Federal Fiscal Court ruling: when does trade tax liability for notional business activities arise?

Consistent treatment beyond the limits of the tax assessment period

Income taxes are assessed according to certain time periods. For income tax and corporate income tax this is the assessment period (sections 25(1) and 2(7) sentences 1 and 2 of the Income Tax Act [Einkommensteuergesetz-EStG] and section 7(3) of the Corporate Income Tax Act [Körperschaftssteuergesetz–KStG]).Trade tax is also based on this principle (section 14 sentence 1 of the Trade Tax Act [Gewerbesteuergesetz–GewStG]; “principle of periodic taxation,” Federal Fiscal Court judgement of 13 Feb 2008, file ref. I R 63/06, Federal Tax Gazette [Bundessteuerblatt-BStBl] II 2009, p. 414, under II.3.a.). This is also how assets are measured on the tax balance sheet as of the balance sheet date (section 252(1) no. 3 of the Commercial Code [Handelsgesetzbuch–HGB]; section 5(1) sentence one of the Income Tax Act). 

When measuring them in this way, a reduction in the market value due to an expected permanent impairment may be used for a partial write-down (section 6(1) no. 1 sentence two and following; section 6(1) no. 2 sentence two), although for tax balance sheet purposes this is only an election (Federal Ministry of Finance Circular of 12 Mar 2010, Federal Tax Gazette I 2010, p. 239, para. 12 and following; Federal Fiscal Court judgement of 29 Jul 2015, file ref. X R 37/13, para. 49, regarding the year in dispute of 2001). The second half of the first sentence of section 5(1) expressly provides the possibility to choose different recognition when exercising a tax election. However, the continued existence of the expected permanent impairment must be demonstrated again on the following reporting dates (section 6(1) no. 1 sentence four; section 6(1) no. 2 sentence three). 

If the asset in question consists specifically of shares in a corporation held by another corporation, the prohibition on a deduction under sentence three of section 8b(3) of the Corporate Income Tax Act applies, regardless of the ownership percentage (Munich Fiscal Court judgement of 31 Jul 2025, file ref. 6 K 2438/22). If the equity interest is measured lower under sentence two of section 6(1) no. 2 of the Income Tax Act, this does not reduce corporate income tax or trade tax (section 7 sentence one of the Trade Tax Act [Gewerbesteuergesetz–GewStG]). If the asset is revalued, however, the equity interest must be measured at the higher value (section 6(1) no. 2 sentence three of the Income Tax Act). Only 95 percent of the income thus generated is tax-exempt under section 8b(2) sentence three in conjunction with section 8b(3) sentence one of the Corporate Income Tax Act. 

Consequently, tax leakage occurs, even though the provision in section 8b(3) sentence three was actually intended to structure the corporate income tax system “consistently”. “The purpose of not allowing the deduction is to establish a correspondence on the expenses side with the tax exemption established in section 8b(2) of the Corporate Income Tax Act for capital gains” (Federal Fiscal Court judgement of 9 Jan 2013, file ref. I R 72/11, para. 9). This particularly covers “losses from the sale of shares and the liquidation of the company, as well as reductions in profits resulting from the recognition of the lower market value of the share referred to in section 8b(2) of the Corporate Income Tax Act” (Federal Fiscal Court judgement of 24 Apr 2024, file ref. I R 11/23, para. 14).

Corresponding treatment of loan receivables between corporations

But what if the asset in question is a loan receivable from a subsidiary corporation? For a long time, section 8b(3) sentence three did not cover the partial write-down of the loan receivable (Federal Fiscal Court judgement of 14 Jan 2009, file ref. I R 52/08, Federal Tax Gazette II 2009, p. 674). In the Annual Tax Act 2008, however, section 8b(3) sentence three was extended to include certain debt instruments (section 8b(3) sentence four; repeated in section 3c(2) sentence two and following of the Income Tax Act). In contrast to section 8b(3) sentence three of the Corporate Income Tax Act, however, a “qualifying interest” in the debtor of more than a quarter is required. Conversely, the phrasing “holds or held” means that the entire “history” of the holding is relevant (Federal Fiscal Court judgement of 12 Mar 2014, file ref. I R 87/12, Federal Tax Gazette II 2014, p. 859). 

