The decision (official head note):

If a taxpayer pays money to a blackmailer in order to prevent the latter from telling the taxpayer's marital partner about an extramarital (sexual) relationship, the expenses will not be deductible for taxation.

The case:

The taxpayer (TP) had an extramarital sexual relationship. His girlfriend gave birth to a son. A friend (F) of his girlfriend got wind of the relationship and blackmailed the unfaithful spouse. TP, in order to prevent F from informing his wife, an elderly (83) lady who was suffering from a heart disease, paid a total of ca. 95,000 Euros to F between 1994 and 1997.

After his wife had died, TP reported the case to the police. F was sentenced for extortion (and probably for tax evasion) to two years and three months in prison.

In 1998 TP summoned F to pay back all the money plus interest. F refused to obey. TP did not pursue his claims against F.

iQ: From the decision it does not come clear, why.

During the appeal proceedings with respect to his 1996 tax assessment, however, he moved for roughly 30,000 Euros, which were paid to F in 1996, to be deducted from his 1996 income as so-called extraordinary burden (außergewöhnliche Belastung) in the sense of section 33 German Income Tax Code (Einkommenssteuergesetz, EStG).

The tax authority refused to accept that.

The tax court (1st instance) hold, that the amount was tax-deductible. TP, as to the court, was not supposed to deny paying and thus to threaten - not his marriage, but - the health and life of his suffering wife.

The Federal Tax Court, as it is to be taken from the above mentioned head note, held that the elements of section 33 EStG were not present, quashed the lower-court ruling, and re-established the decision of the tax authority.

The rationale:

II. 1.: The law - section 33 EStG

Under section 33 paragraph 2 clause 1 EStG income tax will be reduced,

- in case the taxpayer faces extraordinary expenses, i.e. expenses the ordinary, average taxpayer of his kind (comparable to him with regard to income, financial circumstances and marital status) is not confronted with

and

- if the expenses are inevitable, i.e. if he is bound to pay by virtue of legal, factual or moral obligations

and

- insofar as the expenses are reasonable, i.e. adequate to the circumstances.

Section 33 EstG takes into account that there might be expenses, the general tax law can not allow for without becoming overly prescriptive.

Section 33 together with section 12 EStG show, that the expenses have to be inevitable. A general principle of income tax law is, that decisions concerning private living, i.e. spending, not income, remain private affairs and do not influence taxation. Section 33 EStG is an exception of that rule and does only apply to cases, where the taxpayer has no reasonable alternative of acting.

Thus, other than with respect to medical expenses, one has to bear in mind the cause of the expenses. If the taxpayer does wilfully set the cause, i.e. if he has an alternative of acting, the caused expenses will not be tax-deductible.

iQ: The "Thus"-conclusion is not convincing. In fact, it is not a conclusion, but a mere allegation, because the general principle, explained in the previous paragraph, does not lead to the "conclusion" in this paragraph, that circumstances beyond the situation of the extortion itself have to be examined. Not at all does the general principle lead to the particular circumstances named by the court (for the to be considered circumstances vide below).

Moreover, the court does not explain the differences between medical expenses and expenses, which were caused by blackmail (vide below).

Furthermore, an objective yardstick has to be applied. Hence, the deductibility will not depend on the taxpayer's subjective standards, but on an objective view (i.e., the rather narrow understanding of the tax authority and the severe view of the Federal Financial Court).

Money being paid to a blackmailer, thus, will not be deductible, in case the taxpayer himself sets the major cause for the extortion; vice versa: expenses will be deductible, if he does not set the cause and pays without having an alternative.

iQ: As an example for the latter case, the court mentions the fact that someone is (very) rich and does that is why become the victim of an extortion.

However, if the taxpayer has become rich by his own acting (e.g. working hard or luckily, buying a Lotto ticket, succeeding to an estate), the court's example is wrong, because then he will be "responsible" for setting the cause for the extortion. This cause, other than the extortion itself, he has set wilfully (indeed) and while having an alternative (i.e., remaining poor or only ordinarily rich).

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The court's example, thus, is not an example for not setting the cause for the extortion or doing so without an alternative. It is an example for setting the cause in a legally appreciated or at least not prohibited way. Thus, it is an example for the fact that those who play by the rules do principally deserve an extraordinary tax allowance, if they suffer extraordinary losses.

