In preliminary proceedings, the lower tax court of Lower Saxony published the first decision on Germany’s rule that limits interest deductions since 2008 (case reference 6 V 21/10). The tax court expressed serious doubts as to whether the German tax authorities’ approach to determining whether a harmful shareholder financing would prevent a taxpayer from relying on the equity ratio comparison (“escape clause”) is covered by the specific language of the law. The court also raised the possibility that the rule may be in conflict with the German Constitution.
An exception from the 30% of tax EBITDA restriction under the interest deduction limitation rule generally applies if the taxpayer can demonstrate that (i) the equity ratio of the tax consolidated German business is higher than, or at least equal to, the worldwide consolidated group’s equity ratio (within a permitted 2% tolerance); and (ii) no more than 10% of any group entity’s net interest expense is paid on debt to substantial (i.e. more than 25%) shareholders, parties related to such shareholders (in both cases not belonging to the IFRS/German GAAP group) or secured third parties.
The method for calculating the 10% threshold has been subject to discussion. While the tax authorities’ approach is to add up all interest paid to any outside shareholder that holds more than 25% of the company’s shares, the taxpayer in the case argued that each shareholder’s interest payments had to be compared separately to the 10% threshold according to the statutory language.
The court concluded that because the language in the statute could give rise to more than one interpretation, this was sufficient to presume that there may be doubts about the legitimacy of the tax authorities’ view and it therefore suspended the execution of the tax assessment. A court decision in preliminary proceedings does not predetermine a future court decision in the case. Taxpayers for whom the calculation of the 10% threshold is decisive to rely on the equity ratio comparison should follow the proceedings closely.
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