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Tax courts rule on the scope of consideration ...

Tax courts rule on the scope of consideration ...

... for debt added back for trade tax purposes

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Accounting for the consideration for debt for trade tax purposes

Interest and fees charged for borrowed capital represent an expense under commercial law. In tax accounting, too, expenses incurred by a company are recorded against profit. This principle, which derives from income tax, is generally also applicable for corporation tax and trade tax. However, due to its specific purpose, trade tax must not differentiate between equity financing and debt financing. This is governed by a special legal provision. Pursuant to Section 8 no 1 a) of the German Trade Tax Act [GewStG], the consideration for debt is to be proportionally added back to the trade tax basis of assessment if it has previously been recorded as an expense. This helps to mitigate the tax shield effect while at the same time counteracting the debt-equity bias. However, the wording chosen by legislators "consideration for debt" ("Entgelte für Schulden") is proving in many real-life cases to be too imprecise. As a result, the interpretation of this abstract legal concept has raised a number of questions.

Criteria from the German Federal Fiscal Court

According to the ruling of the German Federal Fiscal Court, "consideration for debt" is the payment for the provision of debt. Specifically, this means that a debt obligation must exist and the payment due must be calculated based on this debt obligation. These criteria outlined by the German Federal Fiscal Court may sound trivial at first, but loan agreements frequently diverge from the simple case of a bullet loan, meaning that these criteria require further interpretation. The main problem is the classification of the different types of consideration economically linked to the loan, such as swap fees or interest accrued on securities loans. 

Recent ruling of the tax courts

If swaps are concluded to hedge the interest risks resulting from the loan, the question arises of whether the expenses incurred for such transactions are also to be viewed as "consideration for debt". The tax court of Berlin-Brandenburg states in its ruling of 8 January 2019 (file ref.: 6 K 6242/17) that consideration paid for a service rendered on a different legal basis is not subject to the add-back rule [Hinzurechnung]. A swap is ultimately not based on the granting of capital per se, but rather constitutes a bet on the future changes to the interest rate. However, this separate classification applies only if the swap is concluded with a third party (i.e. not with the lender). Should the swap be agreed with the creditor, it cannot be ruled out that the swap and the loan form an economic unit, meaning that the swap fee could potentially be recognised as "consideration for debt".

In its decision of 22 February 2018 (file ref.: 3 K 3018/15), the tax court of Baden-Württemberg ruled on the question of whether interest accrued during a securities loan involving fixed-rate bonds constitutes consideration for debt within the meaning of Section 8 no 1 GewStG superseded version. The court rejected this motion in the specific case.

The claimant (borrower) entered into a securities loan involving fixed-rate bonds. A securities loan constitutes a contract for a non-cash loan [Sachdarlehensvertrag] within the meaning of Section 607 (1) of the German Civil Code [BGB]. In a contract for a non-cash loan, the borrower is required to pay consideration in return for receiving the non-cash item and, on maturity, to repay items of the same type, quality and amount. To hedge this repayment obligation, the claimant concluded unconditional forward transactions involving equivalent bonds with a bank. The bank charged the claimant for the interest accrued up to purchase. The claimant only had to pay the accrued interest to the bank. The claimant did not have to pay any interest to the lender, because there were no interest payment dates during the term of the loan.

According to the tax court, the accrued interest does not represent consideration for debt within the meaning of Section 8 no 1 GewStG superseded version. This is because consideration for debt is the payment for the provision of debt and not the payment for a service rendered on a different legal basis. The interest accrued in this case does not constitute the payment for the provision of debt. This is because civil law requires a distinction to be made in the case of securities loans between the handing over of the non-cash item and the repayment of items of the same type, quality and amount. This distinction under civil law is to be taken into account in the interpretation of the term "consideration for debt" within the meaning of Section 8 (1) GewStG superseded version. Only the payment for the handing over of the non-cash item constitutes consideration for the provision of debt, whereas the payment for the procurement of non-cash items of the same type, quality and amount to fulfil the repayment obligation does not. The repayment of non-cash items of the same type, quality and amount is itself also not consideration for the handing over of the non-cash item, but merely the consequence of the non-cash item being conferred (only) for a limited period. However, the interest accrued is not consideration for the handing over of the non-cash item (in this case, bonds), but rather for the procurement of non-cash items (bonds) of the same type, quality and amount to fulfil the repayment obligation.

Although the tax court issued its decision on the superseded version of Section 8 no 1 GewStG, since Section 8 no 1 point a GewStG in the currently applicable version still contains the constituent element "consideration for debt", the decision is still relevant for the law as currently in effect.

The ruling is dependent on appeal from the German Federal Fiscal Court (file ref.: III R 15/18).

Conclusion

It should be noted that the ruling in both judgments establishes a strict separation between the actual debt obligation and other legal transactions, even if the other legal transactions are closely entwined economically with the debt obligation. In this respect, the tax courts base their arguments on the interpretation of the loan agreement under civil law. This reasoning is convincing.

Source: KPMG Corporate Treasury News, Edition 88, January - February 2019
Author: Dr. Dirk Niedling, Partner, International Tax, dniedling@kpmg.com

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