Loss Declaration in the Event of Insolvency - Claiming Losses for Tax Purposes

Equity crowdfunding is a form of early-stage financing and is therefore considered venture capital. The purpose of equity crowdfunding is to support innovative business ideas with capital and ideally to generate a high return. However, high return is also linked to high risk, wherefore it is common in venture capital for startups to become insolvent.

For investors, this usually means a loss of their invested capital – an upsetting result that has held nothing positive so far. Up until now, yields from equity crowdfunding were subject to tax but one could not claim losses for tax purposes. Now, however, jurisdiction has changed in the favor of private investors.

Loss declaration in the event of insolvency: BHF judgment as a signal

The highest German tax court, the Bundesfinanzhof (BFH) in Munich, recently ruled that losses from private loans can be offset against other investment income. Income from interest, dividends and realized capital gains from equity transactions are relevant for the offsetting of losses. If there is no investment income, it is possible to carry the loss forward.

"The definitive default of a capital claim leads [...] to a tax-recognizable loss in the private sphere of wealth," the judgment VIII R 13/15 of 24 October 2017 states. The BFH thus counters the financial court’s jurisprudence to date. The judgment was based on the following case: The claimant had granted a third party an interest-bearing loan in 2010. As of August 2011, the debtor was no longer able to make his interest payments; insolvency proceedings were initiated regarding the borrower’s assets.

The plaintiff filed the outstanding loan receivable with the insolvency table and asserted the default of the loan receivable as a loss in the income from capital assets. However, neither the fiscal court nor the tax office recognized the damage. The plaintiff filed an appeal against this decision and was granted approval by the Bundesfinanzhof (BFH). The Bundesfinanzhof (BFH) reversed the decision of the fiscal court.

The reason for the ruling was that “[...] With the introduction of the final withholding tax in 2009, all changes in value in connection with investments [should] be fully recorded under tax law. According to the BFH judgment, this means that the traditional separation of asset and income levels for income from capital assets has been abandoned. As a result of this paradigm shift, the final default of a capital claim within the meaning of art. 20, par. 1, point 7 EStG results in a loss to be taken into account for tax purposes in accordance with art. 20, par. 1, sentence 1, point 7, sentence 2, and par. 4 EStG.”

Loss declaration in the event of insolvency: What does the judgment mean for private investors?

Dr. Rainer Schenk has a long-standing career as a tax consultant and has been increasingly involved in the topic of equity crowdfunding since 2011. He provides a detailed explanation of the consequences of the ruling for private and institutional investors in a guest post on the industry portal Crowdfunding.de.

“The guiding principle of the judgment, contrary to previous jurisprudence, is that the (insolvency-related) default of a private loan receivable is considered as a loss of income from capital assets in accordance with art. 20, par. 1, point 7 on the Income Tax Act,” Dr. Schenk comments about the ruling on Crowdfunding.de. “Thanks to the resulting paradigm shift in tax jurisdiction, the final default of a private investors’ capital claim finally and rightfully counts as a loss to be taken into account for tax purposes.”

But when is a loss taxable? The BHF explains that damage due to the default of receivables only exists when it is clearly established that no further repayments will be made beyond amounts already paid. “The opening of insolvency procedures generally is not enough,” states the explanation. “Something else applies if the opening of insolvency proceedings is refused for lack of assets, or if other reasons confirm that no more repayments are to be expected.”

According to our legal understanding, equity crowdfunding is the exception to the rule. Participations on Companisto are profit participating loans. They entail subordination, which is why they are also called subordinated loans. This means that the creditors’ claims are subordinate to other lenders in the event of insolvency. Experience has shown that crowd investors cannot count on the repayment of their loan already upon the opening of insolvency proceedings.

Loss declaration in the event of insolvency: How do you claim defaults for tax purposes?

Equity crowdfunding income is included in the category of investment income for tax purposes, as described in our Tax Guide for Equity Crowdfunding. Investment income is subject to a final withholding tax of 25% and a solidarity surcharge of 5.5% since 2009. According to our legal understanding, losses from equity crowdfunding can thus be offset against other investment income.

It is advisable to report default from an investment in equity crowdfunding as early as possible. After the announcement of the opening of insolvency proceedings, the investors concerned should claim their losses at the tax office. To do so, they should submit the following information to the tax office through their tax consultant:

• Copy of loan agreement and participation contract
• Proof of payment as confirmation of the investment made
• Preliminary loss certificate from Companisto (to be found in the Investor Relations area of the startup under “Documents”)
• Confirmation of the opening of insolvency proceedings (to be found at Insolvenzbekanntmachungen.de)
• BFH judgment (to be found on the website of the Bundesfinanzhof)

What is a provisional loss certificate? In the loss certificate, we verify to the investor that he has invested in a certain startup at a loss. In addition, we state that insolvency proceedings have been opened, subordinated receivables cannot be filed, and that it is very unlikely that repayments will be made. However, this certificate of loss cannot replace an official certificate of loss by an insolvency administrator, since Companisto as the mediating platform is not a contractual partner of the existing participation contract.

We are currently working on updating the provisional loss certificate. In the event of insolvency, we will provide all necessary information to all involved investors in a bundled package. All they have to do is pass them on to their tax advisor to settle the losses.

In any case, the information should clarify the procedure for asserting losses with your tax consultant. Investors who have suffered a default in equity crowdfunding should not automatically assume that the tax authorities are aware of the BFH's judgment or share this legal opinion. It may well be that the tax office has a different perspective on the taxation issue. Dr. Rainer Schenk comments:

“In these cases, a written objection [should] be filed against the income tax assessment and refer, among others, to the BFH judgment of 24.10.2017 as justification. The explanatory statement should also be submitted to all other outstanding tax cases. Equity crowdfunding investors, who have had defaults and have not yet filed an income tax return, or who have not yet indicated the defaults in their tax returns, should make use of the change in jurisdiction and, if possible, file a tax return or, in the case of tax assessments that are not yet final, apply for an amendment to the tax return.”

Do you have any further questions on how to claim losses from equity crowdfunding for tax purposes? Then leave us a comment below!

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