The Court held that the requirement imposed under German law, according to which the shareholders of the transferred corporation ("target") are not taxed on the gain from the exchange of their shares in the target for the shares of the acquiring corporation, at the condition that the acquiring corporation takes a tax basis in the shares of the target equal to the transferring shareholder’s tax basis in those shares prior to the transfer (carryover basis), violates the EU directive n. 90/434/CEE of July 23, 1990 (the "Mergers Directive") and EU law.
The facts of the case concern a German public company which transferred a majority shareholding in a German private company to a French public company solely in exchange for stock of the French company. The German transferor took a tax basis in the stock of the French acquiring company received in the transaction, equal to the tax basis it had in the shares of the German transferred company (substituted basis). The French acquiring company carried the shares of the German acquired company at their fair market value at the time of the transaction.
The EU mergers directive prescribes that, in order to qualify for tax free treatment and defer the tax on the gain from the exchange of stock in the target for stock of the acquiring company, the shareholders of the target company must take a substituted basis in the stock of the acquiring company received in the exchange. The directive is silent as to the tax basis at which the acquiring company should carry the stock of the acquired company received in the transaction.
German law prescribed that the acquiring company took a carry over basis in the shares of the target (so called "double carry over basis requirement"). The position of the German government on the issue was that the EU directive is silent and the matter falls within the authority of the Member States.
The Court rejected the argument and held that the double carry over basis requirement imposed by German law violates the EU mergers directive and EU law in that it result in an undue restriction of a cross-border exchange of shares between to EU companies.
Italy implemented the EU mergers directive by way of legislative decree n. 544 of 1992. Recently, the EU mergers directive was amended and extended by Council Directive 2005/19/CE, implemented in Italy by way of Legislative Decree n. 199 of 2007.
In case of cross-border transfer of shares, Italy’s tax administration with resolution n. 190 of December 13, 2000 took the position that shareholders of the target could achieve tax free treatment on their transfer of shares of the target for shares of the acquiring company at the condition that they took a substituted basis in the shares of the acquiring company and the acquiring took a carryover basis in the shares of the target received in the transaction.
Subsequently, with resolution n. 159 of July 25, 2007 the tax administration revoked its previous ruling and eliminated the double carryover basis requirement.
Consequently, Italian law is in line with the EU mergers directive and EC Treaty on this particular issue.