CFD trading and the BFH ruling: Is the restriction on loss offsetting unconstitutional?

Unconstitutionality of the restriction on loss offsetting for forward transactions

The German Federal Fiscal Court (Bundesfinanzhof, BFH) has ruled that the restriction on loss offsetting for forward transactions, as provided for in the Annual Tax Act 2020, potentially violates the German constitution.

Since 2020, it has only been allowed to offset losses from certain capital income, such as from the default of claims, the expiration of securities and personal loans, up to a maximum amount of €20,000 per year.

Losses on futures and similar financial instruments such as warrants, leverage certificates and contracts for difference (CFDs) are also affected by this restriction. The intention of this regulation is to prevent intensive tax planning, but it makes it more difficult for private investors to offset losses in full.

Details of loss offsetting for financial derivative contracts:

Losses that exceed this amount cannot be fully offset in the current year but may be carried forward to the following year.

Derivatives such as warrants and certificates are excluded. Losses from financial derivative contracts can only be offset against profits from other financial derivative contract transactions.

Example

Capital gains (including income from securities transactions) are taxed at 25% in Germany. Under the 2020 regulation, a trader could have made a profit of €1 million and a loss of €600,000 at the end of the year. However, he was only allowed to offset €20,000 of the loss, resulting in a taxable profit of €980,000 and a tax bill of €245,000.

The actual after-tax profit for the year was significantly lower, even though the net pre-tax profit was only €400,000.

In situations where a trader made no net profit at the end of the year (e.g. a profit of €1 million and a loss of €1 million), they would still have been subject to a tax bill of €245,000, which would have resulted in significant financial losses despite the lack of a net profit.

Many private investors in Germany were deterred by this restriction. They either withdrew from the market or looked for alternatives such as registering as professional traders or trading with products that are not affected by the restriction on offsetting losses.

Amendments made by the Annual Tax Act 2024:

The government draft of the Annual Tax Act 2024 proposes to retroactively abolish the €20,000 limit. In the future, such losses could be offset against profits without limit.

The Bundesrat is expected to pass the law on 22 November.

Details of the BFH ruling

The BFH's decision is based on a case in which an investor had traded contracts for difference (CFDs) and made both profits and losses. However, the relevant tax office only allowed the offsetting of losses up to a maximum amount of €20,000 and rejected the losses in excess of that amount. The BFH confirmed that this restriction is constitutionally questionable and provisionally suspended the enforcement of the loss offset restriction for the applicant (‘suspension of enforcement’ or AdV).

Implications for capital investors

If the judgment is upheld, capital investors could in the future offset losses from derivative transactions against other income without limit. This could result in significant tax advantages as they would be able to claim more losses to reduce their taxable income. However, it is likely that the tax authorities would react to this and, if necessary, make legislative adjustments to again restrict the offsetting of losses.

Further legal developments and possible consequences

The Bund der Steuerzahler (BdSt) is already calling on the federal government to revise the regulations. If the BFH confirms the unconstitutionality, the question could be referred to the Federal Constitutional Court (Bundesverfassungsgericht, BVerfG) for a final clarification of the legal situation. Otherwise, the tax authorities would have to implement the BFH decision and adjust the affected tax assessments.

Conclusion

The restriction of the loss offset to €20,000 can result in significant disadvantages for investors, as they may not be able to use all losses for tax reduction, which can lead to tax distortions. Furthermore, investors often have no control over when losses may occur, such as when a loan defaults or a forward transaction is terminated.

This meant that German retailers were limited in their ability to use CFDs as an efficient trading tool. With the change, which is expected to come into force at the beginning of 2025, this could once again lead to a greater appreciation of the strengths of CFDs as an effective investment tool and, given the flexibility that CFDs can offer, could once again become an efficient tool for trading.