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German trade tax on leases: a violation of EU law?

Under Section 8 paragraph 7 of the German Trade Tax Act (Gewerbesteuergesetz), 50% of rentals paid for the use of a fixed asset must be added back to the income of a business for the purpose of determining trade tax on income. Trade tax on income is a tax on business income levied at rates determined by the German municipalities. Its basis is the business profit of a company adjusted by certain add-back provisions. The second sentence of Section 8 paragraph 7 of the Act exempts from such add-back requirement lease agreements where the lessor is subject to trade tax, ie essentially leases entered into with German lessors. In contrast, a lessee entering into a lease with a non-German lessor does not enjoy this exemption and must add-back 50% of the rentals to its income for trade tax purposes.

In its judgement of October 26 1999, the European Court of Justice ruled that the current treatment is discriminatory with respect to non-German lessors and constituted a violation of Article 59 of the EU Treaty (Freedom to Provide Services). In the case decided by the Court, Eurowings Luftverkehrs, a German operator, had leased aircraft from a lessor based in Ireland subjecting Eurowings to a higher tax burden than it would have suffered if it had leased the asset from a German lessor.

There are essentially two ways of bringing the Trade Tax Act into line with EU law: either to repeal the special treatment for domestic leases or to abolish the add-back requirement under Section 8 paragraph 7 of the Act. A draft presented by the Federal Ministry of Finance adopts the first alternative: it proposes to abolish the exemption provided for in Section 8 of the Act. Accordingly, the 50% add-back requirement would apply to all leases regardless of the lessor's trade tax treatment. Since this would increase the costs of domestic leasing by an estimated 10%, the German leasing industry has heavily criticised the proposal and plans to implement the draft are currently on hold. Pursuant to a ministerial decree issued on January 24 2000 by the Ministry of Finance in Sachsen-Anhalt in coordination with the Federal Ministry of Finance and the supreme fiscal authorities of the Länder, the tax authorities will not implement the add-back provision with respect to leases with foreign lessors until new regulations compliant with EU law have been enacted.

Olaf Gebler

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