GER: No Income Tax Liability on Loan Cancellations

Apr 5, 2024 Benn-Ibler Rechtsanwälte

According to the German Federal Finance Court (Bundesfinanzhof, hereinafter BFH), receiving compensation for a consumer loan agreement after its cancellation does not trigger income tax.

The couple in the case at hand had taken out a loan in 2008 to help finance their residential property. The bank disbursed the loan, and the spouses paid the interest and the principal on a monthly basis. Citing incorrect cancellation instructions, they cancelled the loan agreement in 2016. The bank paid the couple EUR 14,500 in compensation for interest and repayments up to the date of cancellation, following a civil court settlement.

The tax office defined the compensation for use as income from capital assets. The lower court agreed with the tax office.

The BFH took a different view.

Income from capital within the meaning of Section 20(1)(7) of the German Income Tax Act (Einkommensteuergesetz, hereinafter EStG) is earned by anyone who transfers capital assets for use in return for payment. Income from capital can also include a forced, involuntary transfer of capital. In principle, capital gains can also include using capital to settle legal claims.

As a rule, gainful activity is required for the realisation of income from capital assets.

In the opinion of the BFH, compensation for use does not constitute taxable capital income under Section 20 (1)(7) of the EstG, since the repayment of a loan terminated by the borrower takes place outside the taxable sphere of acquisition.

For income tax purposes, restitution from a debt relationship must be treated as a unit. Individual claims arising from this relationship cannot, therefore, be regarded as gainful employment as such.

In the context of the reversal of the original exchange of services, the payment of compensation is only a partial necessary act.

BFH VIII R 7/21 (7 November 2023)