Receivables defaults from a shareholder loan

The tax treatment of a loan loss for shareholders who have maintained their holding in a stock corporation as part of their private assets within in the meaning of Section 17 EStG (Income Tax Act) (holding of 1 percent or more within the last five years), has been subject to many changes over the last three years. Due to the ongoing “ping-pong” between case law (most recently the decision of the Düsseldorf Fiscal Court on 28/01/2020) and the tax authorities as well as changes in the tax legislation, there are now several competing regulations. This article aims to provide an overview.

New case law: applicable since 27/09/2017

With the landmark decision of the Federal Fiscal Court (BFH) on 11/07/2017, a deviation was made for the first time from the previous tax treatment of a loan loss. The new case law applies from 27/09/2017 onwards. In the opinion of the tax authorities, in all other open cases, for reasons of protection of legitimate expectations, it is possible to continue to apply the previous case law and the approach of the tax authorities concerning equity-replacing financial support or debts.

 I.    Tax treatment before 27/09/2017:
In the case of a shareholder loan, under the case law prior to the latest change in case law and in the opinion of the tax authorities, the final default of capital claims should be regarded as subsequent acquisition costs. Up to 60 percent of the loan loss resulting from the default can generally be used in the context of what is known as the Teileinkünfte¬verfahren or partial income procedure. In this case, the loss can only be considered for tax purposes at the time of the sale or liquidation of the company. In order to be considered as subsequent acquisition costs, the loan must have been granted as a result of the company relationship. This is regularly the case if, at the time the loan was granted or continued to be granted, the repayment of the loan was at risk in view of the financial situation of the company to such an extent that a prudent businessman would no longer have taken the risk of granting a loan on the same terms as did the shareholder.

II.    Tax treatment after 27/09/2017: 
With the change in case law, the expense of granting a loan may also represent a loss of income from capital assets.

The BFH justified its decision based on the cancellation of the equity substitution rights under the “Law for the Modernisation of the German Limited Liability Company Law and the Prevention of Misuse” (MoMiG) in 2008. According to this, an approach based on Commercial Law is to be followed when classifying the loan loss as a subsequent acquisition cost. In principle, only such expenses of the shareholder can represent subsequent acquisition costs of the participation which, in accordance with the principles of commercial and tax accounting law, inversely lead to an open or hidden contribution to the company’s capital. This includes, in particular, waiving a recoverable amount of receivables. Conversely, the default of a non-recoverable claim does not represent any subsequent acquisition cost, as this does not lead to a capital contribution to the company. The case is rather different if the loan provided by the shareholder, due to the contractual agreements, is equivalent to providing a contribution to the company’s assets. This is the case, for example, with a shareholder loan with a subordination agreement within the meaning of Section 5 Para. 2a EStG.

The claim of a loss of income from capital assets due to the default of a non-recoverable loan claim presupposes that it has been established with certainty that no more loan repayments will be made. The actual moment in time and circum-stances under which the shareholder provided the loan will not be decisive in the future.

In principle, the loss may not be offset against income from other types of income, nor deducted under Section 10d EStG. It only reduces the income that the shareholder generates from capital assets in subsequent assessment periods. Shareholders who hold more than ten percent of the corporation are excluded from the restrictions on deduction of losses and the prohibition on off-setting the losses. In this case, the loss from the receivables default can be fully offset without limits.

For reasons of protection of legitimate expectations, the recognized principles for treating the loan loss as subsequent acquisition costs will continue to be applied, if the shareholder granted the loan before 27/09/2017, or the loan was abandoned before 27/09/2017 when the crises occurred.

Legislative change 2019: applicable from 31/07/2019

Under the Annual Tax Act for 2019, the previous situation prior to the change in the case law was restored. The introduction of a new paragraph 2a in Section 17 EStG provided the legal basis for this. Under this, loan losses are subsequent acquisition costs, provided the grant of the loan or the abandonment of the loan during a company crisis, was instigated under company law. The same applies in the case of defaults of surety recourse claims and comparable claims, provided that the provision or the abandonment of the respective security was initiated under company law. Nowa¬days, the law also regulates when something has been instigated under company law. This is regu¬larly the case whenever a third party would have demanded repayment or would not have granted the loan or the security under otherwise identical circumstances.

The new wording of Section 17 para. 2a EStG applies for the first time to disposals from 31/07/2019. At the request of the taxpayer, an application of this rule is also possible for disposals before 31/07/2019.

Conclusion 

The income tax treatment of the loss of receivables from a shareholder’s loan to his company can be seen as confusing due to the constant “ping-pong” between case law, the tax authorities and legislative law. In the case of a loss of a shareholder loan, we recommend a critical review of whether there are any actions possible that would guarantee the optimum treatment of the loan loss.