No expanded trade tax reduction for the subletting model

The Federal Fiscal Court (Bundesfinanzhof) had already blocked applying expanded trade tax reductions to lettings between two controlled companies belonging to the same consolidated tax group in the past. According to the Federal Fiscal Court’s latest judgment, of 11/07/2024 (III R 41/22), this is also to apply if the renting controlled company sublets the properties to third parties. This may result in additional tax burdens in the consolidated tax group in the subletting model.

Expanded trade tax reduction under Section 9 no.1 sentence 2 Trade Tax Act (Gewerbesteuergesetz – GewStG) 

Expanded trade tax reduction offers companies complete relief from trade tax if they exclusively manage and use their own real estate. This also applies to separate real estate entities within a group of companies engaged in trading activities. In these cases, benefiting companies are usually only subject to corporate income tax. Furthermore, they have the option of taxing their profits from property management at a corporate tax rate of only approx. 15 percent. 
The Federal Fiscal Court had already decided on these cases in its judgments on 18/05/2011 (X R 4/10) and 30/10/2014 (IV R 9/11), stating that expanded trade tax reduction under Section 9 no.1 sentence 2 of the Trade Tax Act is excluded for real estate companies if real estate is let among controlled companies within the same consolidated tax group. In the Federal Fiscal Court’s view, claiming this expanded reduction for real estate controlled companies would result in the controlling company not being subject to trade tax on rental income. This applies even though it would be possible to deduct the corresponding rental expenditure (at least partially).

Subletting model within a consolidated tax group 

The claimant (BFH 11/07/2024 – III R 41/22) was a group ultimate parent in the form of a German limited company (GmbH) and functioning as a holding company and controlling company for income tax and VAT purposes. Seventeen controlled companies owning real estate, including the sister company, W GmbH, were included in the consolidated income tax group. The 17 controlled companies had leased their entire real estate to W GmbH to sublet. So W GmbH was the central management and marketing company. It let out the real estate in its own name to third parties outside the consolidated tax group. It bore the expenses and took care of management of the real estate. This is known as the “subletting model” (Weitervermietungsmodell). 

W GmbH recognized lease payments to the 17 real estate companies as an expense. W GmbH did not make an add-back due to the tax group relationship. However, 13 of the real estate companies claimed expanded trade tax reductions under Section 9 no.1 sentence 2 of the Trade Tax Act. During a tax audit the auditor objected to this, referring to the Federal Fiscal Court decisions of 18/05/2011 (X R 4/10) and 30/10/2014 (IV R 9/11). 

Expanded trade tax reduction in consolidated tax group blocked in the subletting model

Unlike the decision of Düsseldorf Fiscal Court of 22/09/2022 (9 K 2833/21 G), the Federal Fiscal Court in its decision of 11/07/2024 followed the tax authorities’ view and denied claiming expanded reduction. With respect to the applicability of the trade tax add-back and reduction provisions in the context of a consolidated tax group, the Federal Fiscal Court referred to the business relations between the group’s controlled companies. From the standpoint of the controlling company, in these business relations expense and income from the same transaction correspond to each other. The fact that only rental expenses and income are settled among the controlled companies but that on the controlling company level trading income also includes the profit from lease payments made by external third-parties doesn’t make any difference. 

If the marketing company were not part of the consolidated group, the real estate companies would have been able to claim expanded trade tax reductions (but half of the amount is added back in accordance with Section 8 no.1(e) Trade Tax Act at the marketing company). The Federal Fiscal Court’s decision consequently results in disadvantaging consolidated income tax groups in the subletting model. 

Practical note on trade tax reduction for the subletting model

Existing structures within consolidated tax groups should be examined and adjusted as necessary to avoid trade tax disadvantages. In consolidated income tax groups, it is recommended that real estate companies carry out the lettings themselves. If it is alternatively desired that a centralised management and marketing company act as an intermediate tenant, this corporation should not be included in the consolidated tax group.  

This judgment may be viewed as a confirmation of the Federal Fiscal Court continuing to allow expanded trade tax reductions for leases between sister companies (outside the consolidated tax group).

If you have any queries about how to structure your consolidated tax groups or other tax aspects, we’ll be glad to talk to you. 

Current advisory news in brief 

Bundestag passes Annual Tax Act 2024: On 18/10/2024, the Bundestag passed the Annual Tax Act 2024. Many amendments were made, compared to the government bill. These include tightening the corporate income tax clause in Section 6(5) sentence 6 of the Income Tax Act (EStG). In response to the Federal Fiscal Court judgment of 15/07/2021 (IV R 36/18), a new sentence has been added to Section 7(5), designed to prevent arrangements involving multiple actions, whose basic content is to transfer individual economic goods from one corporate income tax subject to another. The new rule is to be applied to transfers of economic goods taking place on the day after the law is adopted. So it may still be possible to defend already existing cases by referring to the Federal Fiscal Court decisions referred to at the beginning. The federal council (Bundesrat) has yet to give its approval. The federal council is scheduled to address the matter on 22/11/2024. 

Draft of a revised Federal Ministry of Finance Circular on the interest deduction cap (Section 4h EStG, Section 8a KStG): On 10/10/2024, the Federal Ministry of Finance published a revised Circular on the interest deduction cap. The Kreditzweitmarktförderungsgesetz of 22/12/2023 amended the interest deduction cap of Section 4h of the Income Tax Act (EStG) and Section 8a of the Corporation Tax Act (KStG) starting from the assessment period 2024. The draft deals with the following aspects: the scope of interest expense and income, carrying forward EBITDA, and the exemptions of Section 4h(2) of the Corporate Income Tax Act (stand-alone clause and comparison of equity of group businesses and definition of group). 

Application of the deduction ban on debt interest under Section 4(4a) of the Income Tax Act after transformation, changing a GmbH into a partnership (Münster Fiscal Court of 12 June 2024 – file reference 6 K 564/19 G F): If a GmbH is changed into a partnership by transformation, the positive equity taken over by it is to be considered a (notional) contribution for the purposes of Section 4(4a) of the Income Tax Act. The Münster Tax Court thus contradicts the tax authorities, whose view was that any withdrawals more or less at the date when a GmbH changes form must amount to €0. Therefore, Section 4(4a) of the Income Tax Act does not apply to corporations. In the Tax court’s view, a change in legal form is to be understood in the same way as the new formation of a partnership, with the partners making the initial contribution of funds. 

An appeal is pending at the Federal Fiscal Court under file reference IV R 10/24. Cases concerned should be kept open in reference to the pending proceedings.