Update on trade tax add-backs of rental and lease payments
Legal rules that apply to trade tax add-backs
When calculating the trading profit, in accordance with Section 8, no. 1(d) and (e) of the Trade Tax Act (Gewerbesteuergesetz, GewStG), it is necessary to add back the rental payments that are made in return for the use of movable and immovable capital assets that will have been deducted when determining taxable earnings. However, the full amount is not added back, but instead a standardised interest portion included in the rental expenses (at a rate of 5% for movable capital assets and 12.5% for immovable capital assets).
The background to this is the intention of the German legislator to levy approximately the same level of trade tax – as an impersonal tax (a so-called Objektsteuer) – on all taxpayers. In principle, it should make no difference whether the financing is equity-based or debt-based. However, as financing interest will have reduced the taxable profit of an enterprise, under trade tax regulations this interest has to be added back again. The decision not to purchase fixed assets but, instead, to rent them should likewise not affect the level of the trade tax debt. Those taxpayers who have reduced their taxable profit via rental payments instead of depreciation amounts thus have to add back an appropriate notional interest portion.
More recent BFH case law
Real estate tax passed on to the tenant
In this case (BFH ruling of 2.2.2022, case reference: III R 65/19), the subject-matter of the dispute was whether or not the real estate tax that had been passed on to the tenant had to be included as an add-back amount in addition to the rent. As the real estate tax forms part of the encumbrance on the property it generally has to be borne by the landlord. However, the real estate tax may be passed on to the tenant (as happened in the case in question) via a contractual agreement. In this case, the real estate tax borne by the tenant also has to be included in the amounts that have to be added back. This is because the BFH typically presumes that the assumption of the real estate tax charge by the tenant will have had a positive impact on the actual amount of rent.
Rent for reusable containers in business
The issue at the heart of the dispute in this case (BFH ruling of 1.6.2022, case reference: III R 56/20) was whether or not rental payments existed under civil law. These are the only ones at all where there is a requirement for them to be added back, which is why the user agreement, according to its key legal content, has to be a rental agreement in terms of civil law. In the case in question, the claimant marketed fruit and vegetables and rented so-called reusable crates for transport purposes. The object of the contract that had been agreed with the business that rented out the crates also included a comprehensive system of services, such as transporting the empty crates to the grower, the entire reverse logistics process, waste disposal, sorting, repairing and washing the crates as well as their interim storage at different stages of the goods handling process. The BFH ruled in favour of the claimant that this was a case of a rental agreement with multiple inseparable service components where the rental services do not particularly characterise the contractual relationship. Therefore, add-backs were ruled out because the expenses did not constitute rental payments within the meaning of the add-back regulations.
Maintenance costs in the case of lease agreements
In this case, within the scope of lease agreements for motor vehicles, a lessee had assumed the obligation to also bear the maintenance fees that are incurred. The local tax office included these maintenance fees as add-back amounts in addition to the lease rate. The BFH ultimately confirmed this opinion (ruling of 20.10.2022, case reference: III R 33/21). The definition of a lease rate has to be construed in economic terms, which is why the maintenance costs that are contractually passed on to the lessee are part of the ‘lease rate’ and, thus, there is also a requirement for them to be added back. This is because passing on the costs to the lessee usually leads to a reduction in the regular (‘pure’) lease rate.
Add-backs as a function of the business purpose
The adding back of rental payments is based on the assumption that the case is one of so-called notional fixed assets. This means that it will be necessary to check if the capital assets for the use of which the rent was paid would be the renter’s fixed assets if they were owned by the renter. This check has to be based on the operational circumstances of the respective taxpayer. In this regard, you would have to ask if the business purpose requires the permanent availability of such capital assets. Therefore, since it is the specific designated business purpose that matters, it is possible that while for one company same capital assets will constitute notional fixed assets this will not however be the case for another company.
In the case in question here, (BFH ruling of 19.1.2023, case reference: III R 22/20), the claimant ran an exclusive production and events agency in the field of fashion, lifestyle and culture. When organising fashion shows, product presentations, photo shoots and exhibitions, the claimant would hire a wide range of equipment and event venues. The respective rental payments were added back for trade tax purposes by the local tax office. The tax court (Finanzgericht, FG) accepted this. However, the opinion of the BFH was that the FG had not taken sufficient account of the fact that the incoming supplies had always been used only once because the ordering party had wanted to continually organise new and different events. Multiple use was out of the question for the ordering party and, thus, also for the claimant. In accordance with the stipulations of the BFH, it is necessary to check the extent to which the hired capital assets constituted inputs for the production of the ‘product’, namely, the event. This is because, in this respect, the capital assets would be used up when they are input into the product. Therefore, it is more likely that classifying them as current assets and precisely not notional fixed assets would be considered. This would rule out adding back the rental payments.
No adding back of advertising and sponsorship expenditure
In the case of sponsorship agreements where the sponsor normally gets various types of advertising service in return for their financial support, the BFH, in its ruling of 23.3.2023 (case reference: III R 5/22) concluded that these were sui generis agreements with inseparable performance obligations. Therefore, contrary to the opinion of the lower court, in particular, there cannot even be partial add-backs for renting advertising space such as, for example, shirt sponsorship or perimeter advertising. The main focus of such agreements is on the advertising services to be provided because solely these and not the use of advertising space have a commercial value for the sponsor.