Press Release No. 77/2021 of 18 August 2021
– Interest on back taxes and tax refunds –
In an order published today, the First Senate of the Federal Constitutional Court held that the interest incurred on back taxes and the interest paid for tax refunds pursuant to § 233a in conjunction with § 238(1) first sentence of the Fiscal Code (Abgabenordnung – AO) is unconstitutional insofar as the interest is fixed at 0.5% per month for periods from 1 January 2014.
Taxpayers incur interest of 0.5% for back taxes after the expiry of an interest-free grace period (generally 15 months). This amounts to unequal treatment of taxpayers whose taxes are only assessed after the expiry of the grace period in relation to taxpayers whose tax assessments become final during the grace period. Measured against the general guarantee of the right to equality following from Art. 3(1) of the Basic Law (Grundgesetz – GG), this unequal treatment is constitutional with regard to interest incurred from 2010 to 2013, but it is unconstitutional with regard to interest incurred in 2014. Applying a lower interest rate would be an at least equally suitable means for achieving the purpose of the law, while resulting in less unequal treatment. The interest paid to taxpayers for tax refunds pursuant to § 233a AO is also incompatible with the Basic Law. The provisions continue to apply for interest periods until 2018, but they are declared inapplicable for interest periods beginning in 2019. The legislator must enact provisions that are compatible with the Constitution by 31 July 2022.
Facts of the case:
§ 233 AO governs the interest taxpayers incur on back taxes and the interest paid to taxpayers for tax refunds. Taxpayers are liable for interest from the time the tax arises, even before they receive a tax assessment (according to the principle of interest on taxes from the time they arise). However, interest does not start to accrue at the end of the calendar year in which the tax arose, but only after an interest-free grace period of generally 15 months. Thus, the imposition of such interest payments only affects those taxpayers whose taxes are initially assessed or amended after a rather long period of time has passed since the tax arose. Of practical relevance in this context are (amendments to) tax assessments, in particular following a field audit. Pursuant to § 238(1) AO, interest is 0.5% for every full month, amounting to 6% per annum. Interest is only incurred in respect of the types of taxes listed in § 233a(1) first sentence AO: income tax, corporation tax, capital tax, VAT and trade tax. The interest works both in favour of taxpayers (in case of tax refunds) and to their disadvantage (in case of back taxes). The reasons for a late tax assessment, and in particular whether it is due to the taxpayers or the tax authority, are irrelevant to calculating interest.
The constitutional complaints concern the charging of interest on trade tax arrears pursuant to § 233a AO following a field audit. The complainants challenge the ordinary court judgments upholding the charging of interest. They indirectly challenge § 233a AO, insofar as § 238(1) first sentence AO is applied when calculating interest. The period under review in this case is the period from 1 January 2010 to 14 July 2014.
Key considerations of the Senate:
I. Interest on back taxes pursuant to § 233a in conjunction with § 238(1) first sentence AO was initially constitutional. However, the provision is no longer compatible with Art. 3(1) GG insofar as an interest rate of 0.5% per month is applied to interest periods in 2014.
1. As the law currently stands, taxpayers whose taxes are only assessed after the expiry of the grace period are treated unequally in relation to taxpayers whose taxes are assessed during the grace period. Only the former group is subject to interest charges.
2. Especially strict proportionality requirements apply when it comes to the justification of such unequal treatment.
a) The general guarantee of the right to equality under Art. 3(1) GG does not preclude all differentiation on the part of the legislator. Differentiations, however, must always be justified by factual reasons commensurate with the aim and the extent of the unequal treatment. Depending on the subject matter of the legislation and the criteria for differentiation, the legislator must observe varying limits, which may range from a mere prohibition of arbitrariness to strict proportionality requirements. Stricter limits for the legislator may arise from the freedoms affected in a given case. Moreover, the constitutional requirements become stricter where statutory differentiation is based on grounds that individuals can only influence to a lesser degree. This general standard derived from the right to equality also applies in respect of setting out how the interest is incurred (on taxes when they arise, pursuant § 233a AO) and fixing the interest rate (§ 238 AO).
b) Based on these standards, stricter proportionality requirements apply in the present case. The interest incurred by taxpayers on the basis of taxes as they arise pursuant to §§ 233a and 238 AO essentially only affects the general freedom of action under Art. 2(1) GG. By contrast, freedom of property guaranteed by Art. 14(1) GG is unaffected from the outset given that imposing an obligation to pay interest is not so onerous as to have a fundamental impact on the financial circumstances of the taxpayers. That being said, the timing of the tax assessment and thus whether the grace period will have expired is largely out of taxpayers’ control. The timing of the tax assessment lies in the hands of the tax authorities or – in the case of trade tax – usually also of the municipalities.
3. § 233a in conjunction with § 238(1) first sentence AO initially satisfied the stricter justification requirements applicable in this context and was constitutional.
a) The imposition of interest from the time taxes arise aims to compensate for the fact that taxes are assessed and become payable at different times for individual taxpayers. This is a legitimate aim. Interest is imposed on back taxes based on the assumption that taxpayers whose taxes are assessed late have a theoretical interest advantage. The interest incurred under the challenged provisions is aimed at neutralising this advantage. Interest incurred from the time taxes arise is suitable for helping achieve this aim. In principle, this also holds true when considering the amount of interest charged, given that at least until 2014, it was generally still possible to earn interest on the market.
b) As such, the interest incurred from the time taxes arise is also necessary. No equally suitable means is available for achieving the purpose of the differentiation: neutralising taxpayers’ actual liquidity advantage is not equally suitable, nor is designing the obligation to pay interest in such a way that interest on tax arrears is only payable if the taxpayers themselves are responsible for the late tax assessment. There are no concerns as to the necessity of the interest incurred, also with respect to the fixed rate. Variable interest rates do not per se lead to less inequality than fixed interest rates.
