In Germany the municipal trade tax (German: Gewerbesteuer, GewSt) is levied as a trade income tax on the objective earning power of a business.

For this purpose a trade income is determined for municipal trade tax purposes, which regularly results in a municipal trade tax assessment amount of 3.5% of the trade income. The municipality entitled to levy the tax must levy the municipal trade tax at least in the amount of twice the measured amount (minimum assessment rate: 200%).

Until 1997 the trade capital tax was used to tax the substance of a business, irrespective of its income. Since then, it has only been used in the profit additions, which include certain financing costs in the municipal trade tax assessment base. With the 2008 German corporate tax reform, this component was expanded to stabilize municipal trade tax revenue.

The municipal trade tax is the most important original source of revenue for municipalities in Germany.Steuerstatistik des Statistischen Bundesamts (Saved 25 April 2016 in Internet Archive) According to Sec. 3 (2) of the German Fiscal Code, it is a real tax or property tax, even if this classification is disputed following the abolition of the trade capital tax and the payroll tax. Municipal trade tax is one of the municipal taxes and property taxes. The legal basis is the Municipal Trade Tax Act (GewStG), the Municipal Trade Tax Implementation Ordinance and, as general administrative regulations, the Trade Tax Guidelines.

Equivalence principle By paying taxes one does not acquire any entitlement to a specific state benefit (Sec. 3 para. 1 AO). Nevertheless, the municipal trade tax is often justified on the grounds that commercial enterprises should bear the burdens arising from their establishment and existence. In fact, no other tax has such a strong equivalence principle. It is levied according to a presumed cost causation. However, although the business tax is intended to refinance infrastructure measures and settlement burdens, its reason is not to compensate for tangible economic benefits.Lenski/Steinberg Gewerbesteuergesetz Kommentar – Anm. 3 zu § 1

History of the municipal trade tax The municipal trade tax was introduced in Prussia in 1891 by Miquel's tax reform.

The foundations for its current form were laid in the real tax reform of 1936; the Municipal Trade Tax Act dates from 1 December 1936. In addition to the trade income tax levied, trade capital and – via payroll tax – jobs were also taxed. Using different measurement figures, a municipal trade tax assessment amount was determined from the three different areas, to which the assessment rate was then applied.

In 1978 the payroll tax was initially abolished because of the associated negative employment policy consequences. The Accompanying Budget Law 1983 introduced a deduction restriction for interest on permanent debt for the first time. Originally, interest on permanent debt was fully deductible, i.e. interest payments did not reduce trade income. This was intended to ensure equal treatment of equity financing and debt financing, since (imputed) interest on equity also did not reduce the tax base. This claim was derived from the objective of taxing objective earning power. However, this was limited to 60% (from 1983) and 50% (from 1984) by amendment of the law.

The Act on the Continuation of the Corporate Tax Reform ended the trade capital tax as of 1998, so that the municipal trade tax has become a tax dependent only on earnings – which has led to increased cyclicality. As compensation, the municipalities received a share of the sales tax.

Until the 2007 assessment period, in addition to the addition of interest on permanent debt, half of the rental and leasing interest was also added if it was not already subject to municipal trade tax at the level of the recipient of the payments (usually the lessor). This was intended to avoid a double burden of municipal trade tax. However, due to the unequal treatment of German and foreign companies and the associated restriction of cross-border trade in services, the ECJ declared this provision to be contrary to EU criminal defenses in its Eurowings ruling.

The last major change came in 2008 with the Corporate Tax Reform Act. Among other things, this led to a new treatment of municipal trade tax in the determination of taxable income. As of 2008, this is no longer a operating expense in accordance with Sec. 4 para. 5b) of the German Income Tax Act (EStG) and is therefore not deductible. In addition, the scope of the addition of financing expenses has been significantly expanded. The broadening of the tax base and the elimination of the business expense deduction and the graduated tax rate are to be offset by lowering the municipal trade tax base and increasing the municipal trade tax credit at shareholder level.

