Write-down of a non-interest-bearing loan
In its decision of 11 April 2011 (case reference: 9 K 209/08 K, F), the tax court of Münster held that where a 100 % shareholder grants a non-interest-bearing loan to its subsidiary, the mere fact that the loan is non-interest-bearing does not – per se – result in an impairment of the loan receivable at level of the shareholder. In the case, the taxpayer wanted to write-down a non-interest-bearing receivable with tax effect (which was still possible at the time), and this was denied by the tax authorities. The case is currently pending before the Federal Tax Court (case reference: I R 43/11).
Even though a non-interest-bearing loan usually has a fair market value (FMV) that is below its nominal value, the court held that there may be cases where the receivable nevertheless has to be valued with its full nominal value in the books of the creditor. This may be the case if there are certain compensating (hidden) benefits resulting from the non-interest-bearing loan or other benefits to the business of the creditor as a whole that outweigh the disadvantage inherent in the fact that the loans are non-interest-bearing (e.g. such loans to employees that may lead to a better working atmosphere in the company as a whole because of their “supportive” nature).
The court also held that a non-interest-bearing receivable may have to be valued at its nominal value if a 100 % shareholder grants the loan to its subsidiary, because the loan would have to be considered in combination with the entire business of the creditor and, therefore, in combination with the 100% shareholding in the subsidiary. The fact that the shareholder loan receivable is not interest-bearing may be outweighed by the higher value of the shares in the subsidiary so that a purchaser of the creditor’s business may still be inclined to pay the face value of the loan receivable.
Consequently, the tax court of Münster upheld the tax authorities’ position that a write-down on the shareholding was not possible. This decision should mainly be relevant for the year-end valuation of non-interest-bearing receivables. It does not appear to be relevant for cases where non-interest-bearing receivables are contributed to the debtor company (see below) because in these cases the connection between the business and the receivable should be eliminated, so that the receivable may have to be valued at its lower FMV (which gives rise to a cancellation of indebtedness income at the level of the subsidiary to which the receivable is contributed).
The decision will not be relevant for the valuation of the liability at the level of the subsidiary where the obligation to discount a non-interest-bearing liability under a special valuation rule for tax purposes still applies.
Contribution/waiver of loans
In its decision of 15 June 2011 (case reference: 9 K 2731/08), the tax court of Münster ruled on a case in which a shareholder waived a receivable from accrued interest on a shareholder loan, and then subsequently waived both an interest receivable and a loan receivable of the same loan. In the case, private equity funds and individuals had granted high-yield loans to a German GmbH which acted as a vehicle for acquiring shareholdings in German companies. Interest on the shareholder loans were only payable upon maturity and the amount of accrued interest did not bear any interest.
In 2003, the shareholders decided to waive the receivables from accrued interest until the end of 2002. A further waiver of interest receivables resulting from current year interest and a part of the underlying principal of the loan was agreed six months later. The tax authorities treated the contributions as partly triggering fully taxable cancellation of debt income.
The tax court of Münster came to the following conclusions:
- The FMV of a loan receivable is determined by the price an unrelated third party would pay for the loan receivable. The tax court specifically stated that only the value of the receivable has to be taken into consideration and not – as may be argued – the value of the receivable in the context of the entire business of the shareholder/creditor as a going concern, as in the decision discussed above. The main reason for this difference in the valuation appears to be that, while in the case of a regular “year-end” valuation, the receivable should be valued in connection with the entire business of the creditor, this connection is terminated upon contribution of the receivable so that the receivable has to be valued on a stand-alone basis.
- The value of a loan receivable is not necessarily impaired if (a portion of) the receivable is non-interest-bearing as there may be other factors that can compensate for this disadvantage, so that a high interest rate may technically compensate for the fact that the accrued interest itself is non-interest-bearing. However, this does not eliminate the debtor’s obligation to discount the liability. The tax court referred to its previous decision on the FMV of non-interest-bearing loans.
- If a shareholder waives a portion of a shareholder loan and the FMV of the shareholder loan receivable exceeds the amount at which the shareholder loan is recorded at the level of the debtor company, this may result in a tax deductible expense for the debtor company. The FMV of the loan receivable typically may be higher than the liability recorded in the debtor’s tax books if the interest rate was arm’s length at the time the loan was granted, but subsequently the market interest rates dropped. It is unclear whether the tax authorities will disallow an expense deduction for such a contribution based on the non-deductibility of write-downs of shareholder loans.
- A shareholder may waive each receivable separately (i.e. receivables from interest may be waived independently of the underlying loan receivable).
Even though an appeal against the decision of the tax court of Münster is pending before the Federal Tax Court (case reference: I R 64/11), taxpayers that intend to waive a loan receivable should carefully review whether there are positive or negative effects resulting from the principles set forth by the tax court of Münster.
If you have any questions, please contact the authors of this article at gtln@deloitte.de or your regular Deloitte contact.
