<small>Stefan Deutmeyer:</small><br>Caution with shareholder loans to "their" GmbH

These are very helpful in less favourable times. However, several tax pitfalls lurk. Entrepreneurs should therefore discuss such arrangements in detail with their Steuerberater (German Certified Tax Advisor) and Rechtsanwalt (German Attorney-at-Law) beforehand.

For entrepreneurs, there are many ways to obtain financing. Loans from the principal bank, which may need to be secured by a guarantee, are widely used. But there are also financing alternatives such as leasing or factoring, which have become commonplace today. Of course, entrepreneurs can also help themselves with private equity funds, namely by means of a shareholder loan.

A shareholder loan is initially to be viewed positively, but it also involves tax risks, risks in the event of insolvency or risks with regard to a later sale of the company. The aspects of interest, repayment, collateral and subordination are also important. The effects on the balance sheet are likewise decisive: is this equity or debt capital? Equally important is the question of what threatens in a crisis in the event of insolvency.

This shows how important detailed, individual discussions beforehand with the Steuerberater and Rechtsanwalt are.

A shareholder loan is generally reserved for corporations. The shareholder may grant the company a loan that is subject to the provisions of the German Civil Code. This includes, among other things, a repayment obligation of the debtor. And as long as the corporation is not in a crisis, it may fulfil this repayment obligation and repay due shareholder loans "like normal company liabilities".

With a shareholder loan, care must be taken to conclude it in the same way as one would with an "unrelated third party". The tax office examines not only the business interest of the agreement, but above all whether a so-called "hidden profit distribution" (verdeckte Gewinnausschüttung) might be present. The requirements of the tax authorities are very strict in this regard.

The loan agreement should therefore provide for an arm's-length repayment arrangement and, above all, an arm's-length interest rate. If the conditions are too unfavourable, the tax authorities assume a hidden profit distribution, with the consequence that the interest paid by the GmbH would be added back to profit and taxes would be reclaimed accordingly as in the case of a profit distribution.

For a shareholder loan granted in a crisis, the entrepreneur should also keep the interest rate within customary limits. A bank would also act in this way based on a rating.

The loan agreement should be well documented, as it must regularly be presented to the tax authorities. The contract should therefore have been properly concluded in advance and withstand any arm's-length comparison. It is very important that the contract is complied with exactly as concluded; otherwise, problems can quickly threaten, for example, if repayment is handled "sloppily". Should there be a need for amendment, the contract must be adjusted promptly after prior consultation with the Steuerberater; otherwise, a hidden profit distribution can very quickly threaten.

Then the question arises whether the loan constitutes equity or debt capital. From a balance sheet perspective, it is debt capital. However, due to their position, the shareholder has a substantially deeper insight into the company and thus also more opportunities to influence the use of the loan than a "normal" creditor. In this respect, a shareholder loan is not entirely "normal" debt capital. If the company becomes insolvent, the shareholder loan is treated as equity. In this respect, the view held by many that a shareholder loan is a kind of hybrid form is probably more accurate.

In the event of insolvency, claims of lenders are normally satisfied before those of shareholders, to the extent the insolvency estate allows. With a shareholder loan, however, the situation in a crisis – more precisely, in insolvency – is different. The relevant insolvency code then treats it as equity.

With respect to such a loan, shareholders are automatically subordinated creditors of the lowest rank. No subordination agreement would therefore need to be concluded for this. An exception applies upon acquisition of shares in the case of impending or actual insolvency. In any case, the advice of a Rechtsanwalt should be obtained beforehand on this point.

In principle, loans from a non-managing minority shareholder with a maximum stake of 10 % are likewise not subordinated. This applies regardless of how voting rights or profit participation are structured.

If the company has repaid a shareholder loan prior to insolvency, the repayment can, under certain conditions, be contested by the insolvency administrator. This applies even if the company was not yet in a crisis at the time of repayment.

If the purchase or sale of shares in a corporation with existing shareholder loans is planned, a consultation with a Rechtsanwalt as an expert must be sought beforehand in order to avoid the issue of subsequent reclaiming.

Equity-substituting shareholder loans were also a popular means for a long time to provide more equity in the company in a crisis. If insolvency nevertheless followed later, at least the threatened losses could be claimed for tax purposes. However, there have been heated disputes on this matter for years and, consequently, a high degree of legal uncertainty. A case before the BFH is pending, so the final word has not yet been spoken.

If the entrepreneur is considering an equity-substituting loan, here too it is essential to seek a discussion with the Steuerberater and Rechtsanwalt beforehand.