According to decades of case law of the BFH, losses from shareholder loans could lead to subsequent acquisition costs on an investment within the meaning of section 17 German Income Tax Act [Einkommensteuergesetz – EStG] if it was a so-called equity substitute loan (sections 32a, 32b Limited Liability Companies Act [Gesetz betreffend die Gesellschaften mit beschränkter Haftung – GmbHG] old version). Recognition as subsequent acquisition costs led to a reduction in the disposal/liquidation gain or to an increase in the disposal/liquidation loss, so that the loss could be utilised by the shareholder for tax purposes in the amount of 60 % within the framework of the so-called partial income procedure.
With the Law for the Modernisation of the German Limited Liability Company Law and the Prevention of Misuse [Gesetz zur Modernisierung des GmbH-Rechts und zur Bekämpfung von Missbräuchen – MoMiG] of 23 October 2008, the equity compensation law, i.e. sections 32a and 32b GmbHG old version, was replaced with effect from 1 November 2008 by a regulation under insolvency law covering all legal forms (section 39 para. 1 no. 5, para. 5 Insolvency Code [Insolvenzordnung – InsO]. Furthermore, with effect from January 1, 2009, the so-called final withholding tax was introduced, which also generally assigns loan receivables to the taxable area. In its judgment of 11 July 2017 (case no. IX R 36/15), the BFH took these amendments to the law as an opportunity to abandon its previous case law (cf. our article in the newsletter edition 2017 | Q4). Contrary to the fiscal administrative opinion, equity-substituting financial assistance provided by a shareholder of a limited liability company [Gesellschaft mit beschränkter Haftung – GmbH] therefore generally no longer leads to subsequent acquisition costs for the investment, unless the debt capital was provided by the shareholder prior to publication of the above-mentioned judgment in the Federal Tax Gazette on 27 September 2017 (protection of legitimate expectations).
However, even shareholders whose loans do not fall under the above-mentioned protection of legitimate expectations scheme may currently (still) be able to use loan defaults for tax purposes. Because according to the jurisdiction of the VIII. Senate of the BFH (judgment of 24 October 2017, case no. VIII R 13/15) loan defaults as a “repayment to zero” fulfill the conditions of section 20 para. 2 sentence 1 No. 7 in connection with sentence 2 EStG. They can therefore be fully offset against the other (positive) capital income when applying the final withholding tax. The Court states that the introduction of the final withholding tax has brought about a paradigm shift. As can be seen from the explanatory memorandum to the legislative amendments, the legislator no longer wished to separate the income and wealth levels in income from capital assets. However, if all capital gains in this area are taxed in accordance with the new statutory provisions, it follows from the requirement of consistency that the taxpayer must be able to take account of losses in his economic capacity for tax purposes.
As a result, the loss of shareholder loans attributable to private assets currently leads either to subsequent acquisition costs (prerequisite: application of equity compensation law) or it can be taken into account as losses regarding their capital income (prerequisite: application of final withholding tax). Only shareholder loans that were issued before the publication of the BFH ruling of 11 July 2017 and that do not meet the requirements of equity compensation law are to be allocated to the non-taxable area of the taxpayer according to the current legal situation, so that the loss of such a loan is not eligible for tax purposes.
The group of tax irrelevant loans is now supposed to be (again) significantly expanded at the turn of the year.
II. Planned legal reorganization
As explained above, the BFH decided in its ruling of 24 October 2017 that taxpayers can claim losses from (shareholder) loans in their private asset area for tax purposes due to the introduction of the final withholding tax and the associated system change in the tax liability of investments. The tax authorities had taken a different view and only wanted to subject only capital gains to taxation through section 20 para. 2 sentence 1 no. 7 EStG.
It is therefore not surprising that the Federal Ministry of Finance’s draft bill “Act on the Further Tax Promotion of Electric Mobility and on the Amendment of Further Tax Regulations [Gesetz zur weiteren steuerlichen Förderung der Elektromobilität und zur Änderung weiterer steuerlicher Vorschriften]” (Annual Tax Act [Jahressteuergesetz – JStG] 2019) provides for an amendment to section 20 para. 2 EStG with effect from 1 January 2020, which is intended to codify the previous administrative opinion in law. The intention is a “clarification” according to which, among other things, the total or partial irrecoverability of a capital claim, the derecognition of a worthless claim by the creditor as well as the transfer of a worthless claim to a third party are not to be regarded as a sale within the meaning of section 20 para. 2 sentence 1 no. 7 EStG contrary to the jurisdiction of the BFH (section 20 para. 2 sentence 3 nos. 1 to 3 EStG-E). Furthermore, section 20 para. 2 sentence 3 no. 4 EStG-E is intended to exempt “comparable” situations from taxation.
