Income tax deduction prohibitions and deduction restrictions are becoming prevalent

Outsourcing of liabilities subject to restrictions with regard to valuation 

Sect. 4f of the Income Tax Act is also included in the provisions of Sect. 4 et seqq. of the Income Tax Act. With this provision, the legislature responded to the Federal Fiscal Court ruling that business liabilities which have not been recognized in the seller's tax balance sheet due to tax provisions prohibiting the recognition of provisions are not subject to any prohibition on recognition as liabilities by the acquirer who has assumed the liability in the course of a business acquisition. Rather, they must be reported as contingent liabilities and valued by the acquirer at their acquisition cost or their higher market value on subsequent balance sheet dates in accordance with Sect. 6(1) no. 3 of the Income Tax Act (Judgement of the Federal Tax Court dated December 14, 2011, file number I R 72/10).

In particular, this case law was used to make the higher market value of liabilities – especially in pension provisions (Sect. 6a of the Income Tax Act) – usable for tax purposes. The hidden liabilities typically arose from the restrictions or prohibitions on recognition as liabilities required by Sect. 4f of the Income Tax Act, in particular from the discount rate of 6 percent in Sect. 6a(3) sent. 3 of the Income Tax Act and the prohibitions on recognition as liabilities in the tax balance sheet in Sect. 5(3) et seqq. of the Income Tax Act. This excessive discounting led to insufficient (or complete refusal of) recognition as liabilities, which made it attractive to make these hidden liabilities usable through a transfer in return for a consideration. 

The expense incurred by the seller "in one fell swoop" was then offset by the liability incurred by the purchaser (often dubbed a "pensioner company"): In this regard, the Federal Fiscal Court had ruled in established case law that pension obligations assumed were to be recognized in both the opening balance sheet and the subsequent balance sheets of the acquiring company at acquisition cost and not at partial values in accordance with Sect. 6a(3) of the Income Tax Act (e.g. Judgement of the Federal Tax Court dated December 12, 2012, file number I R 28/11with further references).

In order to spread the recognition of hidden liabilities over time, the legislature introduced Sect. 4f and 5(7) of the Income Tax Act in a marked change to the tax law in December 2013 (Federal Law Gazette I 2013, p. 4318). When transferring a liability subject to recognition restrictions, the expense resulting from this transaction is deductible as a business expense on a straight-line basis over the financial year in which the debt is assumed and the following 14 years (Sect. 4f(1) sent. 1 of the Income Tax Act). The transferee must account for obligations that were subject to recognition prohibitions, restrictions, or valuation reservations at the original obligor on the balance sheet dates following the transfer in the same way as they would have been accounted for at the original obligor without the transfer (Sect. 5(7) sent. 1 of the Income Tax Act). For a profit thus induced, a profit-reducing reserve may be formed in the amount of fourteen fifteenths in accordance with Sect. 5(7) sent. 5 of the Income Tax Act, which must be reversed in the following 14 financial years, increasing profit by at least one fourteenth in each year.

First applicability of Sect. 4f of the Income Tax Act

The introduction of Sect. 4f of the Income Tax Act was accompanied by the application rule in Sect. 52(8) sent. 1 of the Income Tax Act: It was to be applied for the first time to financial years ending after November 28, 2013. This meant that Sect. 4f of the Income Tax Act also applied to assumptions of obligations and assumptions of debts that took place before this date, provided that they fell within the financial year in progress at the time. However, the decisive factor was to be the date on which the assumption of obligations was agreed. Additional expenses triggered by a subsequent increase in remuneration should not lead to the application of Sect. 4f of the Income Tax Act.

However, this interpretation of the application rule was questioned by the German tax authorities: They wanted to distribute any expenses incurred in a financial year ending after November 28, 2013, due to a joint liability, evenly over a period of 15 years (Judgement of the Federal Tax Court dated March 20, 2025, file number IV R 27/22, Federal Tax Gazette II 2025, p. 697, margin number 16). However, the fourth chamber of the Federal Fiscal Court has already taken a different view: In the context of Sect. 52(8) sent. 1 of the Income Tax Act and Sect. 4f of the Income Tax Act, the date of the assumption of debt or the assumption of joint liability should be taken as the basis. On the other hand, it is not sufficient that an expense arises from the subsequent increase in remuneration in a financial year ending after November 28, 2013 (Judgement of the Federal Tax Court dated March 20, 2025, file number IV R 27/22, Federal Tax Gazette II 2025, p. 697, margin number 52).

The first chamber of the Federal Fiscal Court concurred with this line of case law in its ruling dated November 5, 2025 (file number I R 48/22). In the case in question, the issues surrounding Sect. 4f and 5(7) of the Income Tax Act were intertwined with questions regarding the German fiscal unity (Sect. 14 et seqq. of the Corporation Tax Act; Sect. 2(2) sent. 2 of the Trade Tax Act). An addition to an initial agreement in the year 2013 raised the question again as to whether Sect. 4f of the Income Tax Act is applicable to the expenses thus incurred. The first chamber also rejected this, incidentally in the context of examining a hidden profit distribution by the controlled companies (“Organgesellschaften”) within the fiscal unity (margin no. 28), sticking to the legal opinion of the fourth chamber.