New regulation of interest / Penalties for late payment could also be unconstitutional - BMF draft dated 22 February 2022

In its decision of 8 July 2021, published on 18 August 2021, the German Federal Constitutional Court (BVerfG) ruled that an interest rate of 0.5% per month for tax arrears is too high and violates the fundamental right to equal treatment. The German Federal Ministry of Finance (BMF) has drawn up a proposal for a new regulation of interest rates, according to which the interest rate is to be significantly reduced and regularly evaluated in the future. Given the BVerfG's decision, the Regional Financial Courts and the Federal Financial Court (BFH) are also questioning the constitutionality of penalties for late payment.

BMF draft bill:  Reduction of the interest rate to 0.15% per month 

The core of the decision of the Federal Constitutional Court (BVerfG) was that the previous interest rate of 0.5% per month (i.e., 6% per year) for interest on tax arrears no longer corresponds to the interest rates customary in the capital market today, and thus no longer reflects the advantage of paying taxes only at a later date. For interest periods up to the end of 2018, the old interest rate will continue to apply, but for interest periods from 2019 onwards, the BVerfG has obligated the legislature to enact a new regulation by the end of July 2022 that is both retroactive and constitutional. In doing so, the legislature has a certain amount of discretion, which also allows for a fixed but realistic interest rate. Details can be found here.

The BMF's draft bill dated 22 February 2022 intends to reduce the interest rate to 0.15% per month retroactively to January 1, 2019, i.e., to 1.8% per year. To account for future developments, the appropriateness of the interest rate is to be evaluated every three years, taking into account the prime rate in accordance with Section 247 of the German Civil Code (BGB). While this brings the BMF closer to the reality found in the capital market, it does not fully reflect it: the base interest rate published by the Deutsche Bundesbank has been -0.88% from 2019 to now. The BMF could not accept completely abolishing the full interest rate; just as it did not want to be tightly coupled to the prime rate. The state budget will be thankful for that. However, it seems conceivable that complaints will be filed, questioning the constitutionality of the new interest rate.

As soon as the law is in force, the tax offices will resume the currently interrupted proceedings and assess interest accordingly.

BFH and the Financial Court Münster question the constitutionality of the amount of the penalty for late payment

If a tax is not paid by the end of the due date, a penalty for late payment of 1% of the rounded down tax amount in arrears must be paid for each month or part thereof in accordance with § 240 of the General Fiscal Code. This results in an annual interest rate of 12%, making it obvious that this has nothing to do with the reality found in the capital market. It is therefore unsurprising that, given the BVerfG's decision, the constitutionality of the penalty for late payment is also (or even more so) being called into question.

In its ruling of 22 April 2021 (12-K-1420/20-AO), the Financial Court Düsseldorf defends the penalty for late payment and refers to a decision of the Financial Court Münster of 29 May 2020 (12-V-901/20-AO) which states that doubts about the constitutionality of the interest rate cannot be transferred to the penalty for late payment. Penalties for late payment are a means of exerting pressure in a different way and are intended to encourage the taxable person to pay on time. They are thus a form of coercion.  In addition, they represent a consideration for the postponement of payment and are intended to compensate for the administrative expenses incurred by the tax offices as a result of the late payment. In this context, its primary function is as a means of pressure, which speaks against it being compared to an interest charge.  In some literature, it is argued that penalties for late payment contain an interest component, but the Financial Court Düsseldorf disagrees.
However, the Financial Court Münster has since changed its opinion, among other things in its decision of 16 December 2021 (12-V-2684/21). Accordingly, there are serious doubts about the constitutionality of the penalty for late payment. It is true that the BVerfG had emphasised in its decision that interest charges for which the taxable person can decide whether they are fulfilled requires an independent constitutional assessment - and thus establishes a link to the penalty for late payment. Here, too, it is up to the taxable person to procure liquidity on the capital market at favourable interest rates, thus paying off the tax debt and avoiding the expensive penalty for late payment.

However, the Financial Court Münster refers here, among other things, to the BFH decision of 14 April 2020 (VII B 53/19) and to an unpublished decision of 30 June 2020 (VII R 63/18). In these decisions, the BFH stated that constitutional doubts are at least justified insofar as penalties for late payment are not intended as a means of exerting pressure, but as a consideration or compensation for the postponement of payment, i.e., having a function similar to interest. In the underlying case - an application for suspension of execution - the application was, however, limited to half of the penalty for late payment, which, according to the applicant, constituted the interest portion. Thus, the BFH did not have to decide on the total amount of the penalty for late payment.

Given this mixed situation, it seems conceivable that the era of the 12% penalty for late payment may also soon be over. In applicable cases, it may therefore be advisable to keep corresponding assessment notices open, based on the arguments above.

(Dated: 29 March 2022)