Introduction
When planning a cross-border investment in Germany, foreign investors are generally faced with the decision whether to invest via a sole proprietorship, a corporation or a partnership. While each legal form generally carries diverging tax consequences for current taxation, it is also necessary to consider the tax consequences arising from the acquisition itself. Especially when it comes to the taxation and the sale of partnership shares, a multitude of peculiarities have to be considered. In light of a recent verdict from the Federal Constitutional Court from 10/4/2018, the consequences resulting from the sale of partnership shares for German (corporate) income and trade tax are examined in the following.
German Income and Corporate Income Tax
The sale of shares in a German partnership is generally treated as a taxable event for German income and corporate income tax. Since partnerships are generally treated as transparent “pass through” entities for German tax purposes, the resulting capital gains are fully taxable at the level of the shareholder that realized the capital gains. Depending on whether the seller is a natural person or a corporation the capital gains are taxed with income tax (0- 45 per cent) or with corporate income tax (15 per cent). On the buyer side the acquisition leads to a tax neutral purchase with step-up of the tax book values (in a supplementary tax balance sheet), resulting in a higher depreciation base.
German Trade Tax
German trade tax represents a peculiarity that is highly unusual by international standards. The trade tax rate is dependent on the municipal multiplier and usually amounts to around 15 %. According to Sec. 7 sent. 2 of the German Trade Tax Act the capital gains resulting from the disposal of the partnership shares are generally subject to trade tax, unless the direct seller is a natural person, in which case the capital gains are fully trade tax exempt. Notwithstanding the transparent treatment of partnerships for income tax purposes, the arising trade tax is not due at the level of the shareholder, but is instead fully taxable at the partnership level. In other words, the seller is not liable for the trade tax that results from his sale of shares. Instead, the partnership itself owes the trade tax. The Federal Constitutional Court was recently faced with the decision whether this separation of the capital gain at the shareholder level (resulting in a higher financial capability) and the liability to pay trade tax at the partnership level (resulting in a lower financial capability) was in line with the German Constitution. In its verdict the Court declared that the relevant provision does not violate the German Constitution, and that the seeming divergence of financial capabilities is compensated due to the tax neutral step up of the book values in the supplementary tax balance sheet, which leads to higher future depreciation and therefore raises the partnerships financial capability in the long-term.
Outlook
The partnership’s liability to pay trade tax on the capital gains resulting from the disposal of shares represents a divergence from the German transparency principle and is highly unique from an international viewpoint. It is of utmost importance for foreign and domestic investors alike to consider the trade tax consequences from the acquisition and sale of partnership shares in the due diligence and negotiation procedures and to potentially include a corresponding trade tax clause in the purchase agreements.