German Tax Court Decides on Exemption of Real Estate Income from Trade Taxes


The German market for real estate remains highly attractive to investors. An increasing number is acquiring shares in foreign and/or domestic companies which own real estate in Germany. In many cases a later share deal offers several advantages for investors selling real estate, such as opportunities to avoid German real estate transfer taxes. Investments in real estate are often made by several investors in concert. Normally, these investors set-up an asset management company, either as a resident or a nonresident one.


Foreign-headquartered MNEs commonly invest and operate in Germany via lower-tier subsidiaries using rented real estate for their business operations. This rented real estate can be owned by another subsidiary that is designated to manage and exploit this asset class within the MNE.


For German trade tax purposes, it is often unclear whether income from real estate is exempted, and to what extent.

A case study

In a typical case, a German corporation holds limited partner interests in a lower-tier partnership. Alternatively, these interests are held by a German partnership conducting business activities. The lower-tier partnership in turn legally owns real estate, but does not conduct any business activities.


The real-estate-owning lower-tier partnership generates rental income from leasing the real estate over the years. Eventually, it sells the real estate and generates capital gains. The German corporation treats the rental income and capital gains as fully exempt from German trade taxes.


During a tax audit, the German tax authorities decide that the requirements for an extended exemption from trade taxes are not met. They base their decision on the fact the real estate is legally owned not by the German corporation itself but by the lower-tier partnership. The taxpayer argues this is not decisive because the partnership is treated as transparent for German income tax purposes.

Legal background of trade tax exemption

In principle, German corporations are fully subject to German trade taxes. This also applies to partnerships which conduct business activities or which are deemed to do so.


By default, a small percentage of the average unit value of real estate reduces the taxable income for trade tax purposes. This is intended to lessen the blow of any double taxation from real estate taxes and trade taxes. However, in practice the impact of the trade tax relief is very limited.


Alternatively, taxpayers can request an extended exemption of any income from real estate. To be eligible, the German corporation has to exclusively manage and exploit (e.g. lease) its own real estate. This exclusivity is open to interpretation:

  • The management and exploitation of real estate is limited to real estate owned by the corporation. This means the management of other real estate is harmful.
  • No other activities may be conducted by the corporation throughout its fiscal year. The additional (but not sole) management of capital assets, such as the collection of receivables, is harmless.

There are some exceptions from the extended trade tax exemption. In particular, the corporation’s shareholders may not use the real estate.

Grande Senate applies substance over form

Contrary to the view of the tax authorities and the First Senate of the Federal Tax Court, which is competent for international tax matters, the court’s Grand Senate found fault with the application of the concept of the legal ownership in the case at hand (case no. GrS 2/16). It argued income tax principles should take priority over a civil law perspective. Therefore, the real estate legally owned by a mere asset-managing partnership has to be apportioned to its partners according to their interest portion.


The Federal Tax Court’s Grand Senate also confirmed that the asset management activities of the lower-tier partnership are harmless for the application of the extended trade tax exemption at the level of the upper-tier German corporation. This is at least the case if the corporation only exercises its rights as a partner of the lower-tier partnership.

Implications for investors in real estate

The Federal Tax Court decision brings legal certainty to real estate companies, foreign investors and MNEs. In practice, the earlier decision taken by the court’s First Senate had previously led to uncertainty. A strictly civil law perspective would have greatly undermined the already narrow scope of the extended exemption of real estate income from German trade taxes.


Holding an interest in a purely asset-managing partnership, which is the legal owner of the real estate, thus does not stand in the way of the extended exemption of real estate income from trade tax purposes at the level of the upper-tier corporation. Separating the real estate portfolio into several subsidiaries under civil law is therefore no longer hampered by trade tax considerations. It also remains permissible to set up a trust structure to completely ignore incorporated subsidiaries for income tax purposes.


It now remains to be seen how the tax authorities and even the legislature will react to the court’s decision.

Sole relevance of the economic ownership

To benefit from the extended exemption, the real estate must be managed and exploited (e.g. leased) from the first to the last day of the financial year without any interruption. Under civil law, it is left to chance when a transfer of legal ownership takes place, and it is completed only with the entry in the land register. Following the new guiding principles of the Federal Tax Court’s Grand Senate, the decisive factor is whether the ownership of the real estate was transferred for income tax purposes. Under higher-ranking German tax laws, the transfer of ownership of any asset is evaluated primarily on when the economic ownership is transferred.


The economic owner can regularly prevent the legal owner from exercising any economic influence on the asset involved for the usual useful life of that asset. Compliance is measured against the transfer of economic ownership to a purchaser is consistently determined by taking into account the circumstances of the individual case.


In the sale and purchase of real estate, the transfer of its economic ownership requires that possession, opportunities and risks are transferred to the purchaser pursuant to the purchase agreement. The purchaser must, by virtue of a legal act, have already acquired a legal right to acquire the real estate that it can no longer be required to relinquish against its will. As a rule, the purchaser cannot become the economic owner until the purchase agreement is concluded.