Federal Fiscal Court ruling: Profit threshold for the investment deduction

Profit threshold for the investment deduction under section 7g of the Income Tax Act

Under section 7g(1) sentence 1 of the Income Tax Act, taxpayers may deduct, as an investment deduction reducing profit, up to 50% of the anticipated acquisition or production costs for the future acquisition or production of depreciable movable fixed assets. The Annual Tax Act 2020 of 21 December 2020 (Federal Law Gazette [Bundesgesetzblatt–BGBl.] I 2020, p. 3096; for the temporal scope of application, see section 52(16) sentence 1 of the Income Tax Act) fundamentally restructured the provision: in addition to raising the deduction rate from 40% to 50% and including rented-out assets, it replaced the size criteria that had until then differed according to the method of profit determination (business assets, agricultural economic value [Wirtschaftswert], profit) with a uniform profit threshold of EUR 200,000.

Since then, the deduction has only been permissible if profit is determined under section 4 or section 5 of the Income Tax Act (section 7g(1) sentence 2 no. 1 (a) of the Income Tax Act) and, in the financial year of the deduction, does not exceed EUR 200,000 “without taking into account the investment deductions under sentence 1 and the additions under subsection 2” (section 7g(1) sentence 2 no. 1 (b) of the Income Tax Act). Section 7g of the Income Tax Act does not contain a definition of profit of its own. It has since been disputed whether reference is to be made to the tax balance sheet profit (or the result of cash-basis accounting [Einnahmenüberschussrechnung]) or to the profit for tax purposes after off-balance-sheet adjustments. The tax authorities take the profit for tax purposes as the basis (Federal Ministry of Finance [Bundesministerium der Finanzen–BMF] Circular of 15 Jun 2022, Federal Tax Gazette I 2022, p. 945, para. 13).

In its judgement of 1 Oct 2025 (file ref. X R 16, 17/23, Federal Tax Gazette II 2026, p. 412), the tenth chamber of the Federal Fiscal Court had endorsed the view of the tax authorities: “profit” within the meaning of section 7g(1) sentence 2 no. 1 of the Income Tax Act is the profit for tax purposes under section 2(2) sentence 1 no. 1 of the Income Tax Act, i.e. the profit after all off-balance-sheet adjustments have been made – with the exception of the investment deductions and the additions under section 7g(2) of the Income Tax Act, which the statute expressly excludes. The decision rests primarily on the wording and the statutory scheme, since section 2(2) sentence 1 no. 1 of the Income Tax Act specifies the concept of profit by means of its parenthetical reference to sections 4 to 7k and section 13a of the Income Tax Act. The purpose and legislative history of the provision support this result; the Federal Fiscal Court saw no constitutional concerns. The same applies to trade income [Gewerbeertrag], which under section 7 sentence 1 of the Trade Tax Act [Gewerbesteuergesetz–GewStG] is derived from the profit determined under the Income Tax Act.

Non-deductible trade tax proves decisive for the investment deduction

The third chamber of the Federal Fiscal Court has now expressly endorsed this case law and, to avoid repetition, referred to its reasoning (Federal Fiscal Court judgement of 18 Jun 2026, file ref. III R 38/23, paras. 16 and following). Two chambers are therefore now in agreement. A referral to the Grand Chamber (section 11 of the Code of Procedure for Fiscal Courts [Finanzgerichtsordnung–FGO]) is no longer to be expected on this question.

In the case at issue, a sole proprietor [Einzelunternehmerin] operated a food retail business and determined her profit by the accounting method [Betriebsvermögensvergleich] (section 4(1) sentence 1 and section 5 of the Income Tax Act). For 2020, she reported a tax balance sheet profit of EUR 199,309.90 and claimed an investment deduction of EUR 120,000. The off-balance-sheet adjustments were as follows:

• deduction of tax-exempt income under section 3 no. 40 of the Income Tax Act: EUR 1,170.00
• addition of non-deductible business expenses (section 4(5) to (7) of the Income Tax Act): EUR 1,457.00
• addition of trade tax (section 4(5b) of the Income Tax Act): EUR 10,199.00

The profit for tax purposes without the investment deduction thus amounted to EUR 209,795.90. The Baden-Württemberg Fiscal Court [Finanzgericht–FG] (judgement of 2 May 2023, file ref. 10 K 1873/22) had still taken the tax balance sheet profit as the basis and granted the deduction. The Federal Fiscal Court set aside that judgement and dismissed the action (section 126(3) sentence 1 no. 1 of the Code of Procedure for Fiscal Courts).

