Germany: 004. German Thin Capitalization Rules - New Directive Interpreting Statute

Last Updated: 14 February 1995
KPMG Germany Webpage
Click on the above link to visit the KPMG Germany webpage on the Mondaq website
1. Introductory

To prevent foreign shareholders from draining off the earnings of their German subsidiaries in the form of interest on loans (or other compensation paid for debt capital), an anti-earnings-stripping provision was recently added to the German tax code (new sec. 8a of the Corporation Tax Act). For a summary of basic provisions, see section 11 below.

The German tax authorities have now issued a directive addressing questions of interpretation and application of the new thin capitalization rules for corporations. These rules apply to loans to German corporations from foreign shareholders or related persons from 1994 on. Transition provisions exist only for profit-linked loans made before 9 December 1992.

Following enactment of the new law, practitioners quickly determined that it left many questions unanswered and was therefore not a sufficient basis on which to plan investment decisions. In response, the tax authorities first circulated the draft of a directive intended to provide guidance. After receiving comment from tax practitioners and industry, they have now issued the directive in final form. The directive binds tax enforcement officials in their application of the law until it is revised or withdrawn, but does not itself have the force of law and can be challenged by taxpayers in the courts.

The directive leaves some questions unanswered and resolves others in ways which lead to more extensive taxation. The following is a summary of positions taken on selected issues. It is intended to provide a general guide to the subject matter. Specialist advice should be sought with respect to specific questions.

2. Lenders covered by the law

The thin capitalization rules apply to loans made to German corporations by three categories of lenders. The first two categories are 25 % foreign shareholders and foreign persons related to 25 % shareholders, whether or not such shareholders are foreign persons. Attribution rules apply in determining whether a person is a 25 % shareholder, i.e. holds directly or indirectly more than a 25 % share of stated capital. The third lender category covers unrelated third parties if such parties have "recourse" against a foreign 25 % shareholder or a foreign related person (or against a domestic related person if the shareholder is a foreign person). Loans to which the law applies are hereinafter collectively referred to as "shareholder loans". It is primarily the third party loans which are controversial.

3. Meaning of "recourse"

The meaning of "recourse" is a matter of dispute. The tax authorities have decided on a broad interpretation covering all situations in which the lender will in fact be held harmless by the shareholder or some related person in the event of default on the loan, whether or not the lender has rights enforceable at law against such persons. The directive thus states that, in addition to guarantees and "hard" letters of comfort, a "soft" letter of comfort in favor of the lender will also suffice to constitute "recourse". Furthermore, the directive establishes a rebuttable presumption for corporate groups that the parent company will cure any default on a loan to its German subsidiary, hence that there is always recourse against the parent company. Back-to-back financing, in which the German subsidiary receives a loan from a bank and the bank receives a deposit from a shareholder or a related person, also constitutes "recourse" under the directive, whether or not the deposit is pledged to the bank.

4. Third party loans from German lenders

On the positive side, the directive establishes an important exemption from the workings of the thin-capitalization rules for loans received from German banks or the German branches of foreign banks. As long as the German debtor corporation can prove that the interest received on the loan by such lenders was subject to tax in Germany and was not in effect passed along to a foreign shareholder or related person through back-to-back financing, it does not matter whether the lender has "recourse" on the loan.

5. Debt/equity ratio for purposes of the safe haven

For purposes of the safe haven (3 to 1 for interest bearing loans, 1 to 2 for loans linked to profits or sales), equity is measured using the commercial balance sheet at the close of each fiscal year for the entire fiscal year to come. Debt, on the other hand, is monitored constantly as it fluctuates throughout the fiscal year. In effect, the current level of debt is always compared with equity at the outset of the fiscal year. For companies which began the year at the limit of the safe haven ratio, this means that new shareholder loans can only be added at the end of the year, because equity injections made during the year will not count until the following year for safe haven purposes.

