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As reported in article no. 80, the tax laws have been changed effective for fiscal years ending from 1997 onwards to preclude the establishment of accruals with respect to obligations out of contracts in the course of performance (schwebende Vertraege = executory or ongoing contracts - new sec. 5 (4a) EStG). Accruals already in place for prior years must be reversed over a six year period (minimum of 25 % in 1997 and 15 % each in the succeeding five fiscal years).
Because of this change in the law, the impact of a significant recent ruling by an en banc panel (Grosser Senat) of judges on Germany's highest tax court will be limited to tax years through 1996.
In this ruling (BFH GrS DStR 1997, 1442 - 23 June 1997), the court held that losses anticipated with respect to a contract for the performance of a continuing or recurring obligation (Dauerschuldverhaeltnis, a special instance of executory contracts) cannot be considered in isolation from an anticipated countervailing benefit from the contractual relationship. Rather, the benefit must be netted against anticipated losses even if it does not constitute a distinct asset capable of independent capitalisation.
The case involved the owner of a pharmacy who had rented a suite of rooms located just across the street from his pharmacy. Instead of using the rental premises himself, the pharmacist sublet them to a doctor who used them partly for his medical practice and partly as his private residence. The rent which the pharmacist charged to the doctor was only half of that which the pharmacist himself had to pay under the primary lease. The pharmacist was an accrual basis taxpayer and therefore set up an accrual on his tax return for the amount of the shortfall of rent received over rent paid over the term of the two leases (roughly 20 years). The tax authorities refused to accept the accrual for tax purposes on the grounds that the sublease ensured the presence of a medical practice in the immediate vicinity of the pharmacy and therefore generated a benefit for the pharmacist's business which counterbalanced the loss from subletting. There was dispute as to whether the terms of the sublease required the doctor to operate his practice from the subleased premises.
The chamber of the Federal Tax Court which had referred the case to the en banc panel argued that the accrual was justified because the benefit deriving from the proximity of the doctor's practice did not constitute a distinct asset and should therefore not be netted against the loss on subletting the premises. Furthermore, the referring chamber pointed out that the subletting loss was definite and quantifiable while the advantages of the arrangement were uncertain and non-quantifiable.
The en banc panel declined to follow this reasoning and instead held that all economic advantages, whether contractually stipulated or merely contemplated by the parties to an agreement, must be considered in determining whether the agreement involves an excess of obligations over rights (Verpflichtungsueberschuss) for one of the parties. Such (positive) economic advantages need not constitute distinct capitalisable assets in order for them to be netted against the (negative) obligations flowing from a contractual arrangement. The advantages for the pharmacy from having a doctor's practice in the immediate vicinity were therefore to be netted against the loss on the sublease. Since these advantages were not quantifiable, the general presumption of equality between rights and obligations under executory contracts applied. While this presumption is rebuttable, no facts justifying rebuttal were presented by the case at hand. In particular there was no showing that the arrangement with the doctor was a bad business decision (Fehlmassnahme) on the part of the pharmacist.
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