It seems certain that the legal change, which will not only cover capital claims, will take effect on 1 January 2020. However, it is doubtful whether the regulation is constitutional. It is true that the legislator is granted considerable discretion in the question of which circumstances should be subject to taxation. However, if one takes the standard of the Federal Constitutional Court [Bundesverfassungsgericht] as a basis for assessing the constitutionality of a provision, a statutory exclusion of losses would in any case violate Article 3 para. 1 of the Constitution for the Federal Republic of Germany [Grundgesetz] if the mirror-image profits were fully subject to taxation.
The planned new regulation will not simplify the taxation procedure, but will foreseeably lead to a large number of appeals and lawsuits due to the constitutional problems.
III. Structuring with shareholder loans (BFH judgment of 20 July 2018, case no. IX R 5/15)
In the case decided, the shareholders of a GmbH made contributions to the capital reserve of the company in 2010, which was used to repay a bank loan of the company for which the shareholders had given a guarantee. At that time, the company had already completely discontinued its business operations and sold all its fixed and current assets. It would therefore not have been in a position, using its own resources, to honor the remaining bank liability, with the result that the shareholders were threatened with a claim under the guarantee. After payment of the contributions into the capital reserve and subsequent repayment of the loan to the bank, which led to the expiry of the guarantees, the shareholders sold their shares in December 2010 at a purchase price of EUR 0.00 and claimed the payments into the capital reserve in their 2010 income tax return as subsequent acquisition costs when determining the loss on disposal in accordance with section 17 EStG.
The tax office refused to consider the amounts with reference to section 42 German Fiscal Code [Abgabenordnung – AO]. From an economic point of view, the payments into the capital reserve were made solely to redeem the guarantees which were still subject to the equity compensation law of sections 32a and 32b GmbHG old version. According to this, the shareholders would not have been able to claim any subsequent acquisition costs from the company in the event of a drawdown of a guarantee due to the lack of recoverability of the recourse claims against the company when the crisis occurred. The chosen form of a prior payment of the potential liability claims into the company in order to avert the claim arising from the guarantees was therefore supposed to be an abuse of law, since it served solely to circumvent the tax consequences of the equity compensation law and to generate subsequent acquisition costs for the participation.
The BFH did not follow this. The Court states that voluntary additional payments to the capital reserve qualify as additional payments in the commercial balance sheet within the meaning of section 272 para. 2 no. 4 German Commercial Code [Handelsgesetzbuch – HGB]. For tax purposes, these are also contributions to the company’s assets, so that the acquisition costs of the investment increased. It is irrelevant whether subsequent acquisition costs would have arisen even if a different legal structure had been chosen. This is because the business share on which the payment is made and the loan debt are different assets that have to be assigned to different origination areas. The payments enabled the company to pay off its operating liabilities. This procedure, which is also provided for by company law, does not contradict the evaluations of the law. If, therefore, action is taken in conformity with company law, this cannot at the same time constitute an abuse of the possibilities for shaping the law within the meaning of section 42 AO.
The decision is logical and it is to be welcomed that in the meantime the financial administration has also decided to apply it. The judgment was published in the Federal Tax Gazette at the beginning of 2019, accompanied by an order of Oberfinanzdirektion Frankfurt am Main dated 10 April 2019 (S 2244 A-61-St 215).
IV. Consequences for consulting practice
The tax assertion of losses from shareholder loans is and remains a very complex field of consultancy. If there is a loss of receivables, it must first be checked whether the loan still falls under the equity compensation law (sections 32a, 32b GmbHG old version), which has been revoked in the meantime, and whether this results in subsequent acquisition costs. If the answer is in the negative, a tax assertion regarding income from capital assets must be examined, whereby the legislator would like to put a stop to this possibility with effect from 1 January 2020.
If a tax recognition is not possible under current and future law, it must be considered whether tax recognition can be achieved by an equity-financed repayment of the shareholder loan. A change between debt and equity capital by paying amounts into the capital reserve and subsequently repaying debts can also be advantageous from a tax point of view if taxable income is imminent at the company level, such as in cases of liquidation, without prior structuring by derecognition of the liability. The most recent case law of the BFH therefore goes well beyond the assertion of subsequent acquisition costs for investments in the sense of section 17 EStG.