Germany: Shareholder Debt: Draft Finance Ministry Decree on Thin Capitalisation

Last Updated: 12 May 2004

Article by Hans Martin Eckstein

The finance ministry has drafted a new decree to resolve some of the doubts on the application of the thin capital rules following a change in the law for 2004.

The revised statute significantly extending the coverage of the German thin capitalization rules contains many unclear provisions. In a noteworthy effort to provide timely guidance, the Federal Ministry of Finance has drafted a decree dealing with some of the more urgent issues in interpreting the new rules. The new decree is intended to be read in concert with its predecessor of December 15, 1994 which continues to apply to the extent that it does not conflict with the new provisions. Changes to the draft have been requested by the provincial ministries of finance and there are comments on the draft to be expected from the various trade associations before the text can be finalised. However, we would like to take this opportunity to summarise the position the federal ministry of finance would like to take.

Issue not covered

  • The draft decree does not deal with the anti-debt-pushdown rules (Sec 8a (6) Corporation Tax Act). These will be the subject of another decree, to be issued later this year.

General consequences of the thin capitalization rules

  • Interest disallowed under the thin capitalization rules will be requalified to "hidden distributions" or "constructive dividends". The tax authorities are seeking to apply this to the shareholder and to all other related parties within the group. Thus, they do not accept the argument of some authors that only the corporation paying the interest should bear any consequences of a breach of the thin capitalization rules.
  • · Where the group financing is provided from a level in the group structure higher than the immediate shareholder the hidden distribution flows through the whole chain of companies. If the financing is provided from a fellow subsidiary, the hidden distribution flows up to the first common parent. Its balancing item is a series of "hidden capital contributions" down to the entity making the loan. Each German company receiving a hidden distribution will have to charge 5% of it to tax. Apart from this "leakage", the effect within a group is to reallocate the interest income from the lender to the borrower. If a German resident individual is the common parent, half of the hidden distribution will be subject to income tax. A hidden capital contribution increases the (tax) book value of the investment.
  • The authorities confirm the view that the hidden distribution is subject to dividend withholding tax when the interest is paid. This withholding tax is creditable against the tax liability of the resident entity or person receiving the hidden distribution.

Upstream loans

  • The draft decree would also apply the shareholder debt rules to so-called upstream loans. This presupposes, though, that the parent company taking out the loan from its subsidiary has at least one shareholder owning more than 25% of its nominal share capital. On the other hand, the prevailing opinion in the professional press is that upstream financing is not a case of shareholder financing and does not fall subject to the thin capitalization rules. Unfortunately, the tax authorities seem unwilling to accept this argument.

Third party financing with recourse

  • According to the wording of the statute a loan from a third party is treated as group financing if the third party has recourse to the shareholder or a related party. In their draft decree, the tax authorities propose to apply these rules only in cases of true back-to-back financing, i.e. in cases where the shareholder or a related party makes a deposit with the third party lending the funds. The German corporation claiming the interest deduction has to provide proof that there is no back-to-back arrangement in place. The authorities suggest that the confirmation of the lender can be seen as proof if the letter details the security for the loan. If this interpretation survives the discussion of the draft decree, shareholder guarantees of third party debt would therefore not force it into the scope of the thin capitalization rules. The third party debt secured by recourse to a member of the group reduces, however, the available safe haven.

Outbound financing

  • In cases of outbound financing, i.e. where the German parent company lends to a foreign subsidiary, the German tax authorities are willing to follow the application of the thin capitalization rules in the country of the subsidiary. Thus, the interest income of the parent would be requalified to a (tax-free) dividend to the extent the foreign state disallows it as an expense.
  • The tax authorities do not comment on the determination of the safe haven of the foreign subsidiary in the outbound financing situation. It is debatable whether the foreign subsidiary has a safe haven at all (most commentators conclude this not to be the case) and if so, what the basis of its calculation might be (fictitious tax book values versus statutory book values).


  • The thin capitalization rules only apply if the total related-party interest for the year exceeds € 250,000. However, if they apply at all, they apply to the entire amount. The threshold is for the company and not for each shareholder. The draft decree states that all third party debt with recourse to a shareholder shall be taken into account in applying the threshold, even if the company is able to disprove the back-to-back presumption and so avoid the other "hidden distribution" consequences.

