Equity and debt capital are treated completely differently for tax purposes; in particular, interest on operating debt capital is tax-deductible, while dividends from equity investors must be paid from taxed profits. On the investor side, debt capital remuneration is regularly fully taxable, while dividends may be tax-privileged.
In practice, financial instruments are often used that cannot be clearly categorised as equity or debt. Equity instruments under debt law such as profit-participating loans, profit participation rights, silent partnerships, convertible loans, etc. can be very similar to equity in economic terms due to subordination rules, profit and loss participation, participation in hidden reserves or goodwill, information and control rights, conversion rights, etc. These instruments are located between debt and equity. These instruments, which are located between debt and equity, are also referred to as mezzanine capital or hybrid financing (cf. Elser/Jetter, Tax-efficient structuring of mezzanine capital, in: Finanz-Betrieb 2005, p. 625).
From a tax perspective, a decision must be made on a case-by-case basis as to which features of the overall structure make a financial instrument tax equity or tax debt. The corresponding categorisation of financial instruments is often the subject of discussions with the tax auditor. Ideally, legal certainty should be ensured in advance by obtaining binding information from the relevant tax office.
BMF provides new orientation
Fortunately, the Federal Ministry of Finance (BMF) by letter dated 11. In a new letter issued on 1 April 2023, the German tax authorities took a position on the income tax treatment of profit participation capital. The main points can be summarised as follows:
- Profit participation rights are to be distinguished from silent participations (here: A distinction must be made between profit participation rights and silent partnerships (here: existence of a common purpose, right of co-determination as a member) and profit-participating loans (here: interest in the form of a profit share, no loss participation).
- Profit participation capital, which is linked to a repayment obligation (temporary transfer of capital), must generally be treated as debt capital for tax accounting purposes. This also applies if equity is to be assumed for commercial accounting purposes (see IDW/HFA 1/94). Conversion and option rights, the existence of a subordination agreement or loss participations do not change this.
- Only if the profit participation right liability only has to be met from future income or profits is it not recognised as a liability for tax purposes (Section 5 (2a) EStG). The paid-in profit participation capital must then be recognised as income.
- A distinction must be made between a Profit participation right similar to an equity interest (also equity profit participation right) with a share in the profit and of the liquidation proceeds (cf. section 8 (3) sentence 2 KStG; section 20 (1) sentence 1 EStG) from a similar to a profit participation right (also FK profit participation right) without participation in profits and liquidation proceeds.
- Payments on FK profit participation rights are tax-deductible operating expenses, while payments on EK profit participation rights do not reduce the income of the profit participation right holder.
- The feature "Participation in profit" is to be interpreted broadly, i.e. any participation in the economic success (e.g. also in EBIT, EBITDA or profit distributions) is sufficient. However, there is no participation in profits if the remuneration is dependent on the results of a specific business segment (so-called "tracking stocks") or on individual assets. Loss sharing, on the other hand, is not required.
- One "Participation in liquidation proceeds" exists if the holder of profit participation rights has a right to at least partial participation in the hidden reserves upon liquidation of the company.
- Debt mezzanine swapIf, for example, a loan receivable is converted into a profit participation right as part of a reorganisation measure and this qualifies as debt capital, a liability swap takes place with no effect on income. If, on the other hand, the corporation is not economically burdened by the (converted) capital transfer or if it can be assumed that equity has been granted due to the lack of a repayment obligation, the cancellation of the loan liability leads to income for tax purposes. In many cases, a tax burden triggered by this cannot be avoided by existing loss carryforwards (e.g. due to the so-called minimum taxation pursuant to Section 10d (2) EStG or due to the cancellation of loss carryforwards pursuant to Section 8c KStG).
Yours TAXGATE Team will be happy to assist you with the structural organisation of hybrid financing or the implementation of tax-efficient capital measures.
