Federal Fiscal Court ruling: Prohibition on deducting loan losses under section 8b(3) sentence 4 and following of the Corporate Income Tax Act

Section 8b of the Corporate Income Tax Act as a basic legislative decision

Section 8b of the Corporate Income Tax Act is designed to implement the “legislature’s basic decision to tax profits generated under the “half-income” or “partial-income” methods only once – as corporate income tax levied on the generating corporation, and as income tax only when a distribution is made to natural persons who are shareholders”. “To avoid cumulation or cascade effects within chains of shareholdings” the legislature has therefore decided to “exclude payments within corporate ownership structures when determining income” (Federal Fiscal Court judgement of 18 Dec 2019, file ref. I R 29/17, Federal Tax Gazette [Bundessteuerblatt–BStBl] II 2020, p. 690, para. 20). 

This basic decision initially extends to trade tax as well – the exemption under section 8b is also applicable for trade tax purposes under section 7 sentence 1 of the Trade Tax Act [Gewerbesteuergesetz–GewStG] (Federal Fiscal Court judgement of 23 Nov 2021, file ref. I R 5/18, para. 16 and following), although the corporate income tax interpretation of terms such as “tax-effective” (section 8b(2) sentence 4 of the Corporate Income Tax Act) is not to be interpreted specifically in the context of trade tax but purely in the context of corporate income tax (Federal Fiscal Court judgement of 7 Sep 2016, file ref. I R 9/15, para. 11 and following). 

However, the provisions of section 8 no. 5 in conjunction with section 9 no. 2a and 7 of the Trade Tax Act create a separate participation exemption under trade tax law, which supersedes the treatment under section 8b of the Corporate Income Tax Act of distributions and similar income as defined by section 20(1) of the Income Tax Act [Einkommensteuergesetz–EStG] (Federal Fiscal Court judgement of 13 Mar 2024, file ref. I R 30/21, para. 20). For capital gains, however, the Trade Tax Act does not provide for such a “separate treatment” (Explanatory Notes to the Trade Tax Act [Gewerbesteuer-Hinweise–GewStH] 9.3, “Capital Gains”), meaning that the effects of section 8b(2) and (3) of the Corporate Income Tax Act are passed through “unmitigated” to trade tax.

But section 8b encompasses far more than just current income to be exempted from tax as defined by section 20(1) of the Income Tax Act (section 8b(1) of the Corporate Income Tax Act) and capital gains (section 8b(2). In the latter case, the tax exemption is economically (though not legally; e.g., Federal Fiscal Court judgement of 31 May 2017, file ref. I R 37/15, para. 18) in any case accompanied by a (complete) prohibition on deducting corresponding reductions in profits under section 8b(3) sentence three, which establishes a symmetry between income and expenses.

The situation is different, however, under section 8b(3) sentence 4 and following, which, where a creditor corporation holds more than one-quarter of the share capital or stock capital of the debtor corporation, also disallow deductions for reductions in profits arising in connection with a loan claim or from the realisation of collateral provided for a loan. It would be futile to search for corresponding tax-exempt operating income here (Federal Fiscal Court judgement of 12 Mar 2014, file ref. I R 87/12, Federal Tax Gazette II 2014, p. 859, para. 13). Sentence 5 of section 8b(3) of the Corporate Income Tax Act extends this prohibition on deduction to persons closely related to the shareholder as defined by section 1(2) of the Foreign Transactions Tax Act [Außensteuergesetz–AStG].

Interpretation of section 8b(3) sentence 4 and following of the Corporate Income Tax Act by the Federal Fiscal Court 

For many years, the Federal Fiscal Court has had to rule on the scope of application of section 8b(3) sentence 4 and following. The requirement that the creditor holds a stake in the debtor is particular in that the creditor, as a shareholder of the debtor, must hold or have held (“holds or held”) “more than one-quarter, directly or indirectly, of the share capital or stock of the corporation to which the loan was granted”. There is thus no time-based restriction on the ownership requirement – such as the “five-year” limit specified in section 17(1) first sentence of the Income Tax Act. Therefore, the prohibition on deduction “requires only that the shareholder granting the loan or security hold, or have held, more than one-quarter of the corporation’s share capital or stock capital at any time during the term of the loan. The date (by itself) when the loan was granted or the occurrence of the reduction in profits (by itself) is irrelevant” (Federal Fiscal Court judgement of 12 Mar 2014, file ref. I R 87/12, Federal Tax Gazette II 2014, p. 859).

Further issues arise from the question of substantive applicability: the “loan receivable” of section 8b(3) sentence four of the Corporate Income Tax Act is expanded by sentence eight of the same section to include “receivables arising from legal acts that are economically comparable to the granting of a loan”. According to established Federal Fiscal Court case law, the economic assets of “loan receivable” and “interest receivable” must be treated separately for tax balance sheet purposes (Federal Fiscal Court judgement of 11 Nov 2015, file ref. I R 5/14). For example, a failure to make any effort over many years to collect trade receivables may give rise to economic comparability (Münster Fiscal Court judgement of 17 Aug 2016, file ref. 10 K 2301/13 K).

According to a new ruling by the first chamber of the Federal Fiscal Court (file ref. I R 11/24), interest claims, the treatment of which the Federal Fiscal Court had initially left open (judgement of 19 Feb 2020, file ref. I R 19/17, Federal Tax Gazette II 2021, p. 223), are not covered by section 8b(3) sentence 4 of the Corporate Income Tax Act. For the loan receivable, which was clearly subject to section 8b(3) sentence 4 and following, however, it had to be determined whether the circumstances described in section 8b(3) sentence 5 applied. Sentence 5 requires a “person closely related to this shareholder as defined by section 1(2) of the Foreign Transactions Tax Act”. According to this ruling, a natural person who holds a significant interest in the debtor and the creditor cannot be regarded as a “closely related person” as defined by sentence 5.

Further questions on section 8b(3) sentence 4 and following of the Corporate Income Tax Act

The chamber did not need to take a position on the remaining practically relevant issues surrounding section 8b(3) sentence 4 and following. In the case at hand, the failure to include the amount in accordance with section 8b(3) sentence 4 and following meant that the Fiscal Court must examine at second instance the hidden distribution of profits under section 8(3) sentence 2 as an alternative basis for disallowing the deduction.

But a Federal Fiscal Court decision on the applicability of the “escape clause” under section 8b(3) sentence 7 (sentence 6 in the disputed year of 2013) would have been interesting. According to this provision, sentences 4 and 5 do not apply if it is proven that an unrelated third party would also have granted the loan or would not yet have demanded its repayment under otherwise identical circumstances; only the company’s own collateral is to be taken into account here. 

With regard to the proof required under the former sentence 6 of section 8b(3) (now sentence 7), the Federal Fiscal Court holds that “generally, no excessive requirements should be made…since section 8b(3) sentence 4 of the Corporate Income Tax Act relies on a very broad presumption that the corporate relationship was the cause for the transaction in order to establish a case of tax avoidance” (Federal Fiscal Court judgement of 24 Apr 2024, file ref. I R 41/20, Federal Tax Gazette II 2024, p. 785, para. 46). Some successful applications of the “escape clause” so far can be seen in the Münster Fiscal Court judgements of 20 Feb 2025, file ref. 10 K 764/22 (for the year in dispute of 2016) and 17 Feb 2026, file ref. 13 K 905/24 (regarding unsecured convertible loans).