Federal Tax Court rules on trade tax liability of German KG with one partner for income tax purposes

For civil law purposes, a German business partnership (e.g. KG, OHG) must have at least two partners. While such a partnership is tax transparent for (corporate) income tax purposes, the partnership itself is regularly subject to trade tax. Since a partnership cannot be part of a tax group with one of its partners even if that partner holds 100% of the partnership interest (with the other partner holding a 0% interest), trade tax losses suffered at the level of the partnership cannot be offset against trade tax profits at the level of the partners, and vice versa. 

The “trust model” was developed to counteract this adverse tax consequence. Under the trust model, the general partner of a German limited partnership (KG) regularly holds 100% of the partnership and the limited partner holds a 0% interest, but it holds its participation as a trustee for the general partner acting as the trustor. Thus, in the past, the general partner was considered the only partner of the business KG for income tax purposes, as a result of which the business KG was not treated as a co-entrepreneurship (Mitunternehmerschaft) and, therefore, was not liable to trade tax itself. Instead, the business activity carried out in the legal body of the partnership was considered to be conducted by the general partner. 

Both the German tax authorities and the lower tax court of Düsseldorf disallowed the described treatment and concluded that the business KG should be liable to trade tax (only structures implemented until 18 September 2004 were accepted under a transition rule). However, the Federal Tax Court (BFH) recently rejected this position (case reference IV R 26/07). The BFH decision could revitalize the trust model and create opportunities for tax planning in several areas. It is currently unclear, however, how the tax authorities will react to the decision. 

If you have any questions, please contact the authors of this article at gtln@deloitte.de or your regular Deloitte contact.