Trade Tax Act (GewStG):

Fundamentals and historical development

Since its introduction in 1936, trade tax has been the most important original source of revenue for German municipalities and has developed into a central element of local self-government. The historical roots of trade tax go back to the municipal finance reform of the Weimar Republic, whereby the basic structure of the law has remained unchanged to this day despite numerous reforms. The importance of trade tax for municipal financial autonomy is reflected in an annual revenue of more than 70 billion euros, which is subject to considerable economic fluctuations and presents municipalities with particular challenges in terms of budget planning. The constitutional guarantee of trade tax as a municipal tax is ensured by Article 28 (2) sentence 3 of the Basic Law, whereby the municipalities are entitled to the assessment rate as an important instrument of municipal tax policy. The reform of trade tax through the 2008 Corporate Tax Reform Act has led to a significant simplification of the assessment basis, in particular through the elimination of trade tax as a business expense and the introduction of a flat-rate credit against income tax. The close integration with income tax and corporation tax characterizes the systematic structure of trade tax, whereby its independent significance as a property tax is ensured by specific additions and deductions. The international dimension of trade tax is gaining in importance due to the increasing globalization of the economy, particularly with regard to the treatment of foreign permanent establishments and the crediting of foreign taxes. The case law of the Federal Fiscal Court and the Federal Constitutional Court has significantly influenced the interpretation of trade tax law and contributed to the constant development of the statutory regulations. The complexity of trade tax law presents both companies and the tax authorities with considerable practical challenges when determining and assessing the tax. The increasing digitalization of the economy and the development of new business models require a continuous adjustment of trade tax regulations. The importance of trade tax as a location factor in international and inter-municipal competition is constantly increasing.

Tax object and tax liability

As a property tax, trade tax is linked to the objective earning power of the business and covers all standing businesses operated in Germany, regardless of the legal form of the business owner. The definition of a commercial enterprise generally follows the requirements of income tax law, whereby the focus is on independent, sustainable participation in general economic transactions with the intention of making a profit. The distinction from freelance, agricultural, forestry and asset management activities is made according to the criteria developed by case law and administration and often leads to difficult qualification issues in practice. The commercial infection of partnerships means that even minor commercial activities can subject the company’s entire income to trade tax. The extended trade tax reduction for real estate companies allows an extensive exemption from trade tax for pure real estate companies under strict conditions. The personal exemptions from trade tax are regulated conclusively in the law and relate in particular to certain public companies and non-profit organizations. The establishment of tax liability is linked to the commencement of commercial activity, whereby preparatory acts can also lead to tax liability. The geographical allocation of the business is based on the location of the permanent establishment, which makes it necessary to split the trade tax assessment amount if there are several permanent establishments. The cessation of tax liability occurs when the commercial activity is discontinued, whereby the cessation or sale of the business triggers special tax consequences. The increasing importance of digital business models poses new challenges for the traditional definition of a permanent establishment. The qualification of hybrid company forms and the treatment of foreign legal entities require careful tax analysis.

Determination of the assessment basis

The determination of trade income as the basis for calculating trade tax is based on the profit determined for income or corporation tax, which is modified by specific trade tax additions and deductions. The close integration with income tax law leads to a complex system of profit determination, whereby the special features of trade tax require a separate calculation. The authoritative nature of the generally accepted accounting principles under commercial law is interrupted by special tax regulations, which requires careful documentation of the reconciliation. The consideration of special operating income and special operating expenses for partnerships is subject to special regulations that require a precise analysis of the circumstances under company law. The tax options for determining profits must be exercised uniformly for trade tax and income tax, which requires forward-looking tax planning. The treatment of capital gains and extraordinary income is subject to special trade tax regulations, which may differ from the income tax regulations. The consideration of losses from the sale or abandonment of business assets follows its own principles, which require a differentiated approach. The international dimension of profit determination is characterized by special regulations on the treatment of foreign permanent establishment results and cross-border service relationships. The increasing importance of intangible assets and digital business models places new demands on the determination of profits. The complexity of determining the basis of assessment requires efficient tax controlling and regular coordination with the tax authorities. The documentation requirements for trade tax profit determination are extensive and must be carefully fulfilled. The ongoing digitalization of accounting and tax returns requires adapted processes and controls.

Additions and deductions

The trade tax additions in accordance with Section 8 GewStG are aimed at capturing the objective earning power of the company regardless of its financing structure, whereby financing expenses in particular are partially added to the trade income. A flat rate of 25 percent is added back for charges for debts if the total exceeds the tax-free amount of EUR 200,000, which can place a considerable burden on companies with debt financing in particular. The pro rata addition of rental and leasing interest for immovable assets at 50 percent and for movable assets at 20 percent is intended to ensure equal treatment of purchase and rental, but in practice often leads to delimitation difficulties. The treatment of leasing installments follows complex allocation rules that differentiate between financing and usage fees and require careful contractual drafting. The addition of license fees and other expenses for the temporary transfer of rights has been tightened by the license barrier in order to limit tax schemes. The trade tax reductions in accordance with Section 9 GewStG are intended in particular to avoid double taxation and ensure property-related taxation, whereby the reduction for real estate is of particular practical importance. The extended reduction for real estate companies allows extensive exemption from trade tax under strict conditions, but requires strict compliance with the legal requirements. The reduction for intercompany dividends for corporations requires a minimum holding of 15 percent and is intended to avoid multiple charges within the group. The international dimension of additions and deductions is characterized by special regulations for foreign income and cross-border service relationships. The complexity of the regulations requires careful documentation and regular review of the calculation bases. Case law is continuously developing the interpretation of the add-back and reduction regulations. Practical implementation requires efficient controlling and regular employee training.

