Unusual Financing Requires Proof of Intention of Acquiring Income

On May 10, 2007, the Federal Tax Court (re IX R 7/07) clarified the taxpayer’s duty that he needs to prove his intention to acquire profit when using unusual financing strategies.

The taxpayer is a real estate company which not only rents but also develops buildings. The company’s tax office asserted that it did not want to make a profit (“Einkünfteerzielungsabsicht”) when it rented a developed lot. Proving this point is vital if the company is to be allowed to deduct any expenses. The real estate company in question purchased a piece of land and fully financed the sales price and construction costs without written loan contracts. The account at the financing bank was held like a loan account with variable interest rates and special deletion stipulations. In the first year, the company suffered a loss of € 261,633. In the next year, the loss increased. In the year of dispute, the plaintiff achieved a turnover of € 4,019 EUR and had interest costs of € 29,555. While denying the deduction of the interest and lowering the company’s income to € 0, the Finanzamt determined that the taxpayer was not intending to make a profit, therefore such interest costs are not deductible.

During the court proceedings, the plaintiff submitted documents to show that the company’s debt had significantly declined in the interim by using income from life insurance plans. Furthermore, the plaintiff plans to retire soon and to use the income from maturing life insurance plans, valued at approximately € 400,000, and the sale of his business, to cover negative balances.

Following ruling case law, the court affirmed that the balance sheet of this company was typical of a company which qualifies for taxation. §21 I 1 no. 1 EStG demands among other requirements that the taxpayer intends to achieve income and long-term renting implicates this. However, here the plaintiff fails to prove the intention of acquiring profit. The non-existent financing concept leads to gross disproportion between income and interest expenditures. In addition, the allegation that the losses suffered at present will later be compensated does not sound promising. These incidents justify an exception from the principle that a long-term rental is illustrative of the intention to make a profit.

The plaintiff’s problem is not the uncommon manner of financing the real estate, but the gross disproportion between rental income and the interest accrued without showing that the losses will be compensated with profits according to a financial plan. This compensation should occur at the latest by the end of the deletion period. Furthermore, ruling case law demands that this plan predicts repaying the loan within 30 years. In this case, any such compensation was not planned. Therefore, deduction was rejected.

Summary:

Regarding income derived from “Renting and Leasing”, the intention to achieve income from a long term rental must only be proven when the tax payer finances the sales or production costs and the debt interest with loans, without a financing concept that will show from the beginning that the losses will eventually be covered by income.

 

Hint:

Draw up a financing plan with your tax-consulting attorney or tax consultant or the financing bank wherein you describe how an untypical financing will be returned upon maturity. It might cost when drafting the plan. Besides, the costs for such plan will be minuscule in comparison to the losses as shown in the above case.