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Accounting & Finance
04. Sep 2025

Method of determining income for a foreign partnership

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If a foreign partnership is required, under its applicable national law, to keep accounts and periodically prepare financial statements, then it can only determine its income in Germany on an accruals basis in accordance with Section 4(1) of the Income Tax Act (Einkommenssteuergesetz, EStG). Use of the cash basis method of accounting (Section 4(3) EStG) is ruled out; this would also apply even if the relevant income in Germany is admittedly tax-exempt, but is subject to the tax progression clause.

Obligation to keep accounts and prepare financial statements arising from foreign legal rules

Under Section 4(3) sentence 1 EStG, taxpayers can determine their income using the cash basis method of accounting only if:

  • they are not legally obliged to keep accounts and periodically prepare financial statements, and
  • they also actually do not keep any accounts and do not prepare any financial statements.

If income from a different partnership is included in the taxpayer’s income - e.g., in the case of a shareholding via a GbR (company/partnership under German civil law) -, then the income should be determined on the basis of the requirements that apply to the original partnership. This obligation to keep accounts and prepare financial statements can also arise from foreign legal rules. Here, it is necessary for such rules to provide for an ongoing obligation to keep accounts and to include a requirement to prepare financial statements that provides for a balance sheet that is similar to the one described in Section 242(1) of the Commercial Code [Handelsgesetzbuch, HGB] (assets and debt obligations on the balance sheet date).

Obligation to keep accounts for a partnership based in Luxembourg

In a case that was recently dealt with by a tax court, a partnership based in Luxembourg was legally obliged to keep accounts and to periodically produce financial statements because of the commercial and corporate legislation there. The Berlin-Brandenburg tax court, in its ruling of 5.3.2025 (case reference: 7 K 7270/14) found that for the foreign partnership there was an ongoing obligation to keep accounts that included a requirement to prepare financial statements. The requirement to prepare financial statements aimed to provide a basis for the accruals accounting method. It thus included a requirement to prepare a balance sheet that, similar to the one described in Section 242(1) HGB, presents the assets and debt obligations of the subject of the profit determination as at a reporting date. This was because, under Luxembourg law, the partnership was required to produce a balance sheet by no later than by 31.12.2010 (or, in any case, by 3.6.2011) where the transactions realised in the period from 3.12.2009 up to 31.12.2009 would have been reflected.

Please note

Even though there was possibly no explicit obligation to prepare financial statements for the relevant year as at 31.12.2009, this was not significant. The crucial factor was that for the entire taxation period - or at least for part of it - there had been a requirement to determine the income in accordance with the principles of the accrual accounting method.

Conclusion

Even under the legal situation in Germany the only significant factor for the blocking effect for an obligation to keep accounts and prepare financial statements is whether the transactions as at any reporting date are included in the annual financial statements. This is because in (German) domestic cases the taxpayer then also has no right to choose, within the meaning of Section 4(3) sentence 1 EStG, if, after the founding year has expired, no financial statements have to be prepared (but instead at a later point in time).