Tax deduction ban for write-downs on group loans

Deduction ban under Section 8b(3) sentence 4f. of the German Corporation Tax Act [Körperschaftsteuergesetz – KStG] applied to write-downs of intercompany loans to going concern value (Berlin-Brandenburg Fiscal Court of 16/04/2024)

Loans from shareholders and intragroup loan relationships (intercompany loans) are a popular means of structuring how liquidity is provided and distributed within a group of companies. If the debtor gets into difficulties, the creditor is usually affected not only by the loss of value or the bad debt but – if the loans are between corporations and the shareholding is at least 25 per cent – by the ban on tax deduction under Section 8b para. 3 sentence 4 f. of the Corporation Tax Act [KStG] as well. 

The background to the ban on deduction is that capital gains from the sale of shares in corporations, or capital losses, or write-downs to the going concern value are exempt from taxation under Section 8b para. 2 and 3 of the Corporation Tax Act (as a result only 95 per cent of profits are tax-free). Since intercompany loans can be used for equity-like financing, i.e. economically speaking, they can take the place of a shareholding in the company, losses from shareholder loans and corporations related to them (Section 1 para. 2 German Foreign Tax Act [Außensteuergesetz – AStG]) as well as those from the utilisation of securities are also included under the ban on deduction in order to prevent tax avoidance.

The ban on deduction is widely applied in practice and has already been the subject of court decisions several times. Berlin-Brandenburg Fiscal Court has now ruled on further controversial issues of application. 

Interest receivable from loans subject to the deduction ban 

According to the court’s decision, the ban on deduction is not applicable to all types of group claims. It was held that to prevent tax avoidance the rule only calls for including losses from economically comparable legal acts that finance corporations in a similar way to equity. So in the case in dispute, the ban on deduction did not apply to interest receivable. As the underlying interest was to be recognised as taxable income, the interest receivable did not correspond either to the tax exemption from the sale of shares under Section 8b para. 2 of the Corporation Tax Act or originate from a legal act to finance equity-like loans. According to the court, one requirement for the latter is that the loan is granted for a certain minimum term (continuing legal obligation). Whether trade receivables are economically comparable to the granting of a loan must be decided individually based on the circumstances. Regarding interest receivable, however, it was held that this was not financing because it was simply accrued debt interest. The court follows the prevailing opinion in the legal literature, according to which interest receivable and underlying loans are in principle to be seen as independent of each other. It may be necessary to take another view, however, if interest receivable is left to run long-term and so potentially takes on the character of a loan.

Ban on deduction also applies if only natural persons hold shares

In the court’s view, however, the ban on deduction still applies to reductions in profits from loans granted to sister corporations or the utilisation of security granted for this purpose if those holding shares in both corporations are all natural persons.

This is surprising, since elsewhere in its judgment the court stresses the goal of the rule as being to prevent tax avoidance. Tax avoidance by granting loans to the sister company is ruled out in this kind of case because Section 8b of the Corporation Tax Act would not apply to the shareholder, as a natural person, itself either. But the court considers these cases to be covered by the wording of the rule. 

The high bar for arm’s length comparison confirmed

In exceptions this ban on deduction does not apply if it can be proven that, all other circumstances being equal, an independent third party would have granted the loan and not recalled it (Section 8b para. 3 sentence 7 Corporation Tax Act). The burden of proof lies with the taxpayer. In practice it has so far been almost impossible to provide this evidence and the judgment unfortunately does not contain any guidance. According to the explanatory memorandum to the Act, the arm’s length nature of the loan requires interest to be charged and collateral (only the debtor’s own collateral is to be taken into account). The loan must also actually be recalled when the debtor enters into crisis. Crucial to assessing the arm’s length comparison is therefore not only the date on which the loan was granted, but also any possible termination date when the crisis occurs.

Here, the court has confirmed the tax authorities’ excessive requirements on arm’s length comparisons. A lack of collateralisation or a “delay” in recalling the claim in particular mean that proving arm’s length in practice is often unsuccessful. If the collateral is utilised, the Act does not allow any proof of arm’s length anyway. 

Practical note

The fiscal court’s judgment casts more shadow than light on the practical question of how applicable the ban on deducting losses from intercompany loans is. One positive aspect is the restriction according to which intercompany loans and interest receivable on them are to be assessed independently of each other and that the latter are therefore not subject to the deduction ban of Section 8b para. 3 of the Corporation Tax Act. In practice, in order to avoid the deduction ban, care should be taken to ensure that interest receivable is not deferred in an unusual way or that it does not constitute a separate claim to interest, by drafting agreements accordingly and keeping it separate in the bookkeeping. An appeal against the judgment is pending before the Federal Fiscal Court (BFH file reference: I R 11/24), and so further developments in the law are to be awaited.  

Legislation expressly stipulates that exchange rate losses from foreign currency loans are excluded from the ban on deduction. In light of this, losses from intercompany loans should always be checked to see whether they can be recognised for tax purposes despite the far-reaching ban on deduction under Section 8b para. 3 of the Corporation Tax Act. You have questions on the topic? Our experts are ready with answers! Please feel free to contact us.

Current advisory news in brief 

• Taxation of capital gains from contributions I [Einbringungsgewinn I] in the case of (gratuitous) legal succession: Munich Fiscal Court has held that if the blocking period is infringed by the (gratuitous) legal successor, the tax on the capital gains from contributions 1 to be retroactively taxed (detrimental disposal of shares granted in the course of a contribution) is taxable in the hands of  the party who made the original capital contribution. The court thus shares the view of the tax authorities according to para. 22.41 of the BMF Circular on the Reorganisation Tax Act relating to Section 22 para. 6 of the Act (Munich Fiscal Court, 9 February 2024, file reference 8 K 602/23; appeal lodged, file reference BFH: X R 8/24). 
  
  
• Taxation of capital gains from contributions II [Einbringungsgewinn II] in the case of (gratuitous) legal succession: According to Düsseldorf Fiscal Court, however, the original contributor is not to be taxed retroactively on capital gains from contributions II (detrimental disposal of contributed shares) if the blocking period is infringed by the (gratuitous) legal successor, but rather the legal successor is to be taxed as notionally deemed by Section 22 para. 6 of the Reorganisation Tax Act. The court thus does not share the tax authorities’ view here according to para. 22.41 of the BMF Circular on the Reorganisation Tax Act relating to Section 22 para. 6 of the Act (Düsseldorf Fiscal Court, 7 March 2024, file reference 8 K 2849/17; final and binding)
  
  
• Constitutionality of the interest rate for interest on suspension: The Federal Fiscal Court (BFH) holds that the statutory interest rate for interest charged while a tax assessment is suspended, of 0.5 per cent per month (i.e. 6 per cent per year), is unconstitutional. Among other things, it considers it to be unequal treatment in respect of taxpayers who have to pay interest on arrears under Section 233a of the Fiscal Code [Abgabenordnung]. They have to pay an interest rate of only 0.15 per cent per month (i.e. 1.8 per cent per year) for interest periods from 1 January 2019. The BFH therefore appealed to the Federal Constitutional Court in a decision on 8 May 2024 (file reference: VIII R 9/23).