Deduction for trade tax purposes when a business is leased out -The Federal Fiscal Court has clarified important practical issues
The privilege of not having to subject rental and leasing income to trade tax depends on satisfying strict preconditions. In a recent ruling, the Federal Fiscal Court (Bundesfinanzhof, BFH) clarified fundamental questions about the granting of the so-called extended deduction for property when businesses are leased out.
Background - The extended deduction for property under trade tax legislation
The extended deduction for property under Section 9 no. 1 sentence 2 of the Trade Tax Act (Gewerbesteuergesetz, GewStG) allows companies to reduce their commercial income by the amount that can be allocated to the management and use of their own property. The basic purpose of this total exemption here is to put property companies that are subject to trade tax merely because of their legal form (especially corporations and partnerships deemed to be of a commercial nature), in terms of their trade tax burden, on an equal footing with individuals or partnerships that solely manage the assets of property management entities.
The prerequisite is that the company exclusively manages its own property or, in addition to this, its own capital assets. Up to now, it was a matter of dispute whether leasing out a business - thus transferring an entire business, or substantial parts of the operation - precludes this concession. The BFH, in its ruling of 30.10.2024 (case reference: IV R 19/22) has now again provided some more clarity about the circumstances under which leasing out a business may nevertheless be compatible with the extended deduction for property.
Facts of the case and the clarifications by the BFH
The German limited partnership (Kommanditgesellschaft, KG) making the claim had, until the end of 1987, operated a car dealership in its own building complex that had been erected on a plot of land belonging to its partners. At the end of 1987, the KG leased out the spaces that had been used previously to X AG [a joint stock corporation, in German referred to as Aktiengesellschaft, AG], which continued to operate the car dealership there. At the same time, the KG sold all the business equipment to X AG. In 2011 - 2013, the relevant years, the claimant used just a small office in the building complex for its own management activities while the other areas were leased out to X AG and other companies, or were vacant.
The BFH, in its ruling of 19.12.2023 (case reference: IV R 5/21), had already established that terminating the original commercial activity of a partnership deemed to be of a commercial nature does not terminate its trade tax liability, but instead its commercial nature is once again revived and the trade tax liability continues to exist even after the original commercial activity is terminated. The original commercial activity will not be carried on if the business is interrupted or is suspended, therefore, an original commercial activity that would exclude an extended deduction for property cannot generally be deduced from the suspended/interrupted business and its leasing out (a change in the case law). In its aforementioned newer decision of 30.10.202, the BHF stated this view more precisely in three key points.
- Leasing out a business is not automatically harmful with respect to the deduction - Leasing out a business would not rule out the extended deduction for property if solely own (developed) property is rented out and this constitutes the “significant operational items”. The crucial factor is that no additional harmful services (e.g., leasing out furniture and fittings as well) may be provided. In the present case, the claimant had sold the business equipment in 1987 already so that the leasing out was limited to the property that it held. The BFH stressed that the specificities of the leased out property, leading to the property that is held constituting the sole essential operational base for the interrupted trade or business, would in themselves not be sufficient to cross the boundary for the classification as a trade or business and thus to the refusal of the extended deduction for property.
- Own property held in special business assets - The BFH confirmed that property held in a partner’s special business assets is likewise regarded as ‘own’ property within the meaning of Section 9 no. 1 sentence 2 GewStG. This has made it clear that the allocation of assets within a partnership does not matter so long as the property is used for business purposes.
- Definition of harmful ancillary operations - The BFH’s senate differentiates between not harmful and harmful ancillary operations. Services that are not harmful are accordingly those that serve to ensure the security of the property. As examples, the BFH mentioned, depending on the type and size of the property, guarding the property, publicity measures, or the cleaning of communal areas in the let property and in the offices used for its management. By contrast, harmful activities would be those that are of a commercial nature, thus for example, the active management of parking spaces for third parties, or the provision of specific services that go beyond simply leasing out.
Integration into the existing case law
Up to now, the assumption in administrative practice and case law was that when businesses are leased out this normally results in a refusal to allow the extended deduction for property because the assets that are not tax-privileged (e.g., machines) are typically also included (cf., among others, BFH ruling of 14.6.2005, case reference: VIII R 3/03, German Federal Tax Gazette [Bundessteuerblatt, BStBl.] II 2005 p. 778). With its latest rulings, the BFH has qualified its opinion and clarified that merely leasing out a property - even in the form where the tenant continues to operate the business - does not generally contravene the exclusivity requirement.
Concurrently, the BFH confirmed the strict exclusivity requirement; marginal commercial ancillary operations could already result in the complete forfeiture of the deduction. De minimis exceptions are not available.
Practical implications for companies
The ruling provides leeway for tax planning but, at the same time, requires careful documentation and definition.
- Check the property for let - Companies have to ensure that solely property will be let. For example, operating equipment or third party assets should not form part of the lease. The sale of business equipment - as in the case of the claimant - should be clearly spelt out contractually in order to remove any subsequent doubts.
- Critical assessment of ancillary operations - Services, such as the management of parking spaces or security checks, need to be reviewed in order to determine whether they serve to protect own assets or whether they must be viewed as additional services.
Conclusion: BFH has provided clarity on how to deal with the remaining uncertainties
The BFH ruling has provided clarity to the effect that when businesses are leased out this does not per se rule out an extended deduction for property. It simultaneously underscores the need for precise contract arrangements and a clear demarcation of ancillary operations because these are only not harmful with respect to the deduction for property if here the activities are absolutely necessary ones that are focused on the management and use of own property.