Taxation procedure

Subject of taxation Taxes are levied on commercial enterprises that are recorded either via their legal form as a corporation or via their commercial activity as defined by income tax law (sole proprietorships and partnerships). An allowance of €24,500 is granted for individuals and partnerships (Sec. 11 para. 1 No. 1 GewStG). For other legal entities under private law (e.g. associations) and associations without legal capacity, insofar as they maintain a commercial business operation, an allowance of €5,000 applies (Sec. 11 para. 1 No. 2 GewStG). Freelance or other non-commercial self-employed activities as well as agricultural and forestry operations are not subject to municipal trade tax.Das Bundesverfassungsgericht hat die Verfassungsgemäßheit der Gewerbesteuerfreiheit von Freiberuflern und Land- und Forstwirten mit Beschluss 15 January 2008 festgestellt (1 BvL 2/04, BGBl 2008 I S. 1006)

Assessment basis The basis for calculating municipal trade tax is the trade income. This is the profit to be determined in accordance with income tax or corporation tax law. As a rule, the profit or loss is taken over and in individual cases increased (additions, Sec. 8 GewStG) or reduced (reductions, Sec. 9 GewStG) by certain amounts. Both additions and reductions pursue different objectives, which are partly justified by the fact that the assessment basis should reflect the objective earning power – real trade income independent of the entrepreneur's financing decision in the individual case – of a trade. According to the original conception of the legislator, an assumed fictitious standard business operates with its own capital, with its own machinery, but in third-party (rented) premises. However, the regulations on additions and reductions have changed several times, also for fiscal reasons, so that it remains controversial which additions or reductions can be justified with this objective. Municipal trade tax calculation scheme: Profit from trade (profit) according to EStG or KStG + additions – deductions

= Trade income before loss deduction – Trade loss from previous years

= Trade income (to be rounded down to full €100) – Tax allowance of €24,500 (only for sole proprietorships and partnerships) or €5.000 for other legal entities under private law (e.g. associations) as well as commercially active associations without legal capacity

= trade income × tax rate (since 2008: 3.5%)

= tax rate × assessment rate of the municipality

= municipal trade tax to be determined – municipal trade tax prepayments = municipal trade tax payment burden

Additions Since 2008 a quarter of the financing expenses has been added back to the profit. This also applies if the rental and lease payments are subject to municipal trade tax at the recipient of these payments. Financing expenses include payments for debts, pension payments and permanent charges, profit shares of silent partners and financing shares in rents, leases and licenses. These financing shares are determined on a lump-sum basis from the total consideration paid. With the extension of the regulation, the previously described EU illegality has been eliminated. In order to exclude small and medium-sized enterprises from the extension of the additions, an allowance of €200,000 (until 2019: €100,000) is provided for. +Additions:Interest and other consideration for debts (Sec. 8 No. 1a GewStG) + Pension payments and permanent charges (Sec. 8 No. 1b GewStG)

+ profit shares of silent partners (Sec. 8 No. 1c GewStG)

+ 20% of rents, leases and leasing rates for movable assets (Sec. 8 No. 1d GewStG)

+ 50% of rents, leases and leasing rates for immovable fixed assets (Sec. 8 No. 1e GewStG)

(reduced to 50% as of the 2010 assessment period)

+ 25% of the fees for the transfer of rights, concessions and licenses (Sec. 8 No. 1f GewStG)= Total amount of financing fees – Allowance of €200,000

Interim balance

× 25%= Total amount of additions from finance charges In addition to financing expenses, other items are added back to profit: Profit shares distributed to personally liable partners of a KGaA (Sec. 8 No. 4 GewStG), dividends previously exempted from tax under the provisions of the partial income procedure (Sec. 8 No. 5 GewStG), shares in the losses of a domestic or foreign commercial partnership (Sec. 8 No. 8 GewStG), contributions to promote tax-privileged purposes (Sec. 8 No. 9 GewStG), and certain partial write-downs and losses on disposals (Sec. 8 No. 10 GewStG).

Reduction The reductions are intended to avoid multiple charges of real taxes. For example, the trade income is reduced by a portion of the standard value of business real estate, as this is already subject to real estate tax. In addition, profit shares from qualified participations (more than a 15% share) are reduced, as these are already subject to municipal trade tax at the level of the distributing corporation (so-called trade tax intercoporate privilege). In addition, foreign profit shares are reduced to take account of the domestic nature of the municipal trade tax. +Reductions: 1.2% of the unit value of the real estate belonging to the business assets (Sec. 9 No. 1 Sentence 1 GewStG).

+ Profit shares from a foreign or domestic co-partnership (Sec. 9 No. 2 GewStG)

+ Dividends from a domestic corporation, provided that the shareholding is at least 15% (Sec. 9 No. 2a GewStG)

+ Trade income of a foreign permanent establishment within the meaning of Sec. 12 AO (Sec. 9 No. 3 GewStG)

+ donations for the promotion of tax-privileged purposes within the maximum amounts (Sec. 9 No. 5 GewStG)

+ dividends from a foreign corporation, provided that it holds an interest of at least 15% (Sec. 9 No. 7 GewStG)

+ certain dividends from a foreign corporation, subject to double tax agreement (Sec. 9 No. 8 GewStG)

Extended reduction