In Brief
05. Mar 2025

Prohibition on the deduction of a part of business expenses for holding partnerships

A holding partnership that generates solely dividend income may offset against tax only 60% of the general costs for administration and for preparing consolidated financial statements. This was recently decided by the Federal Fiscal Court (Bundesfinanzhof, BFH) with respect to the application of the prohibition on the deduction of a part of the business expenses pursuant to Section 3c(2) of the Income Tax Act (Einkommenssteuergesetz, EStG); this ruling is likely to have far-reaching implications for the tax treatment of holding structures.

The BFH ruling of 27.11.2024 (case reference: IV R 25/22) concerned a GmbH & Co. KG  [a German limited partnership with a private limited company (GmbH) as a general partner] that acted as a holding company and held 100% of the shares in a corporation (V-GmbH), which in turn held shares in other companies. In 2017, the relevant year, the holding partnership generated solely dividend income from its shareholding in V-GmbH. The company claimed that its business expenses for the preparation of financial statements and auditing work, legal advice, money transactions as well as the fees paid to the Chamber of Commerce and Industry (IHK) were fully deductible for tax purposes. By contrast, the local tax office only allowed a partial deduction of 60% of the business expenses in accordance with Section 3c(2) EStG. The legal action brought against this assessment by the holding company before the tax court of Cologne (ruling of 25.8.2022, case reference: 3 K 999/20) was not successful.

The BFH endorsed the view of the local tax office and decided that just 60% of the business expenses of the GmbH & Co. KG were deductible. Under Section 3 no. 40 sentence1(b) EStG, 40% of the dividend income of a partnership is tax exempt. Accordingly, Section 3c(2) EStG specifies that only 60% of the expenses having an economic link with this tax-exempt income may be deducted. The BFH explained its decision stating that the prohibition on the deduction of a part of the expenses is intended to prevent taxpayers from having a double advantage from the deduction of expenses that are linked to tax-exempt income. The determining factor for the application of the prohibition on the deduction of a part of the expenses is the economic link with the tax-exempt income. 

In this respect, the BFH made it clear that expenses would have an economic link with tax-exempt dividend income if the reason for them was the generation of this income.  However, the following aspects need to be taken into account:

  • The economic link does not depend on whether the expenses are based on legal or civil obligations (e.g., financial statements and auditing costs, or IHK fees).
  • An indirect economic link is sufficient.
  • If there is an economic link with several types of income (both taxable as well as tax exempt), then the expenses have to be divided up proportionally.

Outcome

In the present case, the holding company had generated solely dividend income so that its expenses, according to the BFH, were entirely subject to the prohibition on the deduction of a part of these. The refusal to allow the deduction of a part of the business expenses was justified because, in the relevant year, the company had only generated income that was subject to the partial income method. The ‘triggering moment’ for the expenses, which were the subject-matter of the dispute, was the business decision to hold shares in other companies in order to generate dividend income.