If, upon the sale of an asset in a private estate, the parties expressly agree to an interest-free deferral of the purchase price and all installments are to be applied exclusively toward the purchase price, the seller does not, after all, realize income from capital assets pursuant to Section 20(1)(7) of the Income Tax Act (EStG). The Federal Fiscal Court has thus rejected its previous view, according to which the individual installments must be divided into a principal and an interest component in accordance with § 12(3) of the Valuation Act (BewG).

Facts of the Case

A married couple sold a piece of real estate they had owned for more than ten years to their daughter at its market value. Since she was unable to obtain bank financing, the purchase price was deferred in full. It was to be repaid in monthly installments over a period of several decades. Early repayments were not to result in a reduced total repayment amount. The notarized contract expressly stipulates that no interest is to accrue, that all installments are to be credited exclusively against the purchase price, and that the benefit of the lack of interest is to accrue to the daughter. The tax office, in accordance with previous case law of the Federal Fiscal Court and applying Section 12(3) of the Property Valuation Act (BewG), mathematically broke down the installment payments into principal and interest components and subject the latter to taxation as income from capital assets. The couple contested this—and successfully so.

Not a Generous Gift

The Federal Fiscal Court initially concluded that the interest-free deferral of the purchase price does not constitute a generous gift. While the parents intended to pass on the interest benefit to their daughter, there is no transfer of assets required for gift tax purposes.

Please note: Unlike in the case of an interest-free loan, no capital is made available to the daughter for her use. Rather, her obligation to pay the purchase price immediately is merely deferred.

No Income Tax

The actual focus, however, is on the assessment under income tax law. Here, the Federal Fiscal Court has emphasized that, while an interest-free deferral does constitute a transfer of capital, if—in accordance with the parties’ mutual intent—there is no consideration whatsoever for this transfer of capital, the elements of Section 20(1)(7) of the Income Tax Act (income from capital assets) are not met.

The civil law agreement is decisive. If the contracting parties have expressly stipulated that all installments constitute exclusively payments toward the purchase price and that no interest is to be paid, this agreement must also be recognized for tax purposes. A different rule may apply “only” in cases of abuse of legal form or a disguised interest agreement.

Note: The Federal Fiscal Court no longer adheres to the practice of categorizing individual installment payments into principal and interest components by reference to Section 12(3) of the Valuation Act (BewG).

The Federal Fiscal Court also justifies this change in case law with the system that has been in effect since the introduction of the flat-rate withholding tax. Since 2009, in addition to current income, changes in the value of capital claims have also been subject to taxation under Section 20(2) of the Income Tax Act (EStG). Therefore, usage fees and repayments must be strictly separated from one another. Purchase price installments are, in principle, entirely principal payments; an artificial division into principal and interest components no longer fits within this system.