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Tax
10. Mar 2026
StB Patrick Loibl / Eric Wagner

Deduction of business expenses in the case of contracts between related parties - There is no written form requirement

Contracts between related parties are repeatedly the subject-matter of disputes between taxpayers and the fiscal administration as to whether the arm's length principle has been applied. If the arm's length principle is not satisfied, then there is a risk that the contract will not be recognised for tax purposes. In a recent ruling, the highest court has now pivoted away from what previously applied.

Pivoting towards taxpayers

In the present case, both the local tax office as well as the Thuringian tax court refused the deduction of business expenses due to the lack of a written contract. However, by setting aside the ruling of the tax court, the Federal Constitutional Court (Bundesverfassungsgericht, BVerfG) - through its ruling of 27.5.2025 (case reference: 2 BvR 172/24) - decided in favour of the taxpayers. In the following section, the key aspects of the arm’s length test are outlined and the practical significance of the ruling by the BVerfG is derived.

Definitions of related parties under tax law

Indications as to who is considered to be a related party can be found in various places in German tax legislation. An affiliation can be established through relationships defined under family law, company law, the law of obligations or also clearly de facto relationships. Both natural persons as well as legal entities may be considered to be related parties. Section 15 of the Fiscal Code (Abgabenordnung, AO) describes, in an exhaustive list, who is considered to be a related party within the meaning of tax law. From a tax perspective, there is generally a close relationship between related parties.

Section 1(2) of the Foreign Transactions Tax Act (Außensteuergesetz, AStG) likewise defines an affiliation between parties where specific ownership structures exist and various profit entitlement ratios are met, and the taxpayer is able to exert, directly or indirectly, a controlling influence or affect the terms of business relationships in any other way.

Requirements for agreements between related parties

In Germany, the conclusion of contracts is generally not subject to any formal requirements, unless otherwise provided for by law. In addition to the formal requirements under civil law, German tax law imposes stricter requirements on contracts between related parties. This is intended to ensure that these contracts are likewise concluded at arm’s length and thus, not least, to guarantee fair taxation for all taxpayers.
According to the so-called arm’s length principle, the following requirements must be imposed on contracts between related parties:

  • Written form - The contracts should be written down with clear and unambiguous content.
  • At arm’s length - The terms and conditions of the contract should be in line with the usual market standards. This applies not only to the amount of the remuneration but also to other conditions, for example, termination provisions.
  • Actual implementation - The contract has to be actually implemented. Agreed payments must be made when they are due and the agreed goods or services must be provided.

Please note

In principle, all types of contracts under the law of obligations are possible, such as loan agreements, but also lease, rental, and employment agreements or compensation agreements.

Requirements in the case of a business expense deduction - Arm’s length comparison

According to Section 4(4) of the Income Tax Act (Einkommenssteuergesetz, EStG), business expenses are the costs that a business incurs while conducting its operations. Business expenses must be documented for the local tax office. The law does not specify any particular formal requirements. Nevertheless, contracts between related parties must satisfy the arm's length test. This means that an unrelated third party would have concluded agreements with the same content and the same effects under the same circumstances. Apart from other criteria, this also includes - but is not limited to - the written documentation of the agreement that has been made. This is precisely where the ruling by the BVerfG was aimed at.

The BVerfG on payments between affiliated partnerships

In the present proceedings, the BVerfG had to deal with the question of the extent to which the deduction of business expenses for payments between affiliated partnerships may be denied (solely) on the grounds of a lack of written form. The key statement in the ruling by the BVerfG of 27.5.2025 (case reference: 2 BvR 172/24) was that the checks of the underlying agreement, which in each case took place on a preliminary basis - in particular the one carried out by the Thuringian tax court and the Federal Fiscal Court - disregarded the established case law of the highest court. According to this, the refusal to allow the deduction of business expenses, whatever the amount, within the scope of an arm’s length test for agreements between related parties cannot occur solely because the agreement was not documented in writing. The tax courts unlawfully made a checking step that was not explicitly provided for by law into an independent factual criterion for the deduction of business expenses under Section 4(4) EStG, thereby violating the principle of equal treatment under Article 3 of Germany’s Basic Law. Consequently, the ruling by the Thuringian tax court was overturned and the matter was referred back there for a hearing and decision by other means.

Practical implications

The ruling by the BVerfG did not abolish the written form requirement for contracts between related parties, but rather it clarified that the arm’s length test should be carried out not solely on the basis of the form, but rather always in the context of an overall assessment of all the circumstances. The Thuringian tax court failed to take this into account insofar as it denied the deduction of business expenses solely on the basis of the agreement not being in writing. In this respect, it can also be inferred from the ruling by the BVerfG that contracts between related parties do not always and only have to be in writing. It is the taxpayer’s responsibility to prove the existence of contracts concluded at arm's length. Besides written contracts, proof could generally also be provided through other documents, for example, accounting records, order documents, or any other records that indicate that there is a contractual relationship.

Conclusion

In practical terms, it remains the case that a written agreement with related parties that conforms to the arm's length principle makes it much easier to provide evidence to the tax authorities. Even though it is possible to provide other forms of evidence, in most cases, these are nevertheless likely to be only the second-best solution. In a specific case, should there be no written agreement, the ruling by the BVerfG shows that searching for alternative proof and a certain degree of persistence on the part of the taxpayer can indeed pay off.