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This article was written by
Certified Tax Advisor, Lawyer, Director, National Office Tax & Legal
Consultant, National Office Tax & Legal
Start-ups are often provided with seed funding through shareholder loans. If, due to a crisis or the borrower’s insolvency, such a loan is expected to suffer a permanent impairment, it must be written down to the lower fair value for commercial accounting purposes, whilst for tax accounting purposes it may be written down to the lower net realisable value. In the case of a lending corporation, a general prohibition on deduction applies to the reduction in profits associated with the investment if it holds a direct or indirect stake of more than one quarter in the share capital or equity capital of the borrowing corporation (Section 8b (3) sentences 3 and 4 of the German Corporate Tax Act (KStG)). As an exception, the prohibition on deduction does not apply if the taxpayer successfully demonstrates that an unrelated third party would have granted the loan or not demanded repayment under otherwise identical circumstances (Section 8b (3) sentence 7 KStG, ‘escape’ via arm’s length comparison). The Münster Tax Court ruled on this regulatory mechanism in its decision of February 17, 2026 (case no. 13 K 905/24 K) in the case of an unsecured shareholder convertible loan to a start-up – that is, a form of financing with the option to convert the loan into profit shares at a later date.
A shareholder holding a 46.8 % stake in a start-up limited liability company (GmbH) granted the company an unsecured convertible loan in 2019 bearing interest at 5 % per annum. The contract stipulated that early termination was permitted only for good cause and included a subordination clause. Shortly afterwards, the start-up GmbH received further convertible loans on the same terms but at a lower interest rate from unrelated third parties. In the 2021 corporate tax return, the shareholder claimed a partial write-down on the impaired loan receivable for tax purposes as a result of the economic crisis and subsequent insolvency of the start-up GmbH, as she considered that the loan had been granted on an arm’s length basis within the meaning of section 8b (3) sentence 7 KStG. The Tax Court rejected the off-balance-sheet addition made by the tax office in the context of the 2021 assessment.
The prohibition on deduction under section 8b (3) sentence 4 KStG does not apply in the present case. Whilst write-downs on shareholder loans must, in principle, be added to the balance sheet off-balance-sheet, the Tax Court considers that the loan granted by the shareholder was structured in accordance with arm’s length principles and that the conditions for the ‘escape clause’ are met. This is supported in particular by the fact that, following the granting of the loan by the shareholder to the start-up GmbH, two third parties not related to either party granted the start-up GmbH convertible loans at even lower interest rates, which were otherwise comparable. In the case of such comparable transactions actually concluded with unrelated third parties, any lack of security and other criteria relating to arm’s length terms take a back seat.
Nor are the strict illustrative examples given in the explanatory memorandum to Section 8b (3) sentence 6 KStG previous version (now: sentence 7) are decisive; these exclude arm’s-length terms, in particular in the case of interest-free loans, as well as interest-bearing but unsecured loans, or where a loan is allowed to stand during a crisis (BT-Drs. 16/6290, p. 74). The legislature did not include this in the wording of Section 8b (3) sentence 7 KStG; the Tax Court rejects such a narrow interpretation of the rule that the arm’s length principle automatically ceases to apply in the absence of security or where a loan is allowed to stand in the event of a crisis.
In specific individual cases, it may also be in line with arm’s length terms or practices to waive the right to grant immediate termination options for the repayment of a loan or not to exercise such options. In exceptional cases of a particular nature, it is even possible to grant a loan without collateral. Particularly in the venture capital market, i.e. in the field of start-up financing, a lack of collateral is regularly offset by increased potential returns – such as through conversion options.
The application of the ‘escape’ clause via the arm’s length principle also applies to reductions in profits arising from convertible loans. Whilst such loans are designed to grant the lender the option of acquiring (or increasing) an equity stake in the borrower; until this option is exercised, the legal relationship retains its debt-financing character in this respect, and a detrimental effect under company law does not arise solely from the conversion option. Rather, the decisive factor is the existence of actually comparable third-party financing in the relevant timeframe and the fact that these loans were maintained during the crisis phase.
Notices:
The Tax Court’s decision sends a positive signal for intra-group loan financing. This is because the principles established by the decision are unlikely to be limited to the granting of shareholder loans to start-ups, but are likely to be applicable to cases involving shareholder loans to portfolio companies with liquidity requirements.
An appeal against the decision is pending before the German Federal Fiscal Court (BFH, case no. I R 4/26). It therefore remains to be seen whether the BFH will uphold the Tax court’s legal opinion.