partners of the partnership in accordance with the profit distribution formula. All partners of the partnership at the time of the waiver are thus fundamentally taxable for the resultant increase in assets (e.g. BFH of 18 April 1996, IV R 48/95).

The allocation of revenue is more complicated, however, where the debt waiver involves a change in partnership structure. This was a problem on which the 4th Chamber of the BFH was required to decide in its recent judgement of 22 January 2015 (IV R 38/10). According to the judgement, the revenue from a debt waiver is to be allocated to the new partner by the partnership creditor if – in the specific case at hand – it has been agreed that financial responsibility for the relevant debts is to be assumed by the new partner in place of the old partner. If it has been agreed, however, that the new partner is not to assume financial responsibility for the relevant debts, the corresponding revenue is allocable to the old partner whom the debt waiver releases from his liability.

Revenue accruing from the debt waiver is thus allocated on the basis of what has been agreed – in the specific case at hand – with regard to who should bear financial responsibility for the relevant debts. The criteria for deciding who should bear financial responsibility for the waived debts are generally set out in the relevant agreements. However, the BFH does state that further criteria may also arise from the circumstances under which negotiations with the banks take place.

If it turns out that the new partners are not required to bear financial responsibility for the Plaintiff’s old debts, the revenue would be allocable to the old partner. Allocation still takes place irrespective of whether debts are waived coincidentally or intentionally in the period before or after the change in partnership structure.

With this judgement, the BFH has abandoned its previous position which was based on the legal and economic grounds triggering the creditor’s debt waiver. This – now obsolete – position held that restructuring profits be allocated to the new partners where the creditor’s waiver legally and financially depended on the injection of new funds into the partnership by the new partners at the time of the old partners’ departure.