4. However, imposing interest of 0.5% per month is no longer necessary for periods in 2014 and violates the right to equality under Art. 3(1) GG.
a) In order to simplify administrative processes, the legislator may in principle apply typification (Typisierung) to determine taxpayers’ interest advantage arising from a late tax assessment. However, the legislator may not choose an atypical case as its model; when establishing standards, it must realistically base its determination on a typical case. Since the legislator never provided explicit reasons for the amount of interest charged, an overall examination of the ascertainable motives and considerations is required in order to establish the – at least presumed – main criteria for the calculation of the interest rate. The legislator imposes interest on back taxes to cancel out an advantage. This is based on the legislator’s assumption that the advantage to be cancelled out here is a potential interest advantage. The legislator set this interest advantage at 0.5% per month in 1990, based on the existing provision determining interest for other cases in the Fiscal Code, § 238 AO. The only reason for this provided by the legislator was the practicality of the existing fixed interest rate. However, it is also ascertainable that this decision was tied to the discount rate at that time, which has been replaced by today’s base rate. The legislator evidently took into consideration the market rate, setting the same rate for interest charged on back taxes and interest paid for tax refunds. Overall, these criteria used by the legislator for setting out standards for fixing the interest rate adequately reflect the potential advantage taxpayers may gain from a late tax assessment.
b) Based on these considerations, the interest of 0.5% per month payable on back taxes was initially constitutional. When the 1990 Tax Reform Act – which introduced the current interest system into the Fiscal Code – was adopted, the legislator was correct in assuming that this interest rate reflected the potential advantage gained from a late tax assessment. The annual interest rate of 6% roughly corresponded to the conditions on the money and capital markets, which were relevant for establishing the standard in this regard.
c) Even though the legislator generally has a prerogative of assessment, applying an interest rate of 0.5% per month is no longer justified when the interest rate determined by way of typification proves to be obviously unrealistic over time due to changed factual circumstances. This has been the case since at least 2014.
Following the financial crisis in 2008, an environment of structurally low interest rates has emerged that is no longer a reflection of usual interest rate fluctuations. This becomes clear when considering how the base rate has developed. While the base rate was above 3% in 2008, it rapidly fell to 0.12% in the course of 2009. It has been negative since January 2013. Given that the discount rate was between 2.5% and 8.75% in the fifty years of its existence, and the base rate ranged between 1.13% and 3.32% before 2009, this development represents a low-interest environment no longer indicative of the usual interest rate fluctuations, but rather, at least since 2014, of a structural and lasting nature. The development of interest rates on the capital markets has followed a similar trend. In 2014, the 6% per annum interest rate had already deviated so far from the actual market rate that it was about twice as high as the maximum interest that could still be earned on the market. The lending rates, which must be taken into account for establishing standards in this context, have also followed the downward trend described above. The interest rate of 6% per annum, determined by way of typification, is therefore obviously unrealistic, at least since 2014, given the changed factual circumstances following the financial crisis. In the current environment of entrenched low interest rates, this interest rate is clearly no longer capable of sufficiently reflecting the potential advantage taxpayers may gain from late taxation. Since the current system of interest incurred from the time taxes arise is based on an annual interest rate of 6%, it now generally has an excessive effect, at least for periods in 2014, and has thus become unconstitutional.
5. For interest periods until 2013, the statutory interest rate is increasingly incapable of achieving the purpose pursued with the imposition of interest on tax arrears. However, for these periods, the interest rate does not yet have an obviously excessive effect. Nor does it violate the principle of proportionality in its strict sense. It is not yet disproportionate to such an extent that it is conspicuously misaligned with constitutional law. In respect of these periods, the interest rate also does not violate the prohibition of excessive measures (Übermaßverbot) following from Art. 2(1) in conjunction with Art. 20(3) GG. The fixed interest rate determined by way of typification has advantages for administrative practice that are still in adequate proportion to the resulting unequal treatment of taxpayers liable for interest payments. Until 2013, the low interest rate environment had not yet become so entrenched that the statutory interest rate generally appeared obviously unrealistic.
II. Insofar as it is admissible, the constitutional complaint in proceedings 1 BvR 2237/14 is unfounded given that it concerns interest payable for 2010 to 2012.
III. The constitutional complaint in proceedings 1 BvR 2422/17 is well-founded in part. Insofar as it concerns the interest period from 1 January 2014 to 14 July 2014, the decision of the Administrative Court (Verwaltungsgericht) violates the complainant’s fundamental right under Art. 3(1) GG. The decision of the Higher Administrative Court (Verwaltungsgerichtshof) violates the complainant’s fundamental right to effective legal protection following from Art. 19(4) GG. For the rest, the constitutional complaint is unfounded.
IV. § 233a in conjunction with § 238(1) first sentence AO is declared incompatible with the Basic Law in its entirety for all interest periods from 1 January 2014. Given the comprehensive approach chosen by the legislator, the interest rate pursuant to § 233a AO is not merely incompatible with the Basic Law with regard to interest charged on tax arrears to the disadvantage of taxpayers, but also with regard to interest paid on tax refunds in favour of taxpayers. However, the provision continues to apply in respect of interest incurred from 1 January 2014 to 31 December 2018; the legislator is not required to retroactively enact provisions that are constitutional for this period. By contrast, for interest periods from 2019, the provision remains inapplicable. The legislator is required to enact new provisions by 31 July 2022, which must apply retroactively to all interest periods from 2019 onwards and to all acts of public authority that have not yet become final.
Decision of the Federal Constitutional Court: