Federal Fiscal Court ruling: Interest-free installment payment agreement does not result in notional income from capital assets

Taxable income from interest-free installment payment agreements until now 

“Annuities granted as consideration” are frequently paid in connection with the transfer of aggregates of assets (section 16 of the Income Tax Act), but also in connection with the transfer of privately held taxable assets. The latter particularly includes assets under sections 17, 20(2) and 23. If these kinds of assets are transferred in exchange for an “annuity granted as consideration”, case law up till now held that an annuity granted for a certain period in the case of a transfer under section 23, for example, had “to be divided, starting from when it started to be received, into a…principal component and an interest component taxable under section 20(1) no. 7 of the Income Tax Act” (Federal Fiscal Court judgement of 14 Jul 2020, file ref. VIII R 3/17, Federal Tax Gazette [Bundessteuerblatt-BStBl] II 2020, p. 813, para. 23). However, if the transfer under section 23 took place outside the “ten-year period” specified by it (section 23(1) sentence one no. 1 sentence one), the principal component was not subject to income tax.

The interest component of the ongoing annuity payments from a sale-based annuity (taxable under section 20(1) no. 7 starting with the first installment) resulted “from the economic comparability and the resulting requirement for equal treatment with the transfer of assets in exchange for installment payments” (Federal Fiscal Court judgement of 14 Jul 2020, file ref. VIII R 3/17, Federal Tax Gazette II 2020, p. 813, para. 24): “Even when an asset is transferred in exchange for a sale-based annuity, it must be assumed that the annuity entitlement has a certain present value, which is determined by discounting the sum of all outstanding installments. From an economic perspective, each installment (annuity payment) therefore always includes an interest component, which is calculated based on the amount of the respective, gradually decreasing present value of the annuity claim, regardless of how its principal component is treated for tax purposes. This interest component, which is economically included in the annuity payments, must be included in income tax calculations from the start of payments, even if the principal payments received at the same time are not subject to income tax”.

The provisions of the Valuation Act [Bewertungsgesetz–BewG] were applied in this case (regarding applicability, see section 1(2) of the Act). Sections 12 and following of the Valuation Act, with their “fixed” interest rate of 5.5%, which is unaffected by general interest rate trends (for the most recent constitutional assessment of this provision, see Federal Fiscal Court judgement of 14 Jan 2026, file ref. II R 35/23), were to be applied to determine the interest component. “This decision was based on section 12(3) of the Valuation Act, according to which non-interest-bearing claims with a term of more than one year and due on a specific date must be discounted, i.e., divided into a principal and an interest component. This also applies if the contracting parties have not agreed on interest or have even expressly excluded it...In the absence of a specific valuation provision in the Income Tax Act, section 12(3) of the Valuation Act also determines the valuation of private claims under income tax law” (Federal Fiscal Court judgement of 26 Jun 1996, file ref. VIII R 67/95). 

Change in case law by the eighth chamber of the Federal Fiscal Court

However, following a fundamental change in case law, the Federal Fiscal Court no longer recognises the income from capital assets arising under section 20(1) no. 7 of the Income Tax Act as previously established by settled case law. In the case in question (file ref. VIII R 30/24), the claimants’ daughter had acquired a piece of real estate from her parents. However, consideration was “initially deferred” and was to be made in monthly installments. Interest was expressly not agreed on. The reduction in the purchase price resulting from this waiver was gifted to the daughter. Should one of the transferring parents die, the agreement was to be continued with his or her heirs.

The eighth chamber of the Federal Fiscal Court did not view this arrangement as a gift inter vivos (section 1(1) no. 2 of the Inheritance Tax Act [Erbschaftsteuergesetz–ErbStG]; section 7(1) no. 1 of the Inheritance Tax Act). The transferred land and building constituted a transfer for full consideration without any intention on the part of the parents to make a gift to their daughter. In its view, the interest-free installment deferral did not constitute a transfer of assets between generations.

For income tax purposes, there is no “life annuity” as defined by section 22(1) no. 1 sentence 3 (a) and (bb) sentence 1 of the Income Tax Act, since the purchase price agreement did not contain a risk component in the form of linking the receipt of the annuity to the lifetime of the recipient or the obligor: It was expressly to be paid by the daughter to the claimants’ heirs following their deaths.

In a change to case law, however, the eighth chamber of the Federal Fiscal Court now also held that there is no income from capital assets under section 20(1) no. 7. The agreement to transfer private assets for full consideration with an interest-free deferral of the purchase price is permissible under civil law and to be recognised as a rule for tax purposes. However, a mandatory division of the individual installment payments into an interest component and a principal component cannot be based on this economic approach, outside of “tax planning arrangements” (para. 39). The interest-free deferral of the purchase price claim was precisely an expression of the claimants’ wish to sell their property to their daughter, making it “economically virtually imperative and therefore acceptable under tax law”.

No longer income from capital assets under section 20(1) no. 7 of the Income Tax Act 

The eighth chamber therefore did not accept that the claimants had income from capital assets under section 20(1) no. 7. It based its decision on the explicit agreement between the claimants (the parents) and their daughter, according to which deferral interest was expressly excluded. Instead, it was agreed that the benefit of the deferral would be granted to the daughter free of charge, as the daughter had only limited financial means. Neither the validity of the agreement under civil law nor its recognition for tax purposes was in doubt. 

Accordingly, no taxable capital gains arise from a capital transfer under section 20(1) no. 7. The eighth chamber also excluded income under section 20(2) sentence one no. 7. Under the first clause of the second sentence of section 20(2), this kind of income may also arise from substitute events related to the “primary event” of the sale, including a “repayment”. However, in such cases, the acquisition cost of the entitlement must first be consumed through principal repayments (section 20(4)).

It should be noted that the chamber left open the possibility that “tax-motivated arrangements” (para. 38 and following) may “remain under observation” and could therefore be denied tax recognition under section 39 and following of the Fiscal Code [Abgabenordnung–AO] (e.g., due to “concealment of an agreement or an abusive tax planning scheme under section 42 of the Fiscal Code”, according to the parallel ruling, file ref. VIII R 1/23, para. 24). Furthermore, it is repeatedly implied in the ruling that the purchaser’s lacking or only conditional (para. 49) “financial capacity” (para. 39) played a large role in the assessment. Under the previous legal situation, in such cases the recipient also faced the risk of being denied the flat-rate withholding tax regime (in addition to taxable income being assumed under section 20(1) no. 7 of the Income Tax Act): section 32d(2) no. 1 (a) specifically focuses on this “dependence” – whether of an economic or personal nature – as the basis for the “close relationship” between creditor and debtor that it requires (Federal Ministry of Finance Circular [Bundesministerium der Finanzen-BMF] of 14 May 2025, Federal Tax Gazette I 2025, p. 1330, para. 136 with further references).