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The German trade tax has no equivalent in the tax laws of most other countries and is therefore often perplexing for foreign businesses operating in Germany. It is a tax imposed on a commercial enterprise as a reified object, as opposed to a tax imposed on a person. Like the real property tax, it is collected from the person to whom the object being taxed is attributed, but is calculated with regard merely to the object of taxation, not the totality of the economic circumstances of the person to whom this object is attributed. The historical origins of the trade tax are found in the diverse forms of taxes on commercial enterprise developed in the middle ages. The modern trade tax dates from the 1890s, when its revenue was assigned exclusively to local government as part of the Prussian tax reform. Since then, the trade tax has been the most important source of tax revenue for local government. The tax is justified in terms of the demands made by commercial enterprises on community services and resources.

An enterprise is objectified with respect to its capital and its earnings for purposes of the trade tax. However, objectification with regard to capital is of relevance only for the years through 1997 because the trade tax on capital has been repealed from 1998 onwards. Long term debt (Dauerschulden) constitutes one of the most significant aspects of such objectification. Half of the interest paid on long term debt is included in the base of the trade tax on earnings and, for years through 1997, half of long term debt in excess of DM 50,000 is included in the base of the trade tax on capital. This is intended to even out differences between debt-financed and equity-financed enterprises as regards the trade tax.

This article reports on two recent high court decisions relating to long term debt.

1. Long term debt in general

Long term debt is defined in sec. 8 no. 1 GewStG (trade tax act) as debt which strengthens the capital base of the business on a more than temporary basis or which is economically connected with the formation or the acquisition of a commercial business or branch thereof, with the acquisition of an interest in a commercial business, or with the expansion or improvement of the business.

To determine when debt strengthens the capital base of the business on a more than temporary basis, the courts have looked above all to the term of the loan. Loans with a term of over one year are generally presumed to be long term debt, as are a wide variety of debt relationships which are the economic equivalent of long-term loans. Debt with a term of one year or less as a rule constitutes short-term debt, of which no account is taken for trade tax purposes.

The decisions discussed below illustrate two important aspects of the trade taxation of long term debt.

2. Ongoing business debts

Ongoing business debts are debts which arise out of an entity's day-to-day business. Such debts do not constitute long term debt irrespective of their term if they are closely connected with a particular business transaction, e.g. a sale of goods, provided the term of the debt does not exceed what is normal for transactions of the sort involved (cf. R. 47 (7) GewStR - trade tax guidelines).

In its decision of 30 July 1997 (DB 1997, 2308), the Federal Tax Court held that interest-bearing debt owed by a life insurance company to its policy holders by reason of their prepayment of life insurance policy premiums constituted ongoing business debt and therefore was excluded from the trade tax base even though the debt ran for several years. Under the arrangement with its policy holders, the insurance company agreed to pay interest on sums they deposited in certain policy-specific accounts. As premiums on the policies fell due, the insurance company debited the amounts owing from the balance on the accounts. This set-off constituted economic repayment of the loan. Premature cancellation of a policy resulted in the reimbursement of any balance owing to the policy holder.

Emphasising the direct economic relationship between the debt and ongoing business transactions, i.e. the sale of insurance policies and performance of the obligations arising thereunder, the court upheld a lower court decision which had likewise treated the loans as ongoing business debt even though they extended over several years. The strong and continuing interrelationship with day-to-day business transactions prevented the loans from constituting long term debt.

3. Current account credit

There is a considerable body of trade tax case law on current account credit (clearing accounts). A current account arrangement exists for instance when two companies sell goods to each other on a running basis and agree to set off their claims against one another on a clearing account instead of making payment for each individual delivery. A line of credit from a bank, the balance of which is constantly fluctuating, can also constitute a current account. Current account arrangements typically provide for the party whose account has a negative balance to pay interest to the other party.

The trade tax issue posed by current accounts is whether, in spite of a constantly fluctuating account balance, the economic reality of the relationship is not similar to a long term loan. The courts have consistently held that this is the case if the current account has a certain minimum debt balance over a period of time exceeding one year.

In its decision of 3 July 1997 (DB 1997, 2309), the Federal Tax Court held that long term debt could exist in the context of a current account arrangement even if the account showed a balance in the taxpayer's favour at certain times of the year. The decision related to a line of credit extended by a bank to the taxpayer. The account with the bank showed a balance in the taxpayer's favour on up to four days in the years at issue. On audit, the tax authorities refused to treat the positive balances as having interrupted the term of the debt. Instead, they treated the 8th lowest account balance in each of the years under audit as long term debt. This is in accordance with the position set forth in the trade tax guidelines (regulations published by the tax authorities - R. 47 (8) GewStR), which base the assessment on the 8th lowest account balance whenever the lowest account balance is not maintained for at least 8 days during the year in question. Positive balances count among the 8 lowest balances.

The Federal Tax Court stated that a positive balance on only a few days in a given year was not sufficient to interrupt the term of the debt.

The taxpayer apparently argued that the positive balances did indeed restart the clock unless it could be shown that the taxpayer had borrowed funds elsewhere for a short time in order to artificially show a positive balance on the current account credit. The tax court regarded this as irrelevant. Here the Federal Tax Court stated that an investigation of possible matching borrowing was only necessary if the positive balances were of longer duration. The court did not state what this duration might be.

Disclaimer and Copyright

This article treats the subjects covered in condensed form. It is intended to provide a general guide to the subject matter and should not be relied on as a basis for business decisions. Specialist advice must be sought with respect to your individual circumstances. We in particular insist that the tax law and other sources on which the article is based be consulted in the original, whether or not such sources are named in the article. Please note as well that later versions of this article or other articles on related topics may have since appeared on this database or elsewhere and should also be searched for and consulted. While our articles are carefully reviewed, we can accept no responsibility in the event of any inaccuracy or omission. Please note the date of each article and that subsequent related developments are not necessarily reported on in later articles. Any claims nevertheless raised on the basis of this article are subject to German substantive law and, to the extent permissible thereunder, to the exclusive jurisdiction of the courts in Frankfurt am Main, Germany. This article is the intellectual property of KPMG Deutsche Treuhand-Gesellschaft AG (KPMG Germany). Distribution to third persons is prohibited without our express written consent in advance.