The economic conditions of loans should also be viewed in the context of regulations that may affect the position of the parties. For example, insolvency law in the jurisdiction of the borrower may provide that liabilities towards associated enterprises are subordinated to liabilities towards unrelated parties ...

For instance in the case of a loan, those characteristics may include but are not limited to: the amount of the loan; its maturity; the schedule of repayment; the nature or purpose of the loan (trade credit, merger/acquisition, mortgage, etc.); level of seniority and subordination, geographical location of the borrower; currency; collateral provided; presence and quality of any guarantee; and whether the interest rate is fixed or floating ...

G.K. Ktf was a subsidiary of a company registered in the United Kingdom. On 29 December 2010 G.K. Ktf entered into a loan agreement with a Dutch affiliate, G.B. BV, under which G.B. BV, as lender, granted a subordinated unsecured loan of HUF 3 billion to G.K. Ktf. Interest was set at a fixed annual rate of 11.32%, but interest was only payable when G.K. Ktf earned a ‘net income’ from its activities. The maturity date of the loan was 2060. The loan was used by G.K. Ktf to repay a debt under a loan agreement concluded with a Dutch bank in 2006. The bank loan was repaid in 2017/2018. The interest paid by G.K. Ktf under the contract was deducted as an expense of HUF 347,146,667 in 2011 and HUF 345,260,000 in 2012. But, in accordance with Dutch tax law – the so called participation exemption – G.B BV did not include the interest as taxable income in its tax return. The tax authorities carried out an audit for FY 2011-2012 and by decision of 17 January 2018 an assessment was issued. According to the assessment G.K. Ktf had underpaid taxes in an amount of HUF 88,014,000. A penalty of HUF 43,419,000 and a late payment penalty of HUF 5,979,000 had been added. According to the tax authorities, a contract concluded by a member of a group of companies for a term of more than 50 years, with an interest payment condition other than that of a normal loan and without capitalisation of interest in the event of default, does not constitute a loan but a capital contribution for tax purposes. This is indicated by the fact that it is subordinated to all other creditors, that the payment of interest is conditional on the debtor’s business performance and that no security is required. The Dutch tax authorities have confirmed that in the Netherlands the transaction is an informal capital injection and that the interest paid to the lender is tax exempt income under the ‘participation exemption’. Hence the interest paid cannot be deducted from the tax base. The parties intended the transaction to achieve a tax advantage. Not agreeing with the decision G.K. Ktf took the case to court. The Court of first instance upheld the decision of the tax authorities. The case was then appealed to the Court of Appeal which resulted in the case being remanded to the court of first instance for reconsideration. After reconsidering the case, a new decision was issued in 2019 where the disallowed deduction of interest was upheld with reference to TPG 1995 para. 1.64, 1.65 and 1.66. The Court of first instance also found that the interest rate on the loan from BV was several times higher than the arm’s length interest rate. G.K Ktf then filed a new appeal with the Court of appeal. Judgement of the Court of Appeal. The Court held that the contested part of the tax authority’s decision and the final judgment of the court of first instance were unlawful and decided in favor of G.K. Ktf. For the years in question, legislation allowing for recharacterisation had still not been enacted in Hungary, and the conditions for applying the “abuse of rights” provision that was in force, was not established by the tax authorities. Click here for English translation Click here for other translation ...

A German corporation,”G Corp” held interests in domestic and foreign companies in the year in dispute (2005). G Corp granted loans to various subordinate companies – resident in France and the USA. These loans were mainly at fixed interest rates; instead of a fixed interest rate, an annual participation of 12.5% in the balance sheet profit of the subordinate company, limited to a maximum amount of 25% of the loan volume, was agreed as consideration for one loan. No collateral was provided. In the year in dispute, G Corp wrote off these loans against taxable profits. G Corp also transferred assets at book value to a Maltese subsidiary company, of which it was the sole shareholder, and contributed the shares in this company, pursuant to section 23(4) of the Reorganisation Tax Act applicable in the year in dispute, also at book value, to another Malta-based company in the context of a capital increase against the granting of company rights. Finally, in the year in dispute, G Corp and its controlled companies earned interest income from loan claims against various foreign subordinated companies totalling … €. The tax authorities issued an assessment where the taxable income related to a partial value write-downs on unsecured loan receivables issued within the group and a book value transfer of assets to foreign subsidiaries had been adjusted. In 2017 the regional tax court issued its decision concluding that the adjustment was not possible under the relevant German arm’s length provision. This decision was then appealed to the Federal tax court by both parties. Judgment of the Court (Bundesfinanzhof) The Federal tax court found the appeal well-founded and referred the case back to the regional fiscal court. Click here for English translation Click here for other translation ...

Lender GmbH acquired all shares in T GmbH from T in 2012 (year in dispute) for a purchase price of … €. To finance the purchase price of the shares, Lender GmbH took out a loan from its sole shareholder, D GmbH, a loan in the amount of … €, which bore interest at 8% p.a. (shareholder loan). The interest was not to be paid on an ongoing basis, but only on expiry of the loan agreement on 31.12.2021. No collateral was agreed. D GmbH, for its part, borrowed funds in the same amount and under identical terms and conditions from its shareholders, among others from its Dutch shareholder N U.A. In addition Lender GmbH received a bank loan in the amount of … €, which had an average interest rate of 4.78% p.a. and was fully secured. Finally Lender GmbH also received a vendor loan from the vendor T in the amount of … €, which bore an interest of 10 % p.a. and was not secured. The shareholder loan was subordinated to all other liabilities. The tax office issued a tax assessment in 2016 with regard to interest payments on the shareholder loan. According to the tax authorities an interest rate of of 5 % would have been agreed between independent parties. The difference up to the actual interest rate of 8% was therefore considered a hidden profit distribution(vGA) and added to the income of Lender GmbH. A complaint filed by Lender GmbH against the tax assessment was unsuccessful (Cologne Fiscal Court, Judgment of 29.06.2017 – 10 K 771/16.) The appeal before the Bundesfinanzhof was directed against this judgment. Lender GmbH claims that there has been an infringement of substantive law and requests that the contested judgment be set aside and that the the 2012 corporate income tax assessment be annulled. The tax authorities requests that the appeal be rejected. Judgment of the Court (Bundesfinanzhof) When determining the arm’s length loan interest rate for an unsecured shareholder loan, the statutory subordination of shareholder loans (section 39(1)(5) InsO) does not preclude a risk premium when determining the interest rate to compensate for the lack of loan collateralisation. It is contrary to general principles of practice if the court assumes without factual findings that a third party would agree on the same interest rate for a subordinated and unsecured loan as for a secured and senior loan. The judgment of the Cologne Fiscal Court of 29 June 2017 – 10 K 771/16 is set aside and the case is referred back to the Cologne Fiscal Court for a different hearing and decision. Click here for English translation Click here for other translation ...

For instance in the case of a loan, those characteristics may include but are not limited to: the amount of the loan; its maturity; the schedule of repayment; the nature or purpose of the loan (trade credit, merger/acquisition, mortgage, etc.); level of seniority and subordination, geographical location of the borrower; currency; collateral provided; presence and quality of any guarantee; and whether the interest rate is fixed or floating ...