Trade tax on sale of co-ownership interests and sub-participations

The principle – trade tax is charged when disposing of an interest in a partnership

When partners who are either a corporation or a partnership sell interests in a partnership (“co-ownership interests”), the gains on disposal are subject to trade tax (section 7 sentence 2 of the Trade Tax Act [Gewerbesteuergesetz – GewStG]).

The trade tax triggered by the sale of the interests in these cases is not charged to the selling partner whose disposal triggered it. Rather, it is charged to the partnership the interest in which was sold. This leads to undesirable effects because those partners who did not sell their share are also financially burdened with the trade tax.

If the sellers or remaining partners are natural persons, the trade tax can be credited against their personal income tax. However, crediting may be subject to considerable restrictions. If it is a corporation or partnership, however, the trade tax burden remains as it is.

Exception – sale by a natural person

No trade tax arises, however, if:

• a natural person
• with a direct interest in a partnership (“co-ownership”)
• terminates or disposes of[MM1]  their entire interest. 

Whether selling the interest is undertaken by a natural person may in certain circumstances be decided differently under tax law than it is under civil law. If tax criteria do not consider a disposal as being undertaken by a natural person, trade tax is due on this transaction, regardless of the fact that under civil law principles it was a natural person who made the sale.

Differing tax assessment[MM2]  of Federal Fiscal Court judgment IV R 26/22

In its judgment of 21 November 2024 (file ref. IV R 26/22), the Federal Fiscal Court (BFH) came to a differing conclusion like this based on the following case (simplified).

The natural person W had an interest and was the limited partner and main participant in a GmbH & Co. KG, a German limited partnership with a limited liability company as the general partner. The natural person F held a sub-participation in W’s interest as limited partner of approximately 65 per cent. The sub-participation was set up in such a way that F participated in the economic success or failure of the GmbH & Co. KG – in proportion to his interest – in the same way as W, and was also able to influence his voting in the GmbH & Co. KG. After F died, the sub-participation fell to the community of his heirs consisting of five children.

At the end of 2014, W sold his entire limited partner interest. This led to the community of heirs’ sub-participation in the limited partner interest coming to an end at the same time. The sub-participation did not provide any entitlement to the limited partner interest in rem, but was only a contractual obligation between W and the community of heirs. Thus it was not possible to transfer the sub-participation to the buyer of the limited partner’s stake. W had to pay out the share of the gains on disposal of the sub-participation to the community of heirs.

The tax authorities held the view that both the sub-participants’ gains on withdrawal and W’s gains on disposal were subject to trade tax on the GmbH & Co. KG level. However, the GmbH & Co. KG expected them to be trade tax-free. The Federal Fiscal Court found in favour of the tax authorities.

In the Federal Fiscal Court’s view, neither the community of heirs nor W met the condition necessary for exemption from trade tax which says that an interest in a partnership must be disposed of “by a natural person”.

Under civil law, W and the sub-participating community of heirs were a silent partnership (Innengesellschaft). For tax purposes, this sub-participant partnership is a partnership (co-entrepreneurship/Mitunternehmerschaft) of its own in the form of an atypical sub-participation. In this specific case, a co-entrepreneurship was considered to exist on the basis of the contractual arrangement of the sub-participation, because the sub-participants were able to develop co-entrepreneurial initiatives on the limited partner interest and bore risk as co-owners.

Under these conditions, the limited partner’s interest in the GmbH & Co. KG was not to be attributed to W or the community of heirs, but to the atypical sub-participation partnership. Although as a silent partnership the atypical sub-participation cannot form collective assets, the limited partner’s interest can be attributed to it for tax purposes based on its connection to the law of obligations.

Under these conditions, from the tax viewpoint it is not W but the atypical sub-participation that disposed of the co-ownership interest. This counts as co-ownership, which is why disposal of a co-ownership interest by a participating natural person directly, in relation to W (who held the limited partner’s interest indirectly via the sub-participation partnership), and in relation to the heirs (who held the interest in the limited partner’s interest indirectly via the community of heirs), was rejected. The trade tax is therefore borne by the GmbH & Co. KG, the limited partner interest of which is transferred.

The Federal Fiscal Court particularly pointed out that if the partnership agreement does not clearly set out the arrangements for disposing of interests, it is questionable whether the partner is under any obligation to compensate for any trade tax burden that comes about under section 7(2) of the Trade Tax Act. In practice, if such an agreement is desired, it must therefore be made explicit.

Conclusion – trade tax and co-ownership interests – what partners now need to know

Precisely because they are silent partnerships, in many cases atypical silent sub-participations within the partnership cannot be identified. It is therefore recommended to include clauses on trade tax in the partnership agreement. This kind of clause cannot prevent the partnership being charged trade tax, but it can ensure that only those partners are charged with the trade tax expense who actually caused it.

Current advisory news in brief

No extended trade tax reduction on disposal of an entire real property during the tax year: Businesses that solely manage and use their own real estate have the option of claiming a so-called extended trade tax reduction (section 9 no.1 sentence 2 f. of the Trade Tax Act). This allows the profits of the on-going rental of real estate, but also gains on disposal to be exempted from trade tax. Claiming this tax privilege is linked to strict conditions. These include it only being granted if the trader has carried on the activities privileged by section 9 no.1 sentence 2 f. of the Trade Tax Act for the entire duration of the tax year. According to the Federal Fiscal Court judgment of 17/10/2024 (III R 1/23), this is not met if an entrepreneur disposes of his entire real estate with effect “as of the start of 31/12”. But disposal on the expiry of 31/12 would be different.

Extended trade tax reduction and rental of business operations: According to the Federal Fiscal Court judgment of 30/10/2024 (IV R 19/22), renting out business operations is not detrimental to an extended trade tax reduction if the main operating objects that characterise the business operation are rented out on the business’s own (developed) property. In the case ruled on, the rental comprised premises that had previously been used for operations with all the installations and appurtenances, including a works hall, but no operating equipment or inventory.

Trade tax add-backs on expenses for advertising from home: Expenses for temporary transfers of rights increase trade income by 6.25% (section 8 no.1(f) of the Trade Tax Act). Transfers of this kind do not include those where a special agency engaged with media planning cannot derive any claims from its contracts with advertising vendors that go beyond the obligation to make advertising visible and include an authorisation to defend against third party claims. In this case, there is no protected position to defend that is necessary (cf. Federal Fiscal Court judgment of 17/10/2024 (III R 33/22).

Pension provisions for contribution-based commitments with no guaranteed minimum amount: According to the Federal Fiscal Court, a pension provision may also be formed under section 6a of the Income Tax Act (Einkommensteuergesetz – EStG) for pensions linked to securities that do not include a guaranteed minimum amount. This contradicts the view of the tax authorities, which had already declined to accept the forming of pension provisions on its merits in these cases. Regarding the size of the pensions provision, according to the Federal Fiscal Court a difference must be made between the contributions made by the employer and those made by the employee as part of their company pension scheme. cf. Federal Fiscal Court judgment of 04/09/2024 (XI R 25/21).