Unfortunately, since November 2016, debt restructurings of companies that are tax resident in Germany have become uncertain from a tax perspective as the Federal Fiscal Court dismissed the German tax authorities’ taxpayer-friendly decree on the cancelation of debt income. A legislative process to pass a new law has been initiated, but debt restructurings so far remain subject to legal uncertainty where restructuring gains arise.
However, debt restructurings of non-real estate companies that are domiciled outside of Germany (e.g., a Luxembourg S.à r.l.) holding real estate investments in Germany may – pursuant to a new decision of the Federal Fiscal Court taken in December 2016 – be granted preferential tax treatment. Under German tax law, real estate companies which are domiciled outside of Germany and do not have a permanent establishment there are subject to German income tax only on rental income and capital gains in relation to their German properties.
In its decision, the court held that the waiver of a shareholder loan granted to such company is not subject to German taxation if the relevant property was distressed and sold at a loss and then, several months after the property sale, the shareholder waived the outstanding shareholder loan. Any restructuring gain resulting from the debt cancelation would not have occurred in connection with the taxable renting business, as this was terminated at the time of the property sale; nor would such gain be classed as a taxable capital gain, as the waiver cannot be deemed consideration for the property sale. Therefore, any restructuring gain from the waiver of a shareholder loan granted to such company is not subject to German taxation.
This, according to the court, remains the case even if the real estate company deducted the interest paid for the shareholder loan for German income tax purposes, as the debt is not a German tax asset and any change in the value of the debt does not impact the German taxation regime applicable to the real estate company.
The new court decision may enable investors to better restructure German distressed real estate portfolios without any exposure to tax in Germany, provided that such portfolios are held by non-resident real estate companies.
However, it is noteworthy that the German tax authorities have not yet published the court decision in the German Federal Tax Gazette (Bundessteuerblatt) and thus have not yet decided whether to apply the decision in other cases. Therefore, before carrying out a restructuring in response to the court decision, taxpayers should carefully watch out for any developments in this regard. It even remains possible that German legislators will enact new legislation that goes against the court decision by subjecting the cancelation of debt income in such cases to German taxation.
Client Alert 2017-116
