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Reduced trade tax burden by offsetting interest on debt...

Reduced trade tax burden by offsetting interest on debt

...against with interest income in the cash pool

1000

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FTM

The trade tax addition of interest, rental and licensing expenses regularly leads to legal disputes between the taxpayer and the tax authorities. On the one hand, the provisions that govern the facts that apply to this addition (Section 8 No 1 of the German Trade Tax Act [GewStG]) have remained essentially unchanged since the corporate tax reform in 2008; the tax authorities have stated their position on this as well, in an extensive edict by the German states issued on 2 July 2012. Nevertheless, there are many sets of facts still surrounded by legal uncertainty to this day. The German Federal Finance Court [BFH] and two Finance Courts [FG] recently decided in favour of addition of trade tax in the following cases:

  • Cash pooling (BFH – III R 37/17): Interest expense and interest income can be offset against each other to a limited extent.
  • Trade fair stands (FG Düsseldorf –10 K 2717/17 G): No addition when renting a trade fair stand.
  • Business databases (FG Lower Saxony – 6 K 187/16): No addition for expenses for business databases.

Interest on debt in the case of cash pooling

Question in dispute

Must interest income and interest expense be offset within a cash pooling scheme when adding fees for debts for trade tax purposes?

Facts

The plaintiff is a limited company [GmbH] and part of a corporate group. The parent company is A-AG, with registered office located abroad. In order to optimise interest and financing, the corpo-rate group operates a cash pool in which the plaintiff also participates. As cash pool manager, A-AG maintains one or more target accounts, and the Plaintiff maintains multiple source accounts. The balance of the source accounts is set to zero every bank working day, either by automatically crediting a positive balance in the source account to the parent company’s target account or by automatically clearing a negative balance by means of transfer from the target account. The Plain-tiff maintains a separate clearing account for each source account, calculates the interest on a daily basis and posts this net on a monthly basis as an expense or income.

In its annual financial statements for the financial year 2010 in dispute, it netted interest expense and income and reported no interest expense in profit or loss. As a consequence, the Plaintiff did not add interest expenses for trade tax purposes. The tax office considered it inadmissible, under trade tax law, to offset interest expenses and income from the cash pool.

Decision

Contrary to the opinion of the tax office and the lower court (FG Lower Saxony – 6 K 243/14), the BFH considers it possible, in the present case and to a limited extent, to net interest expenses and interest income when adding fees for debts (BFH, decision of 11 October 2018, III R 37/17). In principle, each obligation must be considered in isolation, and it is not possible to combine multiple obligations along with the resulting interest on debt and credit (known as the ‘prohibition on offsetting’). Accordingly, any economic connection between a credit account and a loan account that may exist in the individual case will be subordinate to the structure chosen as a matter of civil law. However, the BFH makes an exception. For purposes of the law of trade tax, multiple accounts held with a lender, as well as loans granted on a reciprocal basis between two persons, could be regarded as a single loan relationship if they are similar in nature, serve the same purpose and are in fact regularly offset against each other.

In the view of the BFH, the application of these principles is also necessary for mutual loans in cash pooling, and this is fulfilled in the present case. A pooling of the obligations and a netting of interest amounts would thus come in for consideration.

According to the BFH, the result of the offsetting is that, for purposes of the law of trade tax, addition of the fees for debts can be considered only to the extent that a debt balance remains after the contractually stipulated offsetting, conducted each bank working day, of all of the Plaintiff’s source accounts included in the cash pool. Within the netting context, the numerous obligations that had arisen between the Plaintiff and the parent company were to be summarised, updated and calculated on a continuous basis each banking day with an eye to whether and to what extent the Plaintiff had a debt balance vis-à-vis the parent company. Only the resulting interest on debt is eligible for addition.

Practical consequences

The BFH decision discussed here marks the first opinion by the highest court on the treatment of cash pooling for trade tax purposes. The BFH affirms a (limited) offsetting of interest expenses and interest income resulting from reciprocal loan relationships, and hence a reduction in tax burden, for cash pool participants. The principles should apply mutatis mutandis at the level of the cash pool manager. As in the case decided, offsets are possible for the balances each bank working day in the different source accounts of a cash pool participant. It could also be conceivable that loans received (negative balance on source accounts) must first be offset against a positive total balance of previous days resulting from previous grants of loans (positive source account balance) (see margin no. 32 of the opinion). On the other hand, a ‘carryback’ of a positive total balance is not possible. According to the BFH, a debt balance does not lapse retroactively by virtue of the fact that a credit balance arises on a later day (see margin no. 32 of the opinion). The fact of the debt is already realised at the end of a day on which a debt balance exists. The BFH did not expressly decide the period for which the interest resulting from a debt once realised is eligible for addition:

  • from the date of realisation through to payment of the specific debt (in the case under dispute, this would have been 31 December), or
  • until the date on which there is no longer an economic overhang as a result of subsequent credit balances.

In the case under dispute, the BFH was unable to decide on the specific amount of nettable interest, as the lower court made no determination concerning the credit and debt balances each bank working day. Now, as part of a second legal action, the FG must now determine, whether and, if so, to what extent the credit and debt balances available in the various source accounts offset one another on respective bank working days, and the extent to which the Plaintiff had a debt balance vis-à-vis the parent company in relation to the bank working days in question. It remains to be seen how the FG, in its calculation, interprets the principles laid down by the BFH.

Cash pool participants should examine on a case-by-case basis whether the principles underlying the court’s judgement are transferable to their own cash pool model, and to what extent their own interest expenses and income are deductible for purposes of trade tax addition. Taxpayers should consider filing an objection or submitting an amendment request for trade tax assessment notices without admissible offsetting.

Source: KPMG Corporate Treasury News, Edition 90, April 2019
Author: Dr. Dirk Niedling, Partner, International Tax, dniedling@kpmg.com

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