Global Tax Alert | 29 April 2014
Germany’s highest Tax Court suggests that interest limitation rule may be unconstitutional and grants suspension of proceedings
The first senate of the highest German Tax Court (BFH) has held in a recently published decision1 that Germany's 30% EBITDA-interest limitation rule, in place since 2008, is most likely violating the constitutional principle of equality, and the constitutionally mandated principle of taxation based on financial ability. Contrary to several lower tax courts, the BFH quite clearly joins the ranks of those commentators, who believe that the interest limitation rule in its existing form is not targeted enough on abusive structures, and creates unnecessary and unconstitutional “collateral damage.” The case concerned a German corporation which, in spite of its annual operating loss, had to pay taxes because of disallowed interest expenses.
It is important to understand that the BFH has given its view in a decision on a suspension of enforcement (i.e., by issuing a temporary injunction). Under German procedural law, in such a decision, the court only needs to provide a view as to whether there are significant doubts related to the legality of the tax assessment to be enforced. In the event that such doubts are confirmed by the court, the tax authorities would then be restricted from enforcing the assessment (i.e., demanding tax payment) pending a decision on the principal case, where the question of the legality of the assessment will be decided. Accordingly, a decision on a suspension of enforcement is not yet a final decision on the matter. However, given the very clear position now taken by the BFH's first senate, it would in the given case be surprising if the BFH would not refer the main case to Germany's Constitutional Court, which is ultimately responsible for deciding on the interest limitation's constitutionality.
The practical implication for taxpayers currently affected by the interest limitation rules is that based on the BFH's decision, they should be able to claim to be tax-assessed as if the interest limitation would not apply - with the risk that the Constitutional Court would eventually decide otherwise. In this case, one would need to pay the additional tax with interest (which is currently imposed at 6% anually and is nondeductible, the interest period starts to run 15 months after the relevant FY end). In certain enforcement suspension cases, the tax authorities may also demand security for their claim. However, there is also the option (which could be more cost effective in the current interest rate environment) to file a protest against the tax assessment and pay the higher tax triggered by the interest limitation. If the Constitutional Court decides that the rules are unconstitutional, a refund would then be obtained (with taxable interest of 6%).
At this stage, it is uncertain if and when a decision by the Constitutional Court can be expected (as such decision would only be requested in the main proceedings), and whether the BFH's stance may prompt the German legislature to adjust the rules proactively, to reduce the risk of unconstitutionality.
1. Case reference I B 85/13, decision of 18 December 2013, published on 16 April 2014.
For additional information with respect to this Alert, please contact the following:
Ernst & Young GmbH Wirtschaftsprüfungsgesellschaft, Munich
- • Christian Ehlermann
+49 89 14331 16653
Ernst & Young GmbH Wirtschaftsprüfungsgesellschaft, Stuttgart
- • Dr. Daniel Zöller
+49 711 9881 28504
Ernst & Young LLP, German Tax Desk, New York
- • Thomas Eckhardt
+1 212 773 8265
EYG no. CM4382