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Supreme Tax Court Cases Tax & Legal News October 13, 2011 4 tender takes precedence over the tax exemption for exports or intra-community supplies to other businesses. Thus, recording the transaction as a sale does not open the way to an input tax deduction. Full rate VAT on ensemble fees charged to theatres Entrance tickets to theatres, concerts and similar performances are subject to reduced rate VAT. However, this does not apply to charges to theatres and other organisers by visiting ensembles for performances under their own direction. Rather, these charges are a standard rate service. A finance ministry decree has emphasised this position, whilst allowing visiting companies to continue to charge reduced rate VAT for performances up to December 31, 2011. Foreign limited partnership does not shield non-trading income from German taxation The taxpayer held most of the capital in a Hungarian limited partnership (Bt. equivalent to a German KG) as a limited partner. The only general partner had its own limited liability as a Kft., the equivalent of a German GmbH. Had the partnership been registered in Germany, if would thus have been a GmbH & Co. KG and its entire income would automatically have been recast as trading income, as though it had been earned through a corporation. In Hungary, all partnerships are taxed as corporations, with partners’ drawings against profits being treated as dividends. The partnership’s sole business activity lay in letting a fully equipped factory to a related party. The taxpayer maintained that the net profits of the partnership should be exempt in Germany as the trading income from a foreign permanent establishment. He based this claim on the alternative contentions that (a) the partnership was taxed as a corporation and therefore as a trading entity in Hungary, or (b) the partnership’s income was trading income by German legal definition. The Supreme Tax Court has now rejected both contentions. The court took the view that the Hungarian taxation of the Hungarian entity was a matter for Hungarian law. The Hungarian tax status of an entity was not decisive for the German taxation of its partners. This depended on the nature of their income as defined by the double tax treaty. That income was taxable, or exempt, in Germany following the provisions of the treaty. Similarly, the court refrained from applying the German domestic rule redefining partnership income as trading income if earned through a partnership with no ultimate unlimited liability, where this was in conflict with the treaty allocation of taxing rights. The ultimate conclusion was thus to split the income into its component parts. That earned from letting the Hungarian property was taxable in Hungary and exempt in Germany under the treaty. That earned from the hire of plant and equipment (from moveable assets) was taxable in Germany in the hands of a German resident partner. Supreme Tax Court judgment I R 95/10 of May 25, 2011 published on August 10 No write-down of fixed-interest securities below nominal value A bank held a significant portfolio of debentures and other fixed-interest securities as current assets. It took them up initially at cost but wrote them down in its annual accounts to the lower stock market value on balance sheet date. This treatment was correct under the accounting provisions of the Commercial Code, but the tax office refused to accept it to the extent that the write-down took the net book value below the nominal amount. It argued that the valuation provisions of the Income Tax Act only allowed a write-down as necessary to reflect a “foreseeably lasting” loss in value. Fixedinterest securities were generally redeemable at the end of a fixed term and at their nominal value. Thus any current loss below this level could not be “lasting”. The Supreme Tax Court has now held with the tax office and for the same reason. The bank argued that securities held as current asset were for trading and there was no reason to suppose that they would be held until redemption. The court, though, pointed out that there was also no reason to suppose that they would be sold before redemption. This unknown destiny meant that the loss in market value at balance sheet date might, or might not, be “lasting”, but its ultimate incidence was certainly not “foreseeable”. This departure of tax law from the Commercial Code was emphasised with the recent ”BilMoG” accounting reform, which required marketable securities to be carried at
Tax & Legal News October 13, 2011 5 market value on balance sheet date, abolished the strict conformity of the taxable income and accounting profit, but which did not change the tax valuations rules in a here relevant respect. Clearly, a divergence in treatment was intentional. This remark suggests that this case is still relevant after BilMoG. Equally significantly, the court made the comment that doubts as to the ultimate redemption of a fixed-interest security could justify a write-down below the redemption value. Thus the bottom limit of the nominal value can be overstepped, if it appears likely that the ultimate sale or redemption proceeds will, in fact, be less. Supreme Tax Court judgment IR 98/10 of June 8, 2011 published on August 17 Handling fee on subsidised loan immediate expense if not refundable on early repayment A factory took out loans from banks with interest subsidies from public funds. In some cases the bank charged a handling fee payable when the loan was granted. The taxpayer saw this fee as a single charge for the grant and thus as immediate expense. The tax office saw it as a charge for the finance over the agreed term to be treated as prepaid interest. The Supreme Tax Court has now held the treatment to be dependent on the reason for charging the fee. If it was intended as part of the overall cost of providing finance over a set period, it should be spread over that period. If it was intended as a one-time only charge in recognition of a specific service, it should be taken to expense immediately. The court saw the distinction as a question of fact, turning on the agreed provisions for early loan repayment. If the handling fee was partially refundable on early repayment, it was part of the charge for the provision of finance for a given period. The same applied where the borrower had no early repayment option; that is, the contract was only cancellable for good cause (such as the insolvency of the other party) and there was no reason at the time of contract signature to suppose such cancelation for good cause to be anything more than a purely theoretical possibility. If, on the other hand, the customer had an early repayment option without a claim to partial refund of the fee, the charge was an immediate expense. The court also called for accounting consistency between bank and customer, but did not go into the steps needed to ensure this. Supreme Tax Court judgment I R 7/10 of June 6, 2011 published on September 7 Foreign tax credit on hedged loan interest takes hedge costs into account A bank bought two short-term Brazilian notes in cruzeiros with a cruzeiro loan from a US bank. It hedged this liability with a forward exchange contract with the same bank and with the same maturity. Its net result from