Düsseldorf Tax Court: No blanket partial deduction restriction for pooled refinancing costs under section 21 InvStG

Partial deduction restriction for expenses under section 21 InvStG

Under section 20 InvStG, income from equity funds, mixed funds and real estate funds is partially exempt from taxation depending on the fund category and investor category (Federal Ministry of Finance letter of 21 May 2019, Federal Tax Gazette 2019 I p. 527, para. 20.5). For business investors, the partial exemption can be significant. The downside: section 21 sentence 1 InvStG provides that expenses that are economically connected with partially tax-exempt income may not be deducted to the same percentage extent. This covers, in particular, reductions in business assets, business expenses, disposal costs and income-related expenses.

In the case at issue, the claimant was a credit institution whose asset-side business consisted predominantly of granting customer loans. In addition, it held fund interests from which partially tax-exempt income was generated in 2019. The tax authorities allocated not only administrative expenses but also general interest expenses from the refinancing of the banking business to the fund investments. For this purpose, a refinancing ratio derived from the average balance sheet total was applied to the carrying amounts or acquisition costs of the fund interests. The pooled refinancing costs determined in this way were allowed as deductible expenses only on a pro rata basis in line with the respective partial exemption rates.

The basis for this treatment was margin no. 21.06 of the Federal Ministry of Finance guidance on the Investment Tax Act dated 21 May 2019 (Federal Tax Gazette 2019 I p. 527). According to that guidance, credit institutions are generally deemed to have an economic connection between partially tax-exempt investment income and interest expenses for customer deposits, interbank deposits, bonds and comparable general interest expenses.

Düsseldorf Tax Court, by contrast, focused on the statutory requirements. The term economic connection must be understood, as in section 3c(2) of the German Income Tax Act (Einkommensteuergesetz – EStG), as a causal nexus. The decisive factor is the triggering cause, i.e. the reasons for which the taxpayer incurred the respective expenses. A direct connection is not required. However, even an indirect connection must be identifiable on the basis of the actual facts and circumstances. A merely mathematical or notional allocation is insufficient.

Accordingly, the focus is not on the abstract suitability of a refinancing source, but on the specific economic reason for incurring the expense in the individual case. For practical purposes, this means that general refinancing costs do not fall within section 21 InvStG merely because the asset side also includes partially tax-exempt fund investments. Rather, it must be examined whether the acquisition or holding of those investments was the cause, or at least a contributing cause, of the interest expenses.

No blanket allocation of pooled refinancing costs for credit institutions

Düsseldorf Tax Court allowed the pooled refinancing costs in dispute to be fully deducted as business expenses. In its view, it could not be established that the partially tax-exempt fund income was the triggering cause, or even a contributing triggering cause, of the bank’s general refinancing expenses.

The following circumstances were particularly relevant for this assessment:

• The fund interests accounted for only around 6.2 percent of the assets attributable to the asset-side business.
• Around 84 percent of the asset-side business related to customer receivables.
• Total fund income amounted to only around 9.13 percent of the income from the asset-side business.
• The partially tax-exempt fund income amounted to merely around 0.97 percent of the total income from the banking business.
• Based on the economic circumstances, the fund units could also have been acquired using equity or retained earnings.

Against this background, the court regarded the lending business as the clearly dominant triggering cause for the interest expenses of the liabilities-side business. Although the court considered it conceivable that funds from the liabilities-side business had also been used to acquire fund units, the mere possibility of such financing was not sufficient. The defendant had neither demonstrated that debt capital had been used at all, nor to what extent such funds had actually or indirectly been used to finance the fund investments.

The court also rejected a presumption based solely on the status as a credit institution. Section 21 InvStG contains neither a sector-specific special rule nor a statutory lump-sum allocation mechanism. The fact that the legislature can expressly provide for blanket deduction restrictions is illustrated, for example, by section 8b(5) of the German Corporation Tax Act (Körperschaftsteuergesetz – KStG). In the court’s view, a burdensome lump-sum approach that is not provided for by statute cannot be replaced by an administrative provision interpreting the law. Margin no. 21.06 of the Investment Tax Decree is therefore not binding on the tax courts.

Practical implications for credit institutions and other fund investors: the causal nexus is decisive

The judgment is particularly relevant for credit institutions, but its principles extend beyond the banking sector and beyond section 21 InvStG. Section 21 InvStG also requires, in the case of general financing and administrative expenses, a robust assessment of whether the expenses were incurred for the purpose of generating partially tax-exempt fund income. An automatic allocation key based solely on balance sheet values or fund ratios is unlikely to be appropriate in every case.

Affected companies should therefore document the actual source and use of funds as well as the economic reasons for raising and using debt capital. Financing policies, treasury documentation, maturity and currency matching, internal allocations, cash-pooling structures and evidence of available equity can be particularly helpful. At the same time, it should be assessed whether expenses can be specifically allocated to individual fund investments. The partial deduction restriction may apply only to the extent that a direct or indirect causal nexus can be established.

For assessment periods that are still open and pending objection proceedings, the judgment provides arguments against schematic add-backs under margin no. 21.06 of the Investment Tax Decree. However, the decision remains fact-specific. The Tax Court did not grant leave to appeal, but an appeal against the denial of leave to appeal is pending before the Federal Fiscal Court under case no. VIII B 69/26. In addition, the court expressly relied on the factual assessment of the specific circumstances of the case. Companies should therefore assess transferability by reference to their individual refinancing structure and support their position with robust factual evidence. We would be happy to support you in analysing existing allocation models, preparing tax documentation and assessing the procedural implications.