In a recently published decision, the tax court of Munich rejected a taxpayer’s application to suspend the execution of a tax assessment on the grounds that there were doubts about the constitutionality of the German interest limitation rules (case reference: 7 V 822/11). This is the second case dealing with the interest deduction limitation rules which replaced the German thin capitalization rules in 2008 (see Deloitte Tax-News).
Under the interest deduction limitation rules, the deductibility of interest expense is limited to 30 % of the taxable EBITDA of the business, provided none of the three exceptions applies:
- Net interest expense per annum is less than EUR 3 million;
- The debtor is a stand-alone entity and can demonstrate the absence of harmful shareholder financing;
- For group companies, the individual company’s equity ratio is less than 2 % (since 2010) of the group’s equity ratio (provided there is no harmful shareholder financing).
The case involved a taxpayer whose net interest expense exceeded the EUR 3 million threshold and, due to harmful shareholder financing, the equity ratio ratio comparison test could not be applied. In addition, the taxpayer, a real estate developing company in its project start-up phase, did not generate sufficient taxable EBITDA to fully deduct the interest expense incurred.
Consequently, the local tax authorities disallowed the interest deduction and the company was put into a taxpaying position, despite the fact that the overall operating profit was presumably still low or negative due to the start-up situation. The taxpayer appealed the assessment. Based on the limited facts disclosed, two main arguments were advanced: the German interest limitation rule violates the constitution and the interest was taxed twice at the level of the taxpayer (once due to the non-deductibility at the level of the taxpayer and then taxation at the level of the financing banks/shareholder).
The tax court of Munich denied the suspension on the following grounds:
- As long as there is no evidence that the law became effective outside of the constitutional proceedings, no suspension of the execution can be based on non-conformity with the constitution;
- The general public’s interest in having stable tax revenue exceeds the individual concerns of the taxpayer. In particular, the tax court held that the interest dedcution limitation rule was introduced in 2008 in connection with the reduction of the corporate income tax rate from 25 % to 15 % and the rules cannot be suspended as long as the lower tax rate still applies as any suspension would compromise the budget.
The court indicated, however, that a suspension of the execution may be granted in extraordinary cases where the enforcement of the tax charges would result in irreparable damages, such as an insolvency procedure. The decision has been appealed and is pending before the Federal Tax Court (case reference I B 111/11). The proceedings should be monitored, as some technical experts believe there is a possibility that this decision may be overruled.
If you have any questions, please contact the authors of this article at gtln@deloitte.de or your regular Deloitte contact.
