06.02.2025Federal tax court clarifies requirements for trade tax deduction for income from certain real estate activities
Company must conduct real estate activities for entire fiscal year.
The German federal tax court (BFH), on 23 January 2025, published a decision dated 17 October 2024, ruling that a real estate company could not take a deduction for trade tax (TT) purposes for income from real estate activites where the company sold all of its real estate at the beginning of the last day of its fiscal year (FY), in contravention of the requirement that real estate activities must be conducted for the entire FY. The decision of the BFH rejects the view of the lower tax court of Muenster, which ruled in favor of the taxpayer, and confirms the view of the tax authorities.
Background
Based on Germany’s federalistic tax system, the TT is an income tax that applies at the local (municipal) level to business activities. The calculation of taxable income for TT purposes starts with the taxable income that is calculated for federal corporate income tax purposes, which is then subject to certain adjustments. Municipalities are free to apply their own TT rate on the adjusted TT basis, but typically the TT rate is between 7% and 17%, with an average rate of approximately 14%. Together with the federal corporate income tax rate of 15.825% (which includes a solidarity surcharge), this results in an average combined rate of approximately 30% for corporations.
Among the adjustments that must be made to the tax basis for TT purposes are certain addbacks, e.g., interest payments, royalties, and rent payments, resulting in the limited deductibility of such payments for TT purposes. On the other hand, certain additional deductions are available, particularly for activities related to real estate. For example, a deduction for TT purposes in an amount of 1.2% of the special tax value of any real estate that is owned by a business (and not exempt from property tax) applies (which is in addition to the corporate income tax deduction allowed for annual real estate taxes). In addition, a TT deduction for income from the operation or use of a company’s own real estate applies where the company exclusively operates or uses the real estate, or exclusively develops and sells such real estate for housing purposes (referred to as the “extended TT deduction”). As a result, income from such real estate activities is essentially exempt for TT purposes.
In order to benefit from the extended TT deduction for income from real estate activities, the activities must be carried out for the company’s entire FY. Activities related to investment assets are allowed, as long as the activities take place alongside the real estate acitivites. However, the investment activities may not be the only activities of a company at any time during the FY (e.g., before or after the company engaged in real estate activities). As such, a pro rata approach where a taxpayer would qualify for the extended TT deduction for only a certain period of the FY is not allowed (i.e., an “all-or-nothing” approach).
Facts of case and BFH decision
In the case decided by the BFH, a real estate company that was engaged in real estate activities sold all of its real estate with effect as of the beginning of the last day of the FY, which in this case was 31 December of the year at issue. The BFH ruled that a sale with effect as of the beginning of 31 December resulted in the company not being engaged in the real estate activities during the entire FY, as the FY includes the period from the beginning of 1 January to the end of 31 December. A sale of the real estate with effect as of the end of 31 December (at midnight) would have been acceptable; however, a sale with effect as of the beginning of 31 December was seen as harmful by the BFH. As a result, the BFH denied the extended TT deduction for income from real estate activities, and only granted the TT deduction of 1.2% of the special tax value of the real estate.
Comments
The BFH decision should remind taxpayers that the proper drafting of documents and timing considerations are of utmost importance from a tax perspective. Although the BFH in its decision mentions that a sale of the real estate as at 31 December at 23.59 hours would have been acceptable, taxpayers should refer to the end/expiration of 31 December in such a situation in order to benefit from the extended TT deduction. Timing considerations in this regard are not only of relevance for purposes of the extended TT deduction but also in many other situations in German tax law.
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