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An about-turn on the tax tainting rule on losses from commercial activity

The Federal Fiscal Court (Bundesfinanzhof, BFH) abandoned its earlier ruling and decided that not just profits but also losses from a commercial activity that exceed the so-called de minimis threshold level would result in the tax treatment of a GbR’s [company under German civil law] other activity, namely asset management, being recharacterized.

The issue – Recharacterization of the income from letting?

In the specific case, the court had to determine whether or not the income of an asset management GbR that was derived from renting out a property had to be recharacterized as commercial income because of the (commercial) operation of a photovoltaic system on the rental property. In 2012, the operation of the photovoltaic system resulted in commercial losses. Consequently, the GbR submitted two sets of income calculation for 2012 - one for income from letting and leasing and one for income from commercial activity. However, both the local tax office as well as the tax court, in deviation from previous caselaw, determined that there had been solely commercial income since the commercial operation had exceeded the accepted de minimis threshold level of 3% of overall net revenues. Not so long ago, the BFH, in its ruling of 12.4.2018 (case reference: IV R 5/15) had still been of the opinion in this matter that losses from a commercial activity would not result in the tax treatment of a GbR’s asset management activity being recharacterized. 

New legal situation – Tax tainting also in the case of losses

Contrary to its previous case law, the BFH, in its ruling of 30.6.2022 (case reference: IV R 42/19) affirmed in the case in question that there was a tainting effect for tax purposes. The amendment to the tax tainting rule at the end of 2019 (Section 15(3) no. 1 sentence 2 alternative 1 of the German Income Tax Act) had clarified that the original commercial activity will have a tainting effect for tax purposes irrespective of whether a profit or a loss is derived from this activity. For the court, reporting a loss when the de minimis threshold level has been exceeded does not preclude the tax treatment for the other activity, namely asset management, being recharacterized. Accordingly, the previous de minimis threshold with its absolute and relative revenue thresholds should be taken into account for both profits as well as for losses. Should the de minimis threshold level be exceeded then commercial profits and commercial losses would have similar tainting effects.

No inadmissible retroactive effect

Although this non-application legislation was introduced with a so-called genuine retroactive effect, which is basically unconstitutional, the BFH considers that, “from the perspective of constitutional law, there is exceptionally no objection to it.” The new legal situation merely means that supreme court settled case law prior to the BFH ruling of 2018 has been codified. There is no protection of legitimate expectations for the case where there was a ruling in 2022 because of the issue that the court ruled on in 2018. 

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