A domestic general partnership (OHG) was the sole shareholder of an Italian corporation (A). OHG had unsecured interest bearing claims against A. During the years of the dispute, the partnership waived part of its claims against A in return for a debtor warrant. Following an audit an adjustment to the taxable income of OHG was issued by the tax authorities. The assessment was later set aside by the administrative court but on appeal by the tax authorities the BFH in 2019 upheld the assessment. A constitutional complaint was lodged against this ruling. Judgment of the Federal Constitutional Court The Court upheld the complaint and overturned the BFH judgment and referred the case back to the BFH. 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 ...

In 2010, “Write-Down KG” granted a loan to its Turkish subsidiary (“T”). The loan bore interest at 6% per annum but was unsecured. In 2011, Write-Down KG decided to liquidate T. Write-Down KG therefore wrote off its loan and interest receivable from T and claimed the write-off as a tax deduction. The German tax authorities disallowed the deduction because the loan had been unsecured which was considered not to be at arm’s length. An appeal was lodged with the local tax court, which upheld the tax authorities’ position. An appeal was then made to the Federal Tax Court. Judgement of the Court The court ruled that the waiver of security for a shareholder loan may not be at arm’s length. Such a deviation from the arm’s length principle may lead to a write-off of the loan receivable and thus to a reduction in income. This reduction in income may be reversed on the basis of the arm’s length principle contained in Section 1 of the German Foreign Tax Act. Furthermore, article 9 OECD-MTC does not prohibit such an income adjustment. Excerpts “28. (2) The loan relationship between the plaintiff and T Ltd, who are related parties within the meaning of § 1, para. 2, no. 1 AStG, is a foreign business relationship within the meaning of § 1, para. 5 AStG, the conditions of which include the non-security of the claims. In order to avoid repetitions, reference is made to the statements in the Senate’s ruling in BFHE 263, 525, BStBl II 2019, 394. The plaintiff’s objection at the oral hearing that the transactions were ultimately purely domestic commercial transactions is not comprehensible in view of the loan agreement with T Ltd, which is domiciled in Turkey. 29. (3) Furthermore, the Regional Court bindingly determined (§ 118 (2) FGO) that a third party would not have granted the loan to T Ltd. without providing collateral. 30. Even if the FG did not explicitly extend its findings to the interest claims resulting from the loan, it seems impossible on the basis of the further circumstances established that a lender not affiliated with T Ltd. would not have secured these claims. In particular, it must be taken into account that T Ltd was a newly founded company that did not have any significant fixed assets and that the collateralisation was not dispensable from the point of view of the so-called group retention (cf. again the Senate’s decision in BFHE 263, 525, BStBl II 2019, 394, as well as the Senate’s subsequent decisions in BFH/NV 2020, 183; of 19.06.2019 – I R 54/17, juris; of 14.08.2019 – I R 14/18, juris). In this situation, there is no need to refer the case back to the Fiscal Court for further clarification of the facts. 31. (4) The reduction in income within the meaning of section 1(1) sentence 1 AStG occurred due to (“as a result of”) the lack of collateralisation. In this respect, the Senate also refers to its ruling in BFHE 263, 525, BStBl II 2019, 394. 32. (5) Nor does Article 9(1) of the Agreement between the Federal Republic of Germany and the Republic of Turkey for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion in the Field of Taxes on Income of 19 September 2011 (BGBl II 2012, 527, BStBl I 2013, 374) – DBA-Türkei 2011 -, which is applicable as of 1 January 2011, preclude the correction of income.” “34. (6) Finally, Union law does not conflict with an income adjustment under section 1, paragraph 1, sentence 1 AStG. Since Turkey is not a Member State of the European Union, reference is made in this respect to the statements in the Senate rulings of 27 February 2019 – I R 51/17 (BFHE 264, 292) and of 14 August 2019 – I R 14/18 (juris). 35. The freedom of movement of capital, which is in principle also protected in dealings with third countries (Article 63 of the Treaty on the Functioning of the European Union in the version of the Treaty of Lisbon amending the Treaty on European Union and the Treaty establishing the European Community, Official Journal of the European Union 2008, no. C 115, 47 –AEUV–) is superseded by the freedom of establishment, which has priority in this respect (Senate judgements of 6 March 2013 – I R 10/11, BFHE 241, 157, BStBl II 2013, 707; of 19 July 2017 – I R 87/15, BFHE 259, 435, BStBl II 2020, 237). Moreover, it would not be applicable – despite the amendments to Article 1(1) AStG made by the UntStRefG 2008 – also because of the so-called standstill clause of Article 64(1) TFEU (cf. Senate judgment in BFHE 264, 292). Click here for English translation Click here for other translation ...

