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07.01.2014
Court rules on income adjustments
relating to interest-free shareholder
loans
A recent decision issued by the fiscal court of Schleswig-Holstein
addresses the situations in which interest-free loans may be
granted between related companies and whether the income
adjustment rule in sec. 1 of the Foreign Tax Code violates EU law.
In a decision issued on 29 November 2012, the fiscal court of Schleswig-Holstein ruled
that if a loan functions as equity, it cannot be subject to an income adjustment based
on sec. 1 of the Foreign Tax Code (FTC).
The case concerned a German parent company that granted an interest-free loan to a
foreign subsidiary in order to finance the acquisition of an asset that was essential for
the subsidiary to operate its business. During a tax audit, the German tax authorities
concluded that the interest-free loan was not made on arm’s length terms and they
adjusted the income of the German parent company requesting arm’s length interest
income for the German borrowing parent company based on section 1 of the FTC.
The court allowed the tax authorities’ income adjustment related to the loan to the
extent the loan exceeded 40% of the total debt and equity of the subsidiary company.
This ratio was found based on the thin capitalization rules in effect at the time (old
section 8a of the Corporate Tax Code).To this extent the tax authorities were not
permitted assuming an interest payment because the loan concerned would qualify as
equity and not as an intercompany business transaction within the meaning of section
1 of the FTC and could therefore not give rise to an income adjustment under that
provision. The court acknowledged that the loan at issue was at least granted to
compensate for the inadequate capitalization of the subsidiary. Consequently, the
interest-free loan was accepted as far as it qualifies as equity according to applicable
thin-cap rules whereas the adjustment for interest income at the borrowing German
parent company was confirmed for the part qualifying as debt financing.
The court also held that section 1 of the FTC restricts the EU freedom of establishment
principle, but that the restriction can be justified to maintain a balanced allocation of the
power to impose taxes among the EU member states and to prevent artificial
arrangements. The court was of the opinion that the arm’s length principle is an
appropriate mechanism to test whether an arrangement is artificial, but if the arm’s
length test is not passed, the taxpayer must be given an opportunity to demonstrate
that there are justifiable economic reasons for the deviation from the arm’s length
principle. Even though section 1 of the FTC does not specifically provide for this option,
the court held that section 1 must be applied in line with EU law.
The tax authorities were granted the right to appeal to the Federal Tax Court.
Reference:
EFG 2013, 279
Contact
Roland Pfeiffer | Duesseldorf
[email protected]
+49 211 8772 2287
www.deloitte-tax-news.de
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