Decision of the Administrative Court concerning the valuation methodology for convertible bonds

Decision of the Administrative Court issued on 17 July 2024 concerning the valuation methodology for convertible bonds.

This case addressed whether specific circumstances, referred to as “besondere Umstände”, could justify deviating from the standard nominal value principle. 

Here is what you need to know:

• A company holds shares in Company B, acquired through issuing both equity and convertible bonds. The shares in Company B have been assessed at market value. The taxpayer argued for a market-based valuation of the convertible bonds, aligned with the market value of the shares in Company B, into which they could be converted. To support its stance, the taxpayer relied on, inter alia, the terms and conditions of the bonds, which provide for a conversion option at fair market value, contrasting with the tax authorities' position quiring a nominal valuation, unless special circumstances are demonstrated.
• The Administrative Tribunal, in its decision dated 2 February 2024, sided with the tax authorities. For the Administrative Tribunal, there were no "exceptional circumstances” that would justify deviating from the general principle of valuation at nominal. The Administrative Tribunal based its decision on two key criteria: (i) the conversion of the bonds into shares in Company B remains optional, and (ii) neither party has shown any intent to undertake such conversion. Consequently, according to the Administrative Tribunal, bonds as debt instruments, should be valued at nominal, making the (only hypothetical) conversion into shares a key element of the valuation.
• While agreeing on the valuation principle, the Court noted that the threshold for deviation lies in "particular circumstances," as opposed to the "exceptional circumstances" benchmark employed by the Administrative Tribunal. In addition, the Court clarified that the company has the right, but not the obligation, to convert, redeem or transfer the convertible bonds at market value. In other words, the company can repurchase the bonds at either market or nominal value, whichever is greater. Therefore, according to the Court, the hypothetical aspect relates not to the conversion into shares itself but to the repurchase price, which may not necessarily be at fair market value. Thus, the hypothetical conversion at fair market value does not constitute a “particular circumstance” that would justify a deviation from the principle of nominal value assessment.

This decision reaffirms the default nominal valuation of debt instruments unless particular circumstances can be substantiated unequivocally.