A German general partnership (OHG) was the sole shareholder of an Italian corporation (A). In 2002, there was an unsecured claim against this company from a current account overdraft in the amount of approx. … million was outstanding. The receivable bore interest at 4.57 % (1st half of 2002), 4.47 % (2nd half of 2002), 3.14 % (1st half of 2004) and 3.13 % (2nd half of 2004). On 31 December 2002, OHG waived part of this claim in the amount of … € against a debtor warrant. Subsequently, the claim against A rose again by the end of 2004 to approx. …..€. OHG then again waived part of this claim (… €) against a debtor warrant. The amounts corresponded to what the parties to the contract considered to be the worthless part of the claims against A from the overdraft facility. Although these were derecognised in OHG’s balance sheet to reduce profits, the tax authorities neutralised the reduction in profits in accordance with Section 1 (1) AStG by means of an off-balance sheet addition. Judgement of the Bundesfinanzhof The BFH relied on its fundamental ruling on income correction for unsecured group loans and decided that the profit-reducing derecognition of the claim must be corrected by an off-balance sheet addition in accordance with Section 1 Paragraph 1 AStG. “The contested judgement must be set aside and the action dismissed (section 126 (3) sentence 1 no. 1 of the FGO). The lower court wrongly assumed that the plaintiff’s income was not to be corrected.” Click here for English translation Click here for other translation ...

C A GmbH managed an unsecured clearing account for a Belgian subsidiary. After financial difficulties in the Belgian subsidiary, C A GmbH waived their claim from the clearing account and booked this in their balance sheet as a loss. However, the tax office disallowed the loss according to § 1 Abs. 1 AStG. Up until now, the Bundesfinanzhof has assumed for cases that are subject to a double taxation agreement (DTA), that Art. 9 para. 1 OECD was limited to so-called price corrections, while the non-recognition of a loan claim or a partial depreciation was excluded (so-called Blocking effect). The Bundesfinanzhof overturned the previous judgment of the FG. According to the court it was not necessary to determine whether it was really a tax credit or a contribution of equity to the Belgian subsidiary. However, this could be left out, since the profit-reducing waiver by C A GmbH should be corrected in any case according to § 1 Abs. 1 AStG. A limitation to so-called price corrections could not be derived either from the wording or the purpose of Article 9 (1) OECD. Click here for English translation Click here for other translation ...

The German subsidiary of a Canadian group lent significant sums to its under-capitalised UK subsidiary. The debt proved irrecoverable and was written off in 2002 when the UK company ceased trading. At the time, such write-offs were permitted subject to adherence to the principle of dealing at arm’s length. In its determination of profits on October 31, 2002, the German GmbH made a partial write-off of the repayment claim against J Ltd. in the amount of 717.700 €. The tax authorities objected that the unsecured loans were not at arm’s length. The tax authorities subjected the write-down of the claims from the loan, which the authorities considered to be equity-replacing, to the deduction prohibition of the Corporation Tax Act. The authorities further argued that if this was not the case, then, due to the lack of loan collateral, there would be a profit adjustment pursuant to § 1 of the Foreign Taxation Act. Irrespective of this, the unsecured loans had not been seriously intended from the outset and should therefore be considered as deposits. In general, the so-called partial depreciation is not justified because of the so-called back-up within the group. The Supreme Tax Court has held that a write-off of an irrecoverable related-party loan is not subject to income adjustment under the arm’s length rules, although the interest rate should reflect the bad debt risk. The Supreme Tax Court has now held that the lack of security does not invalidate the write-off. The lender was entitled to rely on the solidarity of the group, rather than demanding specific security from its subsidiary as debtor. In any case the arm’s length income adjustment provision of the Foreign Tax Act applied to trading transactions and relationships, but not to those entered into as a shareholder. The loans in question substituted share capital and their write-off was not subject to income adjustment on the grounds that a third party would not have suffered the loss. However, the interest rate charged should reflect the credit risk actually borne. In the meantime, there have been several changes to the relevant statutes. In particular, related-party loan losses can only be deducted if a third party creditor would have granted the finance (or allowed it to remain outstanding) under otherwise similar conditions. Also the Foreign Tax Act definition of “trading” has changed somewhat to bring certain aspects of intercompany finance into the scope of arm’s length adjustments. However, the general conclusion of the court that an arm’s length interest rate must reflect the degree of risk borne by the creditor remains valid In its judgment of 24 June 2015, the Supreme Tax Court made reference to this case-law in relation to Article IV of the DTT United Kingdom 1964, which corresponds in substance to Article 9 (1) of the OECD MA. Accordingly, the reversal of a write-down of an unsecured loan by a domestic parent company to its foreign subsidiary in accordance with Section 1 (1) of the AStG is not lawful. For the fact that § 1 exp. 1 AStG would be overriding agreement, nothing is evident. The wording of the law and also the will of the contracting parties of the DTTA do not permit the interpretation on which the BFH bases its judgments. Thus, according to Article 9 (1) of the DBA-USA 1989 and Article IV of the DTT-UK 1964, which correspond in substance to Article 9 (1) of the OECD-MA, according to their wording as a prerequisite for the correction of “profits” of affiliated companies, that “Are bound in their commercial or financial relations to agreed or imposed conditions other than those which would be mutually agreed by independent companies”. In this case, “the profits which one of the undertakings without these conditions has made, but has not achieved because of these conditions, must be attributed to the profits of that undertaking and taxed accordingly.” On 30 March 2016, the Federal Ministry of Finance issued a non-application decree stating that Article 9 of the OECD Model Tax Convention does not refer to a transfer price adjustment but to a profit adjustment. According to the decree the principles of these two decisions are not to be applied beyond the decided individual cases insofar as the BFH has a blocking effect of DTT standards, which correspond in substance to Art. 9 (1) OECD-MA. The exclusive limitation of the correction on prices or transfer prices postulated by the BFH can not be inferred either from the wording of Article 9 DTT-USA 1989, Article IV DTT-UK 1964 or Article 9 (1) OECD-MA. The OECD Commentary on the OECD MA explicitly refers to the arm’s length terms and states that Article 9 (1) of the OECD-MA is concerned with adjustments to profits and not a price adjustment. If in the audit practice a situation is to be examined which corresponds to the facts of the cases of judgment, it must first be ascertained whether the loan relationship is to be recognized for tax purposes (eg no hidden distribution of profits) and whether the conditions are met pursuant to Section 6 (1) 2 sentence 2 EStG for recognizing a write-down on the loan receivable. If there is a loan relationship to be recognized and a partial depreciation should be carried out on the loan receivable pursuant to § 6 (1) (2) sentence 2 EStG , it must be examined whether the application of § 1 AStG in accordance with the BMF letter of 29 March 2011 (BStBl I S 277) means that the taxable person’s income is to be increased by the amount of the depreciation. Click here for English translation Click here for other translation ...

