The local tax court of Düsseldorf recently decided a case (9 K 2067/03-F) concerning the allocation of the taxable income of a partnership to its partners when the partnership interest is transferred during a financial year. The case involved an individual who sold his limited partner’s interest in a German partnership (GmbH & Co. KG), which was the controlling entity in a German fiscal unity, shortly before the end of the financial year of the partnership and the controlled subsidiaries. Under the purchase agreement, the buyer acquired the interest in the partnership, including the profit participation rights for the profits of the entire financial year. The partnership had incurred losses in the financial year of the transfer, aside from the profits received from its subsidiaries due to the profit and loss pooling agreements. The taxpayer argued that, under German company law, the profits of the controlled subsidiaries had been transferred to the partnership as of the financial year end and, therefore, after the sale of the interest in the partnership took place. Hence, the profits of the controlled subsidiaries should be allocated solely to the new partner for tax purposes.
The court held that the profits of the partnership generally must be allocated to the previous partner and the new partner in the partnership based on interim financial statements and that, according to settled case law of the Federal Tax Court (BFH), all profits of the partnership that arose before the transfer – including profits of the controlled subsidiaries – must be allocated to the previous partner for tax purposes. The court said that the allocation of profits to the new partner according to German company law would not be decisive since, from a legal perspective, the previous partner generally would be entitled to claim his share of the profits of the controlled subsidiaries that arose while he was holding the interest in the controlling partnership. The case is currently pending before the BFH.
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