Determination of the profit threshold for the investment deduction (“Investitionsabzugsbetrag”) (Sect. 7g of the Income Tax Act)

“Profit” as an essential element of income taxation

Income under Sect. 13, 15, and 18 of the Income Tax Act must be determined as “profit” within the meaning of Sect. 2(2) sent. 1 no. 1 of the Income Tax Act. This is determined in accordance with the regulations of Sect. 4 ff. of the Income Tax Act and, in the case of profit determination via tax accounting (Sect. 4(1) of the Income Tax Act), also includes comprehensive off-balance-sheet adjustments. In the case of corporations, these are described in detail in Sect. 7.1(1) sent. 2 of the Corporate Income Tax Guidelines.

The off-balance-sheet adjustments referred to here include, in particular, comprehensive sets of rules such as the (partial) exemptions under Sect. 3 no. 40 of the Income Tax Act, Sect. 8b of the Corporate Income Tax Act, the interest limitation rule (“Zinsschranke”) (Sect. 4h of the Income Tax Act, Sect. 8a of the Corporate Income Tax Act), the CFC (“controlled foreign companies”) rules (“Hinzurechnungsbesteuerung”; Sect. 7 et seqq. of the German Foreign Transactions Tax Act (“Außensteuergesetz”); Sect. 7.1(1) sent. 2 line 18 of the Corporate Income Tax Guidelines), or adjustments for hidden distributions (Sect. 8(3) sent. 2 of the Corporate Income Tax Act). 

In addition, trade tax, among other things, is not to be considered as a business expense due to a statutory provision, Sect. 4(5b) of the Income Tax Act (ruled constitutional in the Judgement of the Federal Tax Court dated September 10, 2015, file number IV R 8/13, Federal Tax Gazette II 2015, p. 1046, for income tax purposes). This regulatory instruction is - despite its wording - implemented in such a way that trade tax is still considered an operating expense (Judgement of the Federal Tax Court dated January 16, 2014, file number I R 21/12, Federal Tax Gazette II 2014, p. 531, margin no. 10), therefore, a provision (“Rückstellung”; Sect. 249(1) German Commercial Code (“HGB”)) must first be recognized as a liability, and its income tax effects are neutralized off the balance sheet (Sect. 7.1(1) sent. 2 line 14 of the Corporate Income Tax Guidelines; Sect. 5.7(1) of the Income Tax Guidelines). 

In many cases, for smaller businesses, the underlying trade tax obligation (Sect. 2 of the Trade Tax Act) coincides with the desire to claim the investment deduction under Sect. 7g(1)-(4), 7 of the Income Tax Act. Since the amendment of Sect. 7g of the Income Tax Act (old version; at the time “accumulated depreciation”; “Ansparabschreibung”) via the 2008 Corporate Tax Reform Act (“Unternehmensreformgesetz”) to Sect. 7g of the Income Tax Act (new version; “investment deduction” (“Investitionsabzugsbetrag”)), its effects must also be accounted for off-balance-sheet upon its initial claim (Judgement of the Federal Tax Court dated April 11, 2019, file number IV R 1/17, margin no. 22). 

Before such a claim can be considered, the eligibility (“Förderungswürdigkeit”) is assessed, among other things, by virtue of the profit threshold under Sect. 7g(1) sent. 2 no. 1 lit. b of the Income Tax Act: This profit may not exceed EUR 200,000 in the fiscal year in which the deductions are to be made, without taking into account the investment deductions according to sentence 1 and the additions according to paragraph 2.” It is questionable how the "profit" is to be determined in this context, which the Federal Tax Court has now decided in a Judgment of 1 October 2025 (file number X R 16, 17/23, combination of proceedings for a joint decision, Sect. 73(1) sent. 1 Tax Court Code (“Finanzgerichtsordnung”)).

The definition of “profit” for the purposes of Sect. 7g(1) of the Income Tax Act

In the case of the Federal Tax Court ruling X R 16, 17/23, the inclusion of trade tax (Sect. 4(5b) of the Income Tax Act, Sect. 5.7(1) of the Income Tax Guidelines) was decisive in determining whether the profit threshold under Sect. 7g(1) sent. 2 no. 1 lit. b of the Income Tax Act was met or not in the year in dispute 2020. The taxable profit within the meaning of Sect. 2(2) sent. 1 no. 1 of the Income Tax Act amounted to approximately EUR 203,000, of which the addition of trade tax accounted for approximately EUR 25,000. The lower court (Judgement of the Lower Saxony Fiscal Court (“Niedersächsisches Finanzgericht”) dated May 9, 2023, file number 2 K 202/22) had - in accordance with the view of the tax authorities (Circular of the Federal Ministry of Finance dated June 15, 2022, Federal Tax Gazette I 2022, p. 945, margin no. 13) - ruled that the off-balance-sheet adjustments were to be taken into account and therefore dismissed the action.