According to para. 19, trade tax was the decisive factor: since it is not a business expense under section 4(5b) of the Income Tax Act, it does not reduce the profit for tax purposes, and in the case at issue it lifted that profit above the threshold. Despite its wording, the statutory command of section 4(5b) of the Income Tax Act is implemented in such a way that trade tax is nevertheless treated as a business expense (Federal Fiscal Court judgement of 16 Jan 2014, file ref. I R 21/12, Federal Tax Gazette II 2014, p. 531, para. 10). A provision must therefore first be recognised as a liability (section 249(1) of the Commercial Code [Handelsgesetzbuch–HGB], section 5(1) sentence 1 of the Income Tax Act), and its effect on income is then neutralised (R 5.7(1) of the Income Tax Guidelines [Einkommensteuer-Richtlinien–EStR]) outside the balance sheet (R 7.1(1) sentence 2 line 14 of the Corporate Income Tax Guidelines [Körperschaftsteuer-Richtlinien–KStR]). By contrast, the other off-balance-sheet adjustments in the case at issue almost cancelled each other out.

As a result, the decision illustrates the cliff-edge effect [Fallbeilwirkung] of the profit threshold: exceeding the threshold by just under EUR 10,000 cost a deduction of EUR 120,000. Special cases are conceivable: in a fiscal unity for income tax purposes [ertragsteuerliche Organschaft], the threshold would have to be applied separately to the controlled company and the controlling company. Since the controlled company does not itself owe trade tax (Federal Fiscal Court judgement of 10 Mar 2010, file ref. I R 41/09, Federal Tax Gazette II 2011, p. 181, para. 17; Federal Fiscal Court judgement of 18 May 2011, file ref. X R 4/10, Federal Tax Gazette II 2011, p. 887, para. 38), section 4(5b) of the Income Tax Act can play no role at its level, whereas it does at the level of the controlling company (Federal Ministry of Finance Circular of 15 Jun 2022, Federal Tax Gazette I 2022, p. 945, paras. 1 and 15). The property-holding company and the operating company in a split business structure [Betriebsaufspaltung] are likewise to be considered separately in this way (Federal Ministry of Finance Circular of 15 Jun 2022, Federal Tax Gazette I 2022, p. 945, para. 15), although in that case both are themselves subject to trade tax (section 2(1) and (2) of the Trade Tax Act).

Investment deduction: check the profit threshold in advance

For practitioners, the judgement of the third chamber settles the question of the concept of profit for the purposes of section 7g(1) of the Income Tax Act. Anyone wishing to use the investment deduction must keep an eye on the profit for tax purposes including all off-balance-sheet adjustments – not merely the result shown in the tax balance sheet. The same concept of profit will also have to be applied for the purposes of section 7g(5) and (6) of the Income Tax Act – the special depreciation that was most recently improved once again (Growth Opportunities Act [Wachstumschancengesetz] of 27 March 2024, Federal Law Gazette 2024 I no. 108). In that context, however, what matters is not the financial year in which the special depreciation is claimed but the financial year preceding the acquisition or production (section 7g(6) no. 1 of the Income Tax Act).

Among the adjustments outside the balance sheet that must accordingly be included, particular attention should be paid to:

• the addition of trade tax (section 4(5b) of the Income Tax Act), which can tip the balance where results are close to the threshold;
• tax-exempt income (e.g. section 3 no. 40 of the Income Tax Act) and non-deductible business expenses (section 4(5) to (7) and section 3c of the Income Tax Act);
• subsequent changes resulting from a tax audit, which may lift the profit for tax purposes above EUR 200,000 and cause the deduction to be lost in its entirety.

Parallels arise in particular with the questions raised under section 4(4a) sentence 2 of the Income Tax Act (“deduction of interest on debt in the case of excess withdrawals”) and section 34a(2) of the Income Tax Act (“preferential taxation of retained profits”). Although these provisions also refer to “profit”, they pursue different objectives. Section 7g of the Income Tax Act is intended to support small and medium-sized businesses, whereas sections 4(4a) and 34a of the Income Tax Act concern the calculation of a potential withdrawal volume. The tenth chamber therefore considered itself justified in treating the concept of profit differently in its judgement of 1 Oct 2025 (file ref. X R 16, 17/23, Federal Tax Gazette II 2026, p. 412). For section 4(4a) of the Income Tax Act (Federal Fiscal Court judgement of 3 Dec 2019, file ref. X R 6/18, Federal Tax Gazette II 2021, p. 77, para. 12) and section 34a of the Income Tax Act (Federal Fiscal Court judgement of 9 May 2019, file ref. IV R 13/17, Federal Tax Gazette II 2019, p. 754, para. 20), the tenth chamber and the fourth chamber respectively had defined profit as the tax balance sheet profit, i.e. without off-balance-sheet adjustments.