Special business assets at the level of partnerships and no end in sight!

Business assets or private assets – that is the question! 

Private assets for tax purposes can be sold free of income tax under certain conditions, which have been steadily eroded over the years. This opportunity is particularly prominent in the case of real estate held as private assets if more than ten years have passed between acquisition and sale (Sect. 23 of the Income Tax Act). In the case of shares in corporations, however, the possibility of tax-free disposal has no longer existed since the introduction of the flat-rate withholding tax (Sect. 32d of the Income Tax Act) and the associated extension of the taxation of capital gains (Sect. 20(2) of the Income Tax Act).

The distinction between private assets and business assets is also important for transfers of the respective assets without remuneration: The transfer of private assets free of charge is less complex in terms of income tax; in the case of business assets, on the other hand, it is often necessary to first conduct a withdrawal from the business assets before they can be transferred to the recipient. The withdrawal, which must be valued at market value (Sect. 6(1) No. 4 of the Income Tax Act), results in a gain that is fully taxable, even though the actual transfer of the asset is conducted without remuneration.

The legal situation for partnerships is further complicated by the fact that – as a German "peculiarity" – "special business assets" may also exist at the level of the partners for income tax purposes. Within this category of business assets, a distinction is made between special business assets I (“Sonderbetriebsvermögen I“) and special business assets II (“Sonderbetriebsvermögen II”), which – at least according to the current state of the case law of the Federal Tax Court – can both exist as "necessary" (“notwendig”) or "discretionary" (“gewillkürt”) business assets. The legal basis for special business assets I can be found in the Income Tax Act itself (Sect. 4(1) of the Income Tax Act, and, in addition, Sect. 15(1) sent. 1 no. 2 sent. 1 half-sent. 2 of the Income Tax Act). However, this does not apply to special business assets II, i.e., assets owned by a partner and not made available for use by the partnership. Rather, based on judicial development of the law and interpretation of Sect. 2(2) sent. 1 no. 1 in conjunction with Sect. 4 et seqq. and Sect. 15(1) sent. 1 no. 2 of the Income Tax Act, these are part of the business assets of the partnership (e.g. Judgement of the Federal Tax Court dated December 19, 2019, file number IV R 53/16, margin number 42).

Transfer to business assets – or to special business assets?

The kind of asset class to which assets are assigned therefore plays a decisive role in income tax law. In the case of commercial partnerships (Sect. 2(1) of the Trade Tax Act), trade tax also applies to taxable business assets. This applies both to the "jointly owned assets" (“Gesamthandsvermögen”, according to Sect. 39(2) No. 2 Sent. 2 of the General Tax Code) and to the special business assets (e.g. Judgement of the Federal Tax Court dated September 20, 2018, file number IV R 39/11, margin number 31).

The German Federal Fiscal Court addresses precisely these issues in its ruling of December 2, 2025 (file number IV R 20/23). The contribution of an individual asset to a partnership can be effected in various ways (margin number 28 et seqq.) – in the case in dispute, it concerned very valuable shares in a corporation. It can be done by contributing

• "to ownership",
• "by value" and
• "for use."

In the case of a contribution "to ownership," necessary or discretionary business assets of the partnership are created. In the case of a contribution according to value, the contributing partner remains the civil law owner of the asset. However, the asset is treated internally as if it constituted company assets.

Finally, in the case of a contribution for use, the partnership is only allowed to use the asset. In this specific case, special business assets I of the partner are formed for income tax purposes. Whether this is the case in the specific instance must be assessed by the lower tax court in the second round of legal proceedings, as there is a dispute between the tax authorities and the partners precisely on the question of whether the assets in question belong to the business assets.

However, the scope of the review by the lower tax court in the second round of legal proceedings is limited by procedural peculiarities of the "separate and uniform assessment" (Sect. 180(1) of the General Tax Act). According to established case law, the assessments in the associated assessment notice are capable of “legal force" independently (e.g. Judgement of the Federal Tax Court dated January 19, 2023, file number IV R 5/19, Federal Tax Gazette II 2023, p. 649, margin number 30) – in the case before the court, for instance, only any special operating results of the partners are still "open" to challenge – the "current joint profit", on the other hand, is – from a procedural standpoint – already "set in stone".

Special business assets also count for trade tax purposes!

Special challenges arise when – as in the case in dispute – the scope of business assets has to be assessed. Business income is influenced by profits and losses in the special business area of the partners. The effects that a partner causes through corresponding results are therefore reflected in the trade tax burden. However, the trade tax burden is borne by the partnership itself as the debtor of the trade tax (Sect. 5(1) sent. 3 of the Trade Tax Act).

The resulting imbalances then have far-reaching consequences. Natural persons as partners receive a credit for trade tax incurred (Sect. 35 of the Income Tax Act). However, this is limited in several ways – in particular to a trade tax collection rate (“Hebesatz”) of approximately 400 %, which is exceeded in many German municipalities and cities.

In the present context, however, the situation is even worse: Fluctuations in income for trade tax purposes triggered by special business assets are not reflected in the credit. The distribution of the potential for the credit pursuant to Sect. 35 of the Income Tax Act is determined precisely by the partner's share "in the profits of the partnership in accordance with the general profit distribution scheme" (Sect. 35(2) sent. 2 of the Income Tax Act). The situation is similar in the case of a loss situation for the partnership, where the (partner-specific) trade tax loss deduction is also based "on the general profit distribution scheme resulting from the partnership agreement for the deduction year" (Sect. 10a sent. 5 of the Trade Tax Act).