I. Background to the change in jurisdiction

Up until the German Act to Modernize the Law on Private Limited Companies and Combat Abuses [MoMiG] came into force on 1 November 2008, it belonged to established case-law and the common understanding that, under the condition that it was a financial plan loan, the default of a shareholder loan leads to subsequent acquisition costs which were to be taken into account as disposal pursuant to sec. 17 German Income Tax Act [Einkommensteuergesetz – EStG]. As a result, the qualification of external financing and the injection of equity capital were generally synchronized.
However, the relevant provisions were adjusted in the same course of adjusting the legislature and a clear separation between equity and external capital in particular was created. A decisive factor for consideration as subsequent acquisition costs has been the task to clarify whether a provision of funds can be classified as equity or external capital. Only if injecting equity capital can a consideration as subsequent acquisition costs take place. More specific guidelines, especially regarding the BFH ruling of 11 July 2017 – file no. IX R 36/15 of 11 July 2017, can be found in our 2017 Q4 issue (“In general, shareholder loans are not taken into account as subsequent acquisition costs within the scope of sec. 17 EStG anymore”).
Since the changes in the BFH case rulings, one aspect is certain: Beyond the temporary solution chosen by the BFH, according to which external financings carried out in an equity-replacing manner up until 27 September 2017 were still needed to be taken into account as subsequent acquisition costs, the clear separation between external and equity capital incidentally applies in connection with sec. 17 EStG. Thus, a default of a shareholder loan does not generally lead to subsequent acquisition costs, which would in turn reduce sale proceeds.

II. Subsequent decision by the BFH

With its judgement of 24 October 2017, the BFH ruled that the default of private loan claims leads to an eligible loss in income from capital assets and thus created the possibility of continuing to take the default of private loan claims into account for tax purposes.
The judgement was based on the following facts: A jointly-taxed married couple granted a third party an interest-bearing loan. After just one year upon granting the loan, no further repayments were effected. Another year later, insolvency proceedings were initiated against the third party’s assets.
The BFH ruled that if a capital claim within the meaning of sec. 20 EStG exists and it irrevocably defaults, the creditor of the capital claim can assert this default in a tax-reducing manner against income from capital assets in accordance with sec. 20 para. 2 sentence 1 no. 7, sentence 2, para. 4 EStG. According to the BFH, this follows from the legal justification for the introduction of capital gains tax which is supposed to help taking into account all changes in value of capital assets as well as from effects which are similar to those occurring during a sale at a symbolic purchase price. It was clear to the BFH that the taxpayer should not be refused deduction because he had not found a purchaser who would accept the capital claim at a symbolic purchase price or the taxpayer would remain open to obtain a quota in insolvency proceedings. In fact, his performance would be limited in both cases equally, so that the negative change in value is to be taken into account.
In the present judgement, the BFH made no statement as to the extent to which the established principles can also be transferred to shareholder loans or how it can be proven in individual cases that the capital claim is irrevocably defaulted.

III. Outlook

In this context it is also interesting to look at the recent judgement passed by the Fiscal Court of Münster on how waiving a shareholder loan leads to a consideration of a loss on income from capital assets (Fiscal Court of Münster, file no. 2 K 3127/15 E, judgement dated 12 March 2018).
According to the judgement passed by the Fiscal Court of Münster, waiving claims under a loan ranks equally with a final default, so that a loss has to be taken into account for tax purposes. In this respect a parallel to a sale at a symbolic purchase price can particularly be drawn. Even if a claim under the loan was waived, there would be a loss in economic performance.
The Fiscal Court of Münster allowed the appeal to the BFH. The proceeding is conducted under file no. IX R 9/18. It remains to be seen whether the BFH will support this argumentation and thus, brings some legal security into the opaque jurisdiction again. The BFH would have to urgently enter into this decision, at least with regard to the question of the transferability of the principles from the above-mentioned BFH judgement to the default of shareholder loans.

IV. Consequences for practical situations

It remains to be clarified when the loss of receivables will finally be determined. According to the previous statements of the BFH, this does not apply if insolvency proceedings have been opened against the debtor’s assets. However, it is sufficient to assume that insolvency proceedings have been rejected for lack of assets. However, it remains to be seen to what extent even purely factual enforcement difficulties can lead to a final default. In this case, the debtor’s relocation to a foreign country or the final refusal of payment should be considered in particular.
However, those shareholders could benefit who hold an interest of more than 10 % in the company to which they have granted external financing from which they receive income pursuant to section 20 para. no. 7 EStG. Section 32d para. 2 no. 1 b EStG does not make the special withholding tax rate applicable in these cases. Furthermore, section 32d para. 2 no. 1 sentence 2 EStG excludes the application of the prohibition on offsetting losses pursuant to section 20 para. 6 and the prohibition on deducting income-related expenses pursuant to section 20 para. 9 EStG, so that the full amount of the loss can be deducted for tax purposes.
Therefore, it can only be hoped that the BFH will confirm the applicability of its case-law on the consideration of the default of private loan claims for income from capital assets to shareholder loans and will make more precise statements on the proof of the final default.