Safe haven equity

  • The safe haven equity is to be determined from the statutory German financial statements at the end of the previous business year of the company. If the company is a member of a partnership, the book value of the partnership share is to be substituted by the proportionate net assets of the partnership with a corresponding adjustment to the equity base. The tax authorities state that the net assets of the partnership are to be determined from its statutory German GAAP financial statements. There is controversy over this in the professional press, not least because it can lead to a significant understatement of the net assets of recently acquired partnership shares if the price paid exceeded book value.
  • The book value of investments in other companies is to be deducted from the equity as shown in the statutory accounts, unless the company qualifies as a holding company (see below). Up to now, the earlier, 1994 decree only required this deduction for domestic investments. The present draft extends this deduction to all investments, including those abroad. This also applies to investments held through a partnership, although only to the extent the book value is included in the net assets of the partnership.


  • All but short-term debt falls under the thin capitalization rules. The precise definition of short-term has long been a subject of controversy.
  • Under the old rules, debt from trading activities was considered short-term debt as long as it was kept within usual payment terms. Any other debt outstanding for not more than six months was also considered to be short-term.
  • The tax authorities have now dropped the reference to trade debt from the definition of short-term debt. Thus any debt outstanding for more than six months is now debt within the scope of the thin capitalization rules.
  • Furthermore, debt outstanding for less than six months but subject to a standing credit arrangement with a contractual term of more than six months (e.g. an overdraft facility) also constitutes debt subject to the thin capitalization rules. Revolving facilities will also be treated as debt within the scope of these rules, even if there is no umbrella agreement and the individual debt is outstanding for less than six months. Thus cash pool arrangements are certainly within the scope of the thin capitalization rules.

Holding companies

  • A holding company within the meaning of the thin capitalization rules has to hold investments in at least two subsidiaries. Either those investments represent more than 75% of all assets of the holding company (balance sheet test), or at least 75% of the gross income of the corporation comes from the subsidiaries (activity test). Investments in held through partnerships also count as qualifying investments in subsidiaries.
  • A corporation without its own single shareholder of more than 25% cannot qualify as a holding company under these rules.
  • Based on this draft decree, any corporation in a group of companies that fulfills the criteria for a holding company would qualify as such, irrespective whether the entity is a German taxpayer. This issue is also hotly disputed amongst German tax professionals.
  • A direct subsidiary of a holding company within the meaning of the thin capitalization rules does not have a safe have under the clear wording of the statute. The tax authorities nevertheless are willing to allow shareholder financing of the subsidiary of a holding company within the relevant safe haven if the finance comes from the immediate shareholder. In consequence, the group financing has to follow the shareholding chain if there is a qualifying holding company at any level.

Shareholder financing of partnerships

  • The thin capitalization rules also apply to a partnership taking out shareholder or related party loans if a corporate partner, alone or together with related parties, owns an interest of more than 25% in the partnership. In this case, the financing is deemed to have been taken out by the corporate partner.
  • The tax authorities make it clear that the thin capitalization rules only apply on the share of the corporate partner in the interest payments. The determination whether the safe haven is exceeded is to be made for the corporate partner, although any resulting disallowance of interest expense will fall on the partnership. This ensures that the trade tax consequence is borne by the partnership.
  • If the provider of the loan is not only a related party to the corporate partner but also himself a partner in the partnership, the interest is not deductible under the normal partnership income determination rules – it is deemed to be a profit share allocated to the financing partner. Although the remuneration on this debt has therefore not reduced the taxable income of the partnership the tax authorities want to apply the thin capitalization rules to the corporate partner's share in the interest, thus requalifying the interest to a hidden distribution.
  • If remuneration on shareholder or related party financing of a partnership is to be requalified to a hidden distribution under these rules, the tax authorities expect the partnership to assume liability for the withholding tax. This statement is astonishing, given that a dividend withholding tax can only be due from an entity able to pay a dividend – i.e. only from a corporation.

It is very positive that the tax authorities are making every effort to provide the guidance to the taxpayers on a timely basis. Some of the statements are welcome relaxations of, perhaps, an overly harsh statute, such as that on third party financing with related party guarantees. Unfortunately, a number of questions still remain unanswered, and the hope is that the discussion of the draft will help to clear some of the open issues as well as making some of the answers already given somewhat more practicable. We will take an active part in these discussions and keep you posted on the outcome.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
Related Articles
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions