The German Bundestag adopted the Act Implementing the Mortgage Credit Directive and Amending Commercial Rules (Gesetz zur Umsetzung der Wohnimmobilienkreditrichtlinie und zur Änderung handelsrechtlicher Vorschriften) on February 18, 2016, followed by the Bundesrat on February 26, 2016. The Act was published in the Federal Law Gazette on March 16, 2016, and has now entered into force. Its name would seem to indicate that the new legislation will have no impact on businesses, but that’s not the case. Legislators have at least partially responded to pressure from industry and the industrial associations and have changed the rules for valuing pension provisions – in commercial balance sheets at least.
The specific issue is that the length of the time period for determining the average market interest rate used to value retirement pension obligations has been increased from seven to ten years. This takes the ongoing low level of interest rates into account. With a residual term to maturity of 15 years for pension obligations, using the average market interest rate over the past seven years would result in an average rate of 3.89%. Using the interest rate for the last ten years results in a rate of 4.30%, which, as a rule of thumb, would likely lead to reporting lower pension provisions of around 6% under commercial law, although this depends on individual cases. This will allow companies – at least temporarily – to take some of the downward pressure off their annual financial statements, since pension provisions will not increase as fast. However, if interest rates remain at their current level, the problem of a lower average interest rate with a correspondingly greater increase in pension provisions will soon return.
The new legislation includes a payout block to keep companies from being deprived of the financial resources now available to them as a result of forming lower pension provisions. The difference between the cash value when applying the seven-year and ten-year interest rates must also be calculated each year and shown in the balance sheet or the notes. It is unclear in that regard whether a provision must be formed for this or whether it must be capitalized as required by section 268 (8) HGB. The current wording does not state, either, that in the event of a profit/loss transfer agreement, the amounts subject to the payout block are also barred for transfer, although that was most likely the legislative intent. It is to be hoped that legislators will clarify this.
In contrast, the new legislation must clearly be applied to annual and consolidated financial statements when the fiscal year ends after December 31, 2015, so it applies to 2016 fiscal years that are calendar years as well as 2015/2016 fiscal years that differ from the calendar year. However, the Act offers the option of electing early use of the ten-year average interest rate when determining pension provisions for annual or consolidated financial statements under commercial law for fiscal years beginning after December 31, 2014, and ending before January 1, 2016. This therefore includes fiscal year 2015 if it is the calendar year, as well as short fiscal years in 2015. The option does not apply to annual financial statements for fiscal years that are not calendar years. If early application is chosen, the entire set of rules must also be applied, including the payout block.
According to background materials on the Act, the option to apply the new rules will be available in fiscal year 2015 only to the extent that annual financial statements have not been audited and approved. However, that limitation is not reflected in the wording of the Act, so in our view contrary passages in the statement of legislative intent are not likely to change anything. Medium-sized and large corporations that elect early application of the new rules must include a statement to that effect in their notes.
The new commercial law provisions have no effect on the calculation of pension provisions for tax purposes. An interest rate of 6 percent must still be used, which is completely out of line with reality given the current level of interest rates. For that reason, pension provisions in tax balance sheets will be much lower and may need to be shown as deferred tax assets in the commercial balance sheet. Once again legislators are turning a deaf ear to industry’s justified requests for more realistic taxation.
Given the enormity of the retirement pension obligations that companies operating in Germany are required to report in their balance sheets, the change in the requirements under commercial law is still welcome, even though the solution that has been adopted only partially takes into account the vehement appeals by industry and the trade associations for an increase in the relevant reference period from seven to ten years. It remains to be seen whether a similar discussion will be necessary in three years based on future interest trends.