If the taxpayer, on the other hand, commits a criminal offence, or violates the (unwritten) social or moral codex, or breaches standards set forth or acknowledged by himself, the thereby caused expenses will be his doing. Payments to the blackmailer will not be objectively regarded inevitable.

iQ: Bearing in mind that becoming rich (the court's aforementioned example) might be the result of acting in an unfair, greedy or immoral manner, the moral code can not be decisive. Taxation, as about 2,000 years ago Roman Emperor Vespasian has shown, when he told his son: "pecunia non olet", is virtually immune to ethics and other principles beyond tax law itself. The decisive fact is the income, whether of a nun or of a prostitute. Consequently, one has to apply the "Vespasianian principle" with respect to tax-deduction, too.

Thus, the acceptable remainder of the court's bunch of criteria are only two simple questions:

Firstly, one has to ask, whether the taxpayer was behaving legally, when he set the cause for the later extortion. If not, his expenses will not be tax-deductible.

Secondly, it could be taken from the general prohibition of tax evasion, that expenses do not have to be tax-deductible, if the taxpayer - acting illegally or not - provoked, i.e. intentionally caused, the extortion he later on became a victim of.

In both the mentioned cases he has acted on his own risk and does not deserve solidarity in the form of a tax allowance.

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Only insofar, the tax authorities or the courts have to examine the "reason behind the reason". In general, the extortion does only remotely depend on the behaviour of the taxpayer. Rather, it depends on the offender's - autonomous - decision.

Moreover, the taxpayer's decision whether "to pay, or not to pay" has to take place at the very moment of the extortion. Thus, the inevitability has to be judged with respect to this particular situation. A payment will be inevitable, if there is so much pressure as to drive an average, reasonable, not overly hard-boiled taxpayer to paying the hush-money. Then, due to the - be it legal, moral or factual - predicament, the payment will be understandable to a degree as to be called inevitable, and the taxpayer will not have to be punished by a second-guessing application of tax law. Tax evasion and antisocial behaviour will be "punished" and thus - to the degree possible - avoided by denying a tax allowance in case of intended extortions (vide preceding paragraph) or criminal offences

The remote - and, in terms of responsibility, interrupted by the blackmailer's decision to commit the extortion - link between the taxpayer's behaviour and the extortion, does in general not suffice to justify holding the taxpayer responsible and denying the deduction. Especially the court's reasoning with moral standards shows, that otherwise one would allow the tax authorities and the financial courts to become moral watchdogs.

Moreover, if the court's principle was correct, one would always have to examine the possibly careless causation of every expenditure: Had not the taxpayer negligently crashed his car, he would not have to buy / lease a new one. If the taxpayer would have treated the machine more carefully, he was not supposed to purchase a new one. Had the taxpayer not eaten while working, he would not have spilled caviar and champagne on his chair and would not have to buy a new one.

Tax law would become the sit-up-eat-more-vegetables-drive-slowly-love-your-husband-don´t-make-fun-of-the-chancellor-law. Tax law would, indirectly though efficiently, enforce not nonly monogamy, but also a couple of other "appreciated principles".

II. 2.: The application of section 33 EStG

Whilst TP's expenses are extraordinary, because not every unfaithful spouse is going to be blackmailed, they are not inevitable.

TP willingly entered into the extramarital relationship, and that at a time, when his wife already suffered from a heart disease. Even though he was not supposed to reckon with being blackmailed, he thus willingly set the cause for the extortion, so that the expenses were not inevitable.

iQ: As it has been pointed out above, the court is mixing the arguments. The question, whether the payment was inevitable, has to be answered for the situation of the extortion. There, one has to ask whether it is reasonable not to pay and thus risking harm. If one would have to ask, whether the underlying activity which exposed the taxpayer to the extortion, was inevitable, virtually every victim of virtually every extortion would have to bear the blame ("Why the hell did he become that rich? Why for heaven's sake did he fall in love with another woman? Or, more generally: why on earth did not he do at once what the blackmailer wanted, instead of doing it later and at higher costs?").

Furthermore, TP could have acted differently.

He could have brought a charge against F, which would have been reasonable.

He could have confessed his adultery to his wife and thereby eliminated the basis for the extortion.

That his wife was 83 years old at that time and was suffering from a heart disease, which later struck her down, does not allow for to assume that it would have killed her, if he had told her of his relationship.

iQ: And, if so, the state's interest in unabridged taxation outweighs her right to live, so that the unfaithful spouse has to become her gravedigger for the sake of taxation?

First of all, one has to say that TP's lawyer / tax consultant apparently did not well prepare the case, because otherwise the court could not have escaped really answering the core question. That is to say the question, whether payments, saving the spouse from being killed by the help of information, are deductible. In fact, the court escaped answering it, and it could do so, because TP apparently did not prove, e.g. by the help of medical documents or the statement of his wife's doctor, that the information probably would have struck her dead. On the basis of the court's view, deductibility failed only because the facts presented in court were too meagre.