6. Equity of newly formed corporations

For newly formed companies, the directive provides that the equity in the opening balance sheet determines the safe haven for the first fiscal year of existence. The opening balance sheet date is the signing of the articles of association, not the date of entry in the Commercial Register. The period between these two events is subject to the thin capitalization rules as long as entry in the Commercial Register later occurs. Consequently, full capitalization of new corporations must be guaranteed from their inception in order to use the safe haven in their first fiscal year.

7. Temporary reduction in equity

The law contains a provision providing that a "temporary reduction in equity" due to net loss for the year will not count for safe haven purposes provided equity is fully restored to its previous level within three years by any combination of contributions to capital and retained earnings. The directive speaks in this connection of "temporary losses".

The directive in its final form differs from the draft directive in two important respects.

The first aspect concerns restoration of equity using subsequent earnings. The directive makes clear that an increase in the balance sheet item "retained earnings" is not strictly necessary. Instead, it is sufficient if a net profit for the year is, by formal shareholder action, netted against a loss carried forward. The same applies to constructive contributions to the corporation, which are treated as revenue for commercial accounting purposes but not for tax purposes. The net profit for the year resulting from such constructive contributions must either be appropriated to retained earnings or formally netted against a loss carried forward.

The second aspect concerns restoration of equity using subsequent contributions. In the draft directive, the position was taken that subsequent contributions were inadequate to restore equity whenever subsequent profits did not by themselves restore equity within five years after the loss was suffered. The reasoning behind this was that losses not equalized by gains within five years were not "temporary losses" to begin with, and the provision in question only applied to "temporary losses". The relevant passages in the draft directive have been deleted from the final directive. The tax authorities appear to have completely abandoned their initial position, the statutory support for which was questionable.

8. Definition of debt

The directive provides that short-term credit extended within the context of a normal trading relationship will not count as debt for purposes of the thin capitalization rules. Whether trade credit is short-term or not will depend on what is customary in the particular trade, with a six-month limit applying as a rule. Current account credit of all sorts will, however, count as debt for thin capitalization purposes, whether or not the same debt is "long term" for trade tax purposes.

The directive further states that debt is not to be disregarded merely because no interest (or other remuneration) is owing or paid on a loan. Interest free loans are thus debt for thin capitalization purposes and reduce the safe haven.

9. Order in which loans made

The directive takes the position that the order in which loans are made determines which loans are within the safe haven. The consequences of this are best illustrated by an example.

Let us assume that the X-GmbH begins the fiscal year with equity of DM 1,000 for purposes of the thin capitalization rules and then receives two shareholder loans at one month intervals, each in an amount of DM 3,000, but the first at 7 % p.a. and the second at 10% p.a.. Let us further assume that both interest rates are arm's length rates, i.e. that the jump in interest rate is justifiable because of changed economic conditions. In the view of the German tax authorities, the interest on the first loan will be deductible in full, while that on the second loan will be non-deductible in full. They reject a pro rata approach to determining how much interest is deductible. Under such an approach, one month's interest on the first loan would be deductible, and thereafter half of the total interest would be deductible (average rate 8.5 %).

If one varies the example to assume that the first loan was interest free, then (according to the new directive) no interest would be deductible, because the interest free loan would have used up the entire safe haven.

10. Holding companies

The statute establishes a basic debt/equity ratio of 9 to 1 for (domestic) corporate holding companies (for interest bearing debt) and also provides that no safe haven at all exists for loans made by other persons to the direct or indirect subsidiaries of such holding companies. This means that all shareholder loans to such subsidiaries must be channeled through the holding unless it can be shown that the subsidiary could have had the same loan on the same terms from an unrelated third party.

The directive states that a holding company must have direct participations in at least two other corporations, including foreign corporations. Shares in corporations without business function do not count. "Participation" is a term of art defined in the German Commercial Code, generally requiring a 20+ % share of stated capital (sec. 271 HGB).