Loss offsetting and trade tax assessment amount

The offsetting of trade tax losses follows separate regulations that differ from the income tax treatment and require a separate loss carryforward at the level of each permanent establishment. There is no limit to the amount of losses that can be carried forward, but they are subject to minimum taxation, according to which losses can only be offset without restriction up to an amount of one million euros plus 60 percent of the excess trade income. The transfer of trade tax loss carryforwards in the case of conversions and restructurings is subject to strict conditions, which in practice often lead to the loss of losses and require careful planning. The trade tax assessment amount is calculated by applying the tax assessment rate of 3.5 percent to the relevant trade income, whereby differentiated allowances must be taken into account for sole proprietorships and partnerships. The final trade tax burden is calculated by applying the municipal assessment rate to the tax assessment amount, which can result in considerable regional differences in the tax burden. Trade tax is offset against income tax for sole proprietorships and partnerships at a flat rate of 3.8 times the trade tax assessment amount, which in many cases largely offsets the trade tax burden. Determining the trade tax base for several permanent establishments requires a careful allocation of profits and losses to the individual permanent establishments. The measurement amount is determined by the tax office as part of a separate procedure that must be coordinated with the determination of profits for income tax purposes. The temporal allocation of profits and losses follows the principle of origin, which requires special calculations in the case of deviating financial years. The provisional nature of trade tax assessment notices with pending basic assessment notices requires efficient controlling of the assessment periods. The increasing complexity of corporate structures places particular demands on the determination and documentation of the bases for assessment. The digitalization of tax administration leads to new requirements for the electronic transmission of assessment bases.

Disassembly and collection

The apportionment of the trade tax base for companies with several permanent establishments is based on a complex system of apportionment criteria, with wages playing a central role as the main apportionment criterion. Determining the apportionment percentages requires precise recording and allocation of wages to the individual permanent establishments, which is becoming increasingly difficult, particularly in the case of flexible working models and home office arrangements. The special features of the apportionment for certain sectors, such as power plants, wind turbines or credit institutions, follow special regulations that are intended to take into account the economic characteristics of these businesses. Trade tax is determined and levied by the municipalities entitled to levy it on the basis of the apportioned trade tax assessment amount, whereby the municipalities have a considerable influence on the actual tax burden through their right to levy. The advance payments on trade tax are levied on a quarterly basis and can be adjusted in the event of significant changes in revenue expectations, which makes it necessary to regularly review business performance. The treatment of back payments and refunds follows complex interest regulations, which had to be restructured following the recent rulings of the Federal Constitutional Court. The electronic transmission of apportionment data and digital communication with the municipalities place new demands on the technical infrastructure of companies and administrations. The increasing mobility of employees and the flexibilization of working models are making inter-municipal coordination on tax allocation issues more important. Appeals against apportionment notices and trade tax notices follow different procedural rules and require careful monitoring of deadlines. The enforcement of trade tax claims by the municipalities is subject to special regulations under administrative enforcement law. The increasing importance of trade tax as a location factor is leading to increased competition between municipalities regarding assessment rates. The complexity of the apportionment and collection procedure requires professional tax management and close coordination between companies, consultants and authorities.

Future prospects and reform discussion

The future of trade tax is at the center of an ongoing tax policy debate, with the question of replacing it with other sources of municipal revenue or a fundamental reform of the existing system being particularly controversial. The increasing digitalization of the economy and the development of new business models are fundamentally challenging the traditional linking of trade tax to physical permanent establishments, which requires new concepts for the taxation of digital value creation. The international competitiveness of Germany as a business location is impaired by trade tax as an additional tax burden, whereby the lack of creditability in international relations in particular leads to disadvantages. The reform of international corporate taxation through OECD minimum taxation will have a significant impact on trade tax and requires national law to be adapted to global standards. The volatility of trade tax revenue poses considerable challenges for local authorities in terms of budget planning, which is prompting considerations about stabilizing municipal revenues through alternative financing models. The increasing importance of working from home and flexible working models requires a reorientation of the breakdown criteria and the definition of permanent establishments in order to ensure an appropriate distribution of tax revenue. The complexity of trade tax law leads to high compliance and administrative costs, which reinforces reform considerations to simplify the system and reduce bureaucratic burdens. European integration and the harmonization of corporate taxation could lead to pressure to adapt the German trade tax system in the medium term. The importance of ecological and social aspects in corporate taxation could lead to a realignment of the trade tax assessment base, taking sustainability criteria into account. Technological developments enable new approaches for determining and monitoring the trade tax base, which could lead to a modernization of the collection procedures. The reform of property tax and other municipal levies will have an impact on the future of trade tax and requires an overall view of the municipal financial system. The political feasibility of fundamental reforms is made considerably more difficult by the constitutional guarantee of municipal financial autonomy and the different interests of the federal, state and municipal governments.