C-GmbH was the sole shareholder of I-GmbH. In 2000, I-GmbH, together with another company, set up a US company for the development of the US market, H-Inc., in which the I-GmbH held 60 per cent of the shares. H-Inc. received equity from the two shareholders and also received a bank loan of approx. $ 1.5 million (USD), which the shareholders secured through guarantees. As of December 31, 2003, the balance sheet of H-Inc. showed a deficit not covered by equity of approx. 950,000 USD. On June 30 , 2004,  I-GmbH became the sole shareholder of H-Inc. Then the bank put the H-Inc. granted loans due. Since H-Inc. was not able to serve the bank loan, C-GmbH paid the bank. As of December 31, 2004, the balance sheet of H-Inc. showed a deficit not covered by equity of approx. $ 450,000 , which at December 31 , 2005 amounted to approx. $ 1.6 million, as at 31 December 2006 $ 2.5 million and at December 31, 2007 USD 3.5 million. During the years 2004 to 2007, the I-GmbH granted its US subsidiary 5% interest-bearing, unsecured loans of € 261,756.22 (2004), € 1,103,140 (2005), € 158,553.39 (2006) and € 75,000 (2007) resulting from the liquidity of future profits of H-Inc. should be repaid. Loan receivables were subject to individual value adjustments already in the respective year of their commitment (2004: € 261,052, 2005: € 1,103,140, ​​2006: € 158,000, 2007: € 75,000). In judgment of 17 December 2014, the German Tax Court stated, with reference to its judgment of 11 October 2012, IR 75/11, that the treaty principle of “dealing At arm’s length ” have a blocking effect on the so-called special conditions. The relevant test according to Article 9 (1) of the DTC-USA 1989, which corresponds in substance to Article 9 (1) of the OECD Model Agreement, could only include those circumstances that have an effect on agreed prices. The concept of agreed conditions in Article 9 (1) of the OECD-Model Agreement should, in principle, include everything which is the subject of commercial and financial relations and therefore the subject of contractual exchange between affiliated undertakings, so that both the price and all other terms and conditions should be included. Following these decisions, on 30 March 2016, the Federal Ministry of Finance issued a non-application decree stating that Article 9 of the OECD Model Tax Convention does not refer to a transfer price adjustment but to a profit adjustment. According to the decree the principles of the above decisions are not to be applied beyond the decided individual cases. Se also the later decision from the German Tax Court I R 29/14. Click here for English translation Click here for other translation ...