As already reported, German tax authorities in current tax audits do not allow loss deduction of negative changes in value for intragroup loans caused by movements in exchange rates.
Losses arising from such loans are subject to a ban on loss deduction if the loan was granted to corporations in which the lender holds a direct or indirect investment of more than 25%. The wording of the legal provision actually intended for credit quality-related impairment losses also includes all other events leading to an impairment of loan receivables, including exchange rate-related losses on loans.
The consequences of the ban on tax deductibility are disproportionate where the lender hedges exposure to foreign exchange risks arising from lending in the customary manner through forward exchange transactions. The absence of corresponding tax exemption for hedging gains arising from these transactions combined with the non-deductibility of loan losses can result in the taxation of profits that never materialised ('dry income taxation').
On 24 March 2021, the German Federal Cabinet adopted the government bill for an act on the modernisation of corporation tax law [KöMoG], which addresses this issue.
According to the proposed legislative amendment, future exchange losses will no longer count as profit reductions that are subject to non-deductibility. As a result, exchange rate-related loan losses would in future be indisputably deductible for tax purposes.
However, this welcome move by the German Federal Government is not yet rigorously implemented. While it is acknowledged that the legislative amendment must "serve to correct imbalances in the taxation of exchange gains and losses on shareholder loans", the opportunity has not been seized to also rigorously correct such imbalances for the past.
The amendment is to apply only to profits generated after 31 December 2021.
This means two things for companies affected. First, the architects of the amendment apparently assume in the present version of law that deduction of exchange rate-related loan losses is prohibited. Indeed, this has been a matter of some debate. Tax authorities are likely to feel vindicated in their approach for past matters.
Second, exchange rate-related loan losses incurred in 2021 and possibly even after promulgation of the law would still not be deductible. It is not clear why taxpayers are expected to accept this acknowledged imbalance for so long. Assuming that initial application of the amendment is not further deferred, this means that affected companies must carefully plan the maturities of their current financing arrangements and, in case of doubt, structure these so as to ensure that newly concluded loans and comparable financing do not fall due until 2022. For current loans falling due in 2021, companies should try to make tax-neutral adjustments to the loan conditions to allow the terms to extend to 2022.
However, there is positive news for old cases in which exchange rate-related losses have already been incurred. In practice, the counter-evidence concerning the arm's length principle legally provided for is faced with the challenge that while the tax authorities often require sufficient collateral for loans, this (as is typical in group structures) was often absent. In other matters, the German Federal Constitutional Court [BVerfG] recently overturned a ruling of the German Federal Tax Court [BFH] on income adjustment for fair value write-down of an unsecured group loan in default and referred the matter to the BFH (BVerfG, ruling of 4 Mar. 2021 –2 BvR 1161/19). The BFH had, without specific reasoning, demanded the loan be fully collateralised to address the arm's length principle. With the above ruling, the German Federal Constitutional Court rejected this view; on this basis it should not simply be assumed that a loan must be fully collateralised to meet arm's length criteria. The outcome of the process remains to be seen. Although the BFH's ruling was not handed down on the issue of collateral for purposes of counter-evidence for the deduction of foreign exchange losses, the BVerfG's recent ruling should give taxpayers support to argue that the group's backing, even without separate collateral by the borrower, can be regarded as sufficient security for the tax authorities.
Author: Dr Dirk Niedling, Partner, International Tax, email@example.com
Source: KPMG Corporate Treasury News, Edition 110, April 2021