the transaction was thus the difference between the interest income and the loss on the hedge. The Supreme Tax Court has now held that where the two transactions are mutually intermingled to the extent that the one is preconditioned by the other, they must be seen as two parts of a single whole. This meant that the Brazilian withholding tax at 20% (including a "tax sparing" notional uplift on the actual deduction of 15%) on the gross interest could only be credited against the corporation tax due on the net income recorded in Germany. This was the corporation tax at the then rate of 50% on the margin between the gross interest received and the hedge loss. The fact that the withholding tax had been levied on the gross interest was irrelevant, as was the fact that the hedge loss did not arise in Brazil, but rather in Germany on a transaction with a US bank. The excess of credit for the Brazilian withholding tax (20% of the gross interest) over the German corporation tax of 50% on the net margin (interest less hedging costs) was irrecoverable. In the meantime, the case has gained in importance as a guide to the foreign tax credit calculation with the fall in the German corporation tax rate to 15%. On the other hand, it lost in relevance to Brazil, when the double tax treaty with that country expired in 2006 (withholding taxes) and 2007 (year of assessment). Supreme Tax Court judgment I R 103/10 of June 22, 2011 published on August 31 No trade tax double dip within Organschaft An Organschaft subsidiary held and managed business property let to other members of the Organschaft. Companies in property management generally qualify for trade tax exemption if they do not have other sources of income. The subsidiary claimed this exemption – granted in the form of a full deduction of the net rental income from trading income, i.e. from the trade tax base – and thus reported trading income of nil to be added to the trading income of the parent. The tax office contested this position, as it would
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Tax & Legal News October 13, <strong>2011</strong> 5<br />
market value on balance sheet date, abolished the strict conformity of the taxable income<br />
and accounting profit, but which did not change the tax valuations rules in a here relevant<br />
respect. Clearly, a divergence in treatment was intentional.<br />
This remark suggests that this case is still relevant after BilMoG. Equally significantly, the<br />
court made the comment that doubts as to the ultimate redemption of a fixed-interest<br />
security could justify a write-down below the redemption value. Thus the bottom limit of<br />
the nominal value can be overstepped, if it appears likely that the ultimate sale or<br />
redemption proceeds will, in fact, be less.<br />
Supreme Tax Court judgment IR 98/10 of June 8, <strong>2011</strong> published on August 17<br />
Handling fee on subsidised loan immediate expense if not refundable on<br />
early repayment<br />
A factory took out loans from banks with interest subsidies from public funds. In some<br />
cases the bank charged a handling fee payable when the loan was granted. The taxpayer<br />
saw this fee as a single charge for the grant and thus as immediate expense. The tax office<br />
saw it as a charge for the finance over the agreed term to be treated as prepaid interest.<br />
The Supreme Tax Court has now held the treatment to be dependent on the reason for<br />
charging the fee. If it was intended as part of the overall cost of providing finance over a<br />
set period, it should be spread over that period. If it was intended as a one-time only<br />
charge in recognition of a specific service, it should be taken to expense immediately. The<br />
court saw the distinction as a question of fact, turning on the agreed provisions for early<br />
loan repayment. If the handling fee was partially refundable on early repayment, it was<br />
part of the charge for the provision of finance for a given period. The same applied where<br />
the borrower had no early repayment option; that is, the contract was only cancellable for<br />
good cause (such as the insolvency of the other party) and there was no reason at the time<br />
of contract signature to suppose such cancelation for good cause to be anything more than<br />
a purely theoretical possibility. If, on the other hand, the customer had an early<br />
repayment option without a claim to partial refund of the fee, the charge was an<br />
immediate expense. The court also called for accounting consistency between bank and<br />
customer, but did not go into the steps needed to ensure this.<br />
Supreme Tax Court judgment I R 7/10 of June 6, <strong>2011</strong> published on September 7<br />
Foreign tax credit on hedged loan interest takes hedge costs into account<br />
A bank bought two short-term Brazilian notes in cruzeiros with a cruzeiro loan from a US<br />
bank. It hedged this liability with a forward exchange contract with the same bank and<br />
with the same maturity. Its net result from the transaction was thus the difference<br />
between the interest income and the loss on the hedge. The Supreme Tax Court has now<br />
held that where the two transactions are mutually intermingled to the extent that the one<br />
is preconditioned by the other, they must be seen as two parts of a single whole. This<br />
meant that the Brazilian withholding tax at 20% (including a "tax sparing" notional uplift<br />
on the actual deduction of 15%) on the gross interest could only be credited against the<br />
corporation tax due on the net income recorded in Germany. This was the corporation tax<br />
at the then rate of 50% on the margin between the gross interest received and the hedge<br />
loss. The fact that the withholding tax had been levied on the gross interest was irrelevant,<br />
as was the fact that the hedge loss did not arise in Brazil, but rather in Germany on a<br />
transaction with a US bank. The excess of credit for the Brazilian withholding tax (20% of<br />
the gross interest) over the German corporation tax of 50% on the net margin (interest<br />
less hedging costs) was irrecoverable.<br />
In the meantime, the case has gained in importance as a guide to the foreign tax credit<br />
calculation with the fall in the German corporation tax rate to 15%. On the other hand, it<br />
lost in relevance to Brazil, when the double tax treaty with that country expired in 2006<br />
(withholding taxes) and 2007 (year of assessment).<br />
Supreme Tax Court judgment I R 103/10 of June 22, <strong>2011</strong> published on August 31<br />
No trade tax double dip within Organschaft<br />
An Organschaft subsidiary held and managed business property let to other members of<br />
the Organschaft. Companies in property management generally qualify for trade tax<br />
exemption if they do not have other sources of income. The subsidiary claimed this<br />
exemption – granted in the form of a full deduction of the net rental income from trading<br />
income, i.e. from the trade tax base – and thus reported trading income of nil to be added<br />
to the trading income of the parent. The tax office contested this position, as it would
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