Thus, one of the unsatisfying aspects of the case / decision is, that it touches upon the legal questions without really answering them. The court is giving hints, the tax authorities will (be able to) utilize against blackmailed taxpayers. The court answers questions which he was not at all called to decide upon. Giving, as the judges saw it, the taxpayer had not proven the deadliness of the information, the court only had to soberly say that it was not called to decide upon the question of deductibility without according evidence, and that the court of the first instance had to more exactly investigate the facts.

Interesting is, furthermore, that the court holds that being 83 and in weak health does not mean that one would be killed by "every excitement" (sic!).

The classification of TP's possible confession as an ordinary "every[day] excitement", does neglect two facts. First, if a person learns that her married partner is having a child with another person, the excitement is going to be slightly stronger than an ordinary, day-to-day excitement.

Second, if the recipient of the news is 83 years of age, she might well see her life in broken pieces and suffer a severe, even deadly shock, instead of simply changing her last will (a possibility, which is not only more likely to have deterred TP from informing his wife than consideration for his wife's life, but which might even have influenced the court's decision, i.e. not to let this suspected villain, TP, also escape taxation, after having wormed himself into his wife's confidence).

TP, before he confessed to his wife, could have consulted a doctor, or could have called the doctor in for to attend his wife during his confession, or (sic! "Beiziehung eines Arztes, entsprechende Medikamentierung oder Ähnliches") could have given her drugs to calm her down.

iQ: All the proposals, however, are inappropriate.

The first is unpractical, because the doctor, consulted by TP, either had to give a "remote diagnosis" or would probably have caused even more disturbance than TP's confession (Imagine the doctor saying: "Sorry, but your husband called me to find out whether you are able to face and overcome very bad news, which might kill you").

The second is unsuitable, too. To obligate TP to have a third person in the room when making a - for both concerned people - not only intimate, but also embarrassing confession, goes far beyond the scope of tax law. That can not be brushed away by saying that TP himself caused the embarrassing situation, because his wife was not responsible, so that at least her constitutional right to privacy would have been violated by such an obligation to avoid payments at all costs.

The third proposal (to give drugs) is, at least partly, illegal. If TP was not supposed to openly let his wife swallow some pill in a manner as described above ("Darling, take this pill please, will You? I have really shocking news") and that way to threaten her life, he obviously was expected to trick her into taking such a pill or to in a clandestine manner let her swallow something supposed to either strengthen her heart or weaken her consciousness. In case basic constitutional rights shall furthermore be observed, and the protection of human dignity shall not be replaced by the principle "tax first", this will not be acceptable.

The court left open the question whether the deduction failed already because of the fact that TP did not pursue his claim for repayment against F.

iQ: The question, why TP did not pursue his - existing, and in 1998/9 not yet statute-barred claim against F, however, was not decisive. The court could not have denied deductibility for the assessment year 1996, because in 1996 TP was not able to get back his money from F.

Summing up, on the basis of the rationale, one has to blame TP's lawyer / tax consultant as well as the court of first instance for not sufficiently presenting or investigating the case, so that the Federal Financial Court could escape the balancing of TP's wife's right to live and the state's interest in taxes.

The danger (for the taxpayers) arises from the to a large degree superfluous and talkative rationale of the decision, which, e.g. does simply state that, but not in the slightest justify why, extortions are not to be treated equally with bodily injuries. There, medical costs are deductible, independent of whether the taxpayer caused them or not. It is not understandable, however, why extortions have to be treated differently. That is all the more so, since the bodily injury, other than the extortion, does not necessarily presuppose the involvement of a third person, i.e. their autonomous decision to blackmail and their carrying out of the extortion.

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It could be held, that tax law does "support" blackmailing by allowing for tax deduction. One could furthermore be of the opinion that the state does not have to assist extortions in this way or that the victims shall contact the police, etc. If so, however, the law has to be changed - by the legislator. As long as it remains unchanged, the blackmailed is being granted support in the form of a tax allowance.

The latter takes into account that the victim is between wind and water and has no clear concept how to react (i.e., to unveil his behaviour and thereby to alienate or even antagonize his fellow men, or to pay). Though one does probably not deserve a subsidy for extramarital intercourse, it would be a bit too harsh, to leave the taxpayer alone with his - no doubt - extraordinary burden, solely because he did not act as acurately as a judge or every other likewise perfectly prudent person surley would have.

CLM