To qualify as a holding company, one of two tests must be met: either a corporation's principal activity must consist in holding and financing participations in other corporations (1st alternative), or participations in other corporations must make up more than 75% of its balance sheet total (2nd alternative - 75 % asset test). The directive states that, in applying the 75 % asset test, debt claims against direct or indirect subsidiaries will not be counted as assets. This reversal of the position taken in the draft directive results from objections that otherwise this test could scarcely ever be met. As for the first alternative, the directive provides that the principal activity of a corporation generally consists in holding and financing participations in other corporations if 75% of the average gross earnings for the three preceding years is derived from the corporations in which it holds participations, either in the form of dividends or loan remuneration.

It remains unclear under the directive whether a corporation with significant interests in both corporate and partnership entities can qualify as a holding company. Such a company might well fail both the statutory 75 % asset test and the 75 % earnings test established by the directive.

11. General structure of thin capitalization rules

The new rules establish safe havens in differing amounts depending on whether the compensation paid for the use of the debt capital is measured in terms of the loan principal (i.e. interest, either fixed or variable), or in terms of some other factor (e.g. profit or gross sales). To the extent shareholder loans exceed the safe haven, deductibility is denied for corporation tax purposes for the interest (or other compensation) paid or accrued on the excessive part of the debt capital. Furthermore, when such non-deductible interest (or other compensation) is paid, this constitutes a constructive dividend and leads to dividend withholding tax at the applicable rate (statutory rate 25 %, current rate inside the European Union for qualified shareholders 5 %, tax treaty rates varying generally from 5 % to 15 %).

For fixed or variable interest bearing loans, the interest paid is non-deductible to the extent the loan amount exceeds three times the pro rata capital of the 25 % shareholder (safe haven ratio of 3 to 1). As an alternative to qualifying under this safe haven, the taxpayer may make a showing that he could have obtained the loan on the same terms from an unrelated party. If this burden of proof can be carried, interest bearing loans will escape the new rules even if the debt-equity ratio permitted under the safe haven is exceeded.

Banks are exempted from the 3 : 1 limit with respect to interest bearing loans taken out to finance their own standard banking transactions.

For loan compensation linked to profits or sales, the applicable debt-equity ratio is 1 to 2 instead of the more generous 3 to 1. Furthermore, there is no opportunity to show that an unrelated third party would have made the same loan and no exemption for banks.

For German holding companies, a higher 9 to 1 ratio applies to interest bearing debt, but this must suffice to finance all of the subsidiaries under the holding as there is no safe haven for shareholder loans made directly to them. If an interest bearing loan is made to such a subsidiary, the possibility remains to demonstrate that an unrelated third party would have made the same loan.

Since the applicable debt-equity ratio for purposes of the safe haven is determined at the outset of each fiscal year, considerable planning may be necessary to ensure that adequate equity is injected in time. While equity added during the fiscal year will not count for safe-haven purposes until the start of the following year, any increase in debt during the year can lead to a loss of safe-haven status. There are special provisions regarding declines in equity due to operating losses.

The new rules do not apply for purposes of the trade tax on earnings, where, it will be recalled, half of all long term interest is non-deductible in any event irrespective of whether it is paid to a shareholder. The new rules also do not apply to partnerships, even to partnerships with a corporation as sole general partner.

Disclaimer and Copyright

This article treats the subjects covered in condensed form. It is intended to provide a general guide to the subject matter and should not be relied on as a basis for business decisions. Specialist advice must be sought with respect to your individual circumstances. We in particular insist that the tax law and other sources on which the article is based be consulted in the original, whether or not such sources are named in the article. Please note as well that later versions of this article or other articles on related topics may have since appeared on this database or elsewhere and should also be searched for and consulted. While our articles are carefully reviewed, we can accept no responsibility in the event of any inaccuracy or omission. Please note the date of each article and that subsequent related developments are not necessarily reported on in later articles. Any claims nevertheless raised on the basis of this article are subject to German substantive law and, to the extent permissible thereunder, to the exclusive jurisdiction of the courts in Frankfurt am Main, Germany. This article is the intellectual property of KPMG Deutsche Treuhand-Gesellschaft AG (KPMG Germany). Distribution to third persons is prohibited without our express written consent in advance.

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”

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
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). 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 & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd 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 or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.

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