Doubts About the Constitutionality of Loss Offset Limitation
The Federal Fiscal Court (BFH) has expressed concerns that the restrictions on loss offsetting in derivative transactions under § 20 (6) sentence 5, as amended by the Annual Tax Act 2020, may be unconstitutional. This was made clear by the BFH in its decision of June 7, 2024, Ref.: VIII B 113/23 (AdV).
According to the loss offset limitation for derivative transactions under § 20 (6) sentence 5 of the Income Tax Act (EStG), losses from derivative transactions can only be offset in a very limited way. Offsetting is only possible up to an amount of EUR 20,000 per year and only with gains from comparable transactions, according to the law firm MTR Legal Rechtsanwälte, which also advises on tax law.
Principle of Equal Treatment
The regulation is, however, under discussion as it may violate the principle of equal treatment enshrined in the German Constitution (Grundgesetz). The Federal Fiscal Court also expressed its doubts regarding the constitutionality of this regulation with its decision of June 7, 2024.
In the underlying case, the plaintiff traded Contracts for Difference (CFDs) through a broker during the disputed year. Additionally, he earned not only income from capital assets but also tax-exempt income subject to the progression clause from dependent employment in Luxembourg. In his tax return for the disputed year, he reported foreign investment income from derivative transactions amounting to approximately EUR 250,000 and losses from derivative transactions amounting to about EUR 227,000.
The tax office stated that it had offset the losses from derivative transactions up to the statutory maximum amount of EUR 20,000 against the gains. The remaining losses of approximately EUR 207,000 were accounted for in the loss determination. The plaintiff challenged the tax assessment and raised constitutional concerns against the restriction on the offsetting of gains and losses from derivative transactions for the disputed year. He argued that only the profit after deducting the losses from the derivative transactions, amounting to approximately EUR 23,000, should be considered for tax purposes.
Suspension of Execution
The competent tax court granted the plaintiff’s application for suspension of execution (AdV). It justified this with significant constitutional concerns regarding the compatibility of the loss offset limitation for derivative transactions with Article 3 (1) of the Basic Law (GG). Thus, the legality of the issued income tax assessment was also doubtful.
The BFH confirmed the decision of the tax court on appeal. It had rightly suspended the contested tax assessment from execution. The BFH shares the doubts about the compatibility of the loss offset limitation for derivative transactions with the Basic Law.
The judges emphasized that, according to the principle of equality from the Basic Law, essentially equal situations must be treated equally, and essentially unequal situations must be treated unequally. This principle is violated if there is no reasonable or apparent reason for differentiation. Section 20 (6) sentence 5 of the Income Tax Act results in a double unequal treatment of taxpayers, depending on whether they incur losses from derivative transactions or other capital investments, as losses from derivative transactions can only be offset against gains from derivative transactions.
BFH Criticizes Unequal Treatment
This unequal treatment is further exacerbated by the asymmetric tax treatment of gains and losses from derivative transactions, the BFH continued. This asymmetry means that losses from derivative transactions can only be considered annually up to a maximum amount of EUR 20,000, while the remaining gains are fully taxed. This can lead to situations where, in the end, gains are taxed that were not economically achieved. A follow-up obligation of taxpayers from other income sources could be the result. In the present case, for example, the taxpayer had an overall economic profit of about EUR 23,000 in the disputed year but was supposed to pay approximately EUR 53,000 in income tax. Further offsetting of losses would take ten more years at the maximum rate of EUR 20,000, provided that the taxpayer continues to generate sufficient gains, according to the BFH.
The Federal Fiscal Court sees no legal basis for this unequal treatment and therefore has constitutional concerns. To clarify the constitutionality, the BFH has involved the Federal Constitutional Court.
Should the loss offset limitation for derivative transactions actually be unconstitutional, this would have significant implications for current practice. For affected taxpayers, it may therefore be advisable to contest the tax assessment in a timely manner.
MTR Legal Rechtsanwälte advises on tax law and tax disputes with the authorities.
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