The Federal Tax Court has now confirmed this view. “The recognized methods of statutory interpretation based on the wording of the provision, its systematics, its meaning and purpose, as well as the legislative materials and the legislative history” (margin no. 18) are not entirely clear on this issue, but ultimately tend to support an approach based on the definition of profit in Sect. 2(2) sent. 1 no. 1 of the Income Tax Act. In this regard, the Federal Tax Court also notes (margin no. 26) that Sect. 7g of the Income Tax Act is generally applicable when determining profit pursuant to Sect. 4, 5 of the Income Tax Act (Sect. 7g(1) sent. 2 no. 1 lit. a of the Income Tax Act) and thus also applies to businesses that are not subject to trade tax (Sect. 2 of the Trade Tax Act; Sect. 13, 18 of the Income Tax Act). Even in relation to these, it considers the addback pursuant to Sect. 4(5b) of the Income Tax Act for trading entities justified.

Parallels are drawn particularly with the issues regarding Sect. 4(4a) sent. 2 of the Income Tax Act (“deduction of interest on debt for over-withdrawals” (“Schuldzinsenabzug bei Überentnahme”)) and Sect. 34a(2) of the Income Tax Act (“retention of profits allowance” (“Thesaurierungsbegünstigungen”)). Although these provisions also focus on “profit”, they pursue different objectives (margin no. 23). Sect. 7g of the Income Tax Act is intended to support small and medium-sized businesses, whereas Sect. 4(4a) and 34a of the Income Tax Act concern the calculation of a potential withdrawal volume. Therefore, the Federal Tax Court considers its different treatment of the concept of profit to be justified. In the case of Sect. 4(4a) of the Income Tax Act (Judgement of the Federal Tax Court dated December 3, 2019, file number X R 6/18, Federal Tax Gazette II 2021, p. 77, margin no. 12) and Sect. 34a of the Income Tax Act (Judgement of the Federal Tax Court dated May 9, 2019, file number IV R 13/17, Federal Tax Gazette II 2019, p. 754, margin no. 20), it had defined profit as tax balance sheet profit, i.e., without off-balance-sheet adjustments. Furthermore, additional points of reference not mentioned by the Federal Tax Court arise in the context of the interest limitation rule, where the “relevant profit” (“maßgeblicher Gewinn”; Sect. 4h(3) sent. 1 of the Income Tax Act) is equally in need of clarification (see Judgement of the Berlin-Brandenburg Fiscal Court dated October 11, 2022, file number 8 K 8034/21).

Implications regarding the definition of profit under Sect. 7g(1) of the Income Tax Act

The legislature has not always clarified the meaning of “profit”, as is the case, for example, with differences between GAAP and tax profits in a fiscal unity (Sect. 14(4) sent. 6 of the Corporation Tax Act, “tax balance sheet profit of the controlled company” (“Steuerbilanzgewinn der OG”)). The controversies specifically for the case of Sect. 7g(1) of the Income Tax Act have, however, not been definitively resolved by the present ruling.

The Baden-Württemberg Fiscal Court (Judgment of May 2, 2023, file number 10 K 1873/22) had taken the exact opposite view of the Federal Tax Court and declared the tax balance sheet profit to be decisive. An appeal against this judgment is pending (file number III R 38/23) and will thus raise the question of whether the chambers of the Federal Tax Court can agree on a common understanding of Sect 7g(1) of the Income Tax Act (Sect. 11(2) of the Tax Court Code (“FGO”); regarding the obligation to refer matters to the Grand Senate of the Federal Tax Court, see most recently the Judgement of the Federal Tax Court dated December 11, 2025, file number IV R 17/23, margin no. 68 et seqq.).

The special depreciation under Sect. 7g(5), (6) of the Income Tax Act, the maximum rate of which has recently been doubled to 40 %, must also be viewed in the context of this ruling. Here, too, the “profit threshold of paragraph 1 sent. 2 no 1” which is addressed in the ruling (file number X R 16, 17/23), is significant (Sect. 7g(6)(1) of the Income Tax Act). However, in this case, the profit threshold is determined based on the “fiscal year preceding the acquisition or production” of the asset in question, deviating from Sect. 7g(1) of the Income Tax Act. Knock-on effects in provisions such as Sect. 4f(1) sent. 3 of the Income Tax Act must also be considered.

For practical purposes, the legal opinion of the Federal Tax Court is also relevant regarding earlier “guidance for practice”. In previous versions, Sect. 7g(1) of the Income Tax Act still referred to the amount of business assets “for trading entities or enterprises engaged in self-employment that determine their profit pursuant to Sect. 4(1) or Sect. 5” of the Income Tax Act. Under these conditions, a corporation’s extraordinary depreciation on shares in corporations (Sect. 6(1) no. 1 sent. 2 of the Income Tax Act) could still serve as a “short-term measure” to reduce these business assets. Due to the off-balance-sheet addition of the resulting expense (Sect. 8b(3) sent. 3 of the Corporate Income Tax Act; most recently Judgement of the Munich Fiscal Court dated July 31, 2025, file number 6 K 2438/22, no appeal pending), “nothing more can be gained” under current circumstances and based on the recent opinion of the Federal Tax Court.