New Rules on Taxing Foreign Currency Gains in Private Assets

Investing private wealth, savings or assets in foreign currencies can make good economic sense. In practice, it has become an established means of diversifying portfolios. Hedging, therefore, plays a key role in foreign currency investments. It often mitigates the risk of a devaluation of the euro or facilitates the realisation of capital gains through foreign exchange trading.  Previously, income from disposals was recognised exclusively within the scope of private sales transactions (as defined in Sec. 23 of the German Income Tax Act [EStG]). This was generally tax-free after the expiration of the 'speculation period', the timeframe during which the profit was made. The new approach in para. 131 of the Federal Ministry of Finance (BMF) circular of 19 May 2022 has now led to broader tax obligations for foreign currency gains. Accordingly, foreign currency gains – provided there is no currency conversion – can be recognised as income from capital assets (as defined in Sec. 20 EStG).

Previous regulations

Prior to the BMF circular from 2022, profits on amounts in foreign currencies within the 'speculation period' had been exclusively allocated to 'other income' under Secs. 22 no. 3 and 23(1) sentence 1 no. 2 EStG. Such gains or losses are subject to the (high) progressive tax rate. To determine foreign currency gains, the taxpayer must review and categorise all purchase and disposal transactions of the 'foreign currency' asset to assess their tax relevance. In particular, spot transactions against euros or in another currency and the purchase or sale of securities are deemed to be tax relevant. No actual currency conversion is necessary. Any intention to sell or speculate is also irrelevant.

Section 23(1) sentence 1 no. 2 EStG provides an exception for foreign currency balances that are sold within one year of their purchase (holding period). Foreign currency gains outside this 'speculation period' remain tax-free whereas losses cannot be taken into account inversely.

The tax authorities' current legal opinion

The new para. 131 of the BMF circular now clarifies the tax authorities' position on foreign currency gains or losses from interest-bearing capital debt instruments. Previously, these did not lead to foreign currency gains under Sec. 23 EStG due to the absence of a purchase taking place. Now they are always classed as income from capital assets and recognised as such by Sec. 20(2) sentence 1 no. 7. These foreign currency gains are subject to the (low) final withholding tax rate; there is no 'speculation period'. As Sec. 20(2) EStG covers “transactions equivalent to sales”, the repayment and redemption of previously purchased foreign currency amounts are also taxable transactions. The currency being used is irrelevant. No actual currency conversion is required to trigger a taxable sale under Sec. 20 EStG either.

However, as before, foreign currency gains from non-interest-bearing or unsecuritised capital debt instruments are not covered by Sec. 20 EStG. Pursuant to para. 131, such transactions are still classified as private sales transactions (Sec. 23 EStG). In addition, Sec. 20(2) sentence 1 no. 7 in conjunction with (4) EStG requires an intention to generate income. This means that balances in payment accounts, digital payment methods and credit cards not used to generate income are generally not recognised.

It should be noted that even a transfer of foreign currency balances between foreign currency accounts within the meaning of Secs. 20 and 23 EStG, for example from an interest-bearing to a non-interest-bearing foreign currency account in the same currency, (can) specifically 'trigger' sales.

According to para. 324, the new regulations apply “to all open cases” and even retroactively to investment income received after 31 December 2008 and for the first time for the 2009 assessment period.

Conclusion and practical implications

The amended legal interpretation of the BMF leads to a considerable expansion of taxable foreign currency transactions in private assets. This leads to the already very complex calculation of foreign currency gains becoming even more convoluted. This applies in particular to interest-bearing foreign currency debt instruments held by natural persons resident in Germany. The immediate and even retrospective application of the new BMF circular means that taxpayers need to act swiftly. Where the foreign currency debt instruments are managed by a foreign bank, this may lead to considerable challenges. However, as domestic banks have only been obliged to determine any currency gains and losses incurred since 1 January 2024, the calculation and declaration will remain the responsibility of the taxpayer until then.