As a result of such a write-down to the lower fair value, the loan receivable is subject to the deferred revaluation obligation under section 6(1) no. 2 sentence 3 of the Income Tax Act, which is difficult to eliminate even through reorganisations (e.g., Federal Ministry of Finance Circular of 2 Jan 2025, Federal Tax Gazette I 2025, p. 92, para. 13.11). If this revaluation does in fact occur, section 8b(3) sentence nine of the Corporate Income Tax Act correspondingly exempts the resulting income from tax, “to the extent that sentence three was applied to the preceding write-down to lower fair value”.

The first chamber of the Federal Fiscal Court has now ruled (file ref. I R 10/23) on whether this exemption should also be granted when the creditor and the debtor are the same entity. In line with the position of the tax authorities (Federal Ministry of Finance Circular of 2 Jan 2025, Federal Tax Gazette I 2025, p. 92, para. 06.02), the Federal Fiscal Court rejected this assertion. The case concerned a “transmission universelle du patrimoine” under the French Civil Code, involving the transfer of the debtor’s entire assets to the claimant as the creditor, with a mandatory dissolution without liquidation. The Federal Fiscal Court did not see a “regulatory gap contrary to the intended purpose, which is necessary for an analogy” in this regard.

Applications of the new case law

The new case law is initially limited in its substantive scope of application by the new section 8b(3) sentence 7 of the Corporate Income Tax Act: This “safety valve” prevents sentences 4 and 5 from being applied “if it is proven that an unrelated third party would also have granted the loan or would not yet have demanded repayment under otherwise identical circumstances; in which case only the company’s own collateral is to be taken into account” (Federal Fiscal Court judgement of 24 Apr 2024, file ref. I R 11/23). In this respect, the situation described by the revised sentence nine to section 8b(3) does not even arise in the first place. Furthermore, the first chamber significantly narrowed the scope of the provision in its most recent decision (judgement of 1 Apr 2026, file ref. I R 11/24).

The typical scenario in which the decision of the first chamber in I R 10/23 applies will arise in the case of reorganisations under the Reorganisation Tax Act [Umwandlungsteuergesetz–UmwStG]. The merger of two corporations under section 1(1) sentence 1 no. 1 of the Act triggers the provisions of sections 11–13 and 19, subject to no personal restrictions since section 1(2) was repealed. If a situation arises where the creditor and debtor are the same entity and a liability and a receivable coincide due to universal succession (section 20(1) of the Reorganisation Act [Umwandlungsgesetz–UmwG]), a gain results in differing tax-accounting valuations of the asset and liability, leading to extraordinary income. Judgement I R 10/23 confirms the position taken by the tax authorities (Federal Ministry of Finance Circular of 2 Jan 2025, Federal Tax Gazette I 2025, p. 92, para. 06.02), according to which the gain in this situation is taxable, despite the previous depreciation to market value under section 8b(3) sentence 4 and following of the Corporate Income Tax Act. 

Section 6(1) of the Reorganisation Tax Act the profit, if applied for, to be spread over three fiscal years for tax balance sheet purposes (similar to section 6b(3) of the Income Tax Act) (e.g., Federal Fiscal Court judgement of 9 Apr 2019, file ref. X R 23/16, Federal Tax Gazette II 2019, p. 483). However, in the case of a merger of corporations, this applies only “to the portion of the profit arising from the consolidation of receivables and liabilities that corresponds to the acquiring corporation’s interest in the share capital or stock of the transferring corporation”, and thus only to upstream mergers (section 12(4) of the Reorganisation Tax Act). The provision is therefore not available for side-stream mergers at all.