Federal constitutional court provides for tax neutral asset transfers between partnerships with identical partners holding same interest percentages
In a decision dated 28 November 2023 (and published on 12 January 2024), Germany’s federal constitutional court (BVerfG) ruled that section 6 (5) sentence 3 of the Income Tax Code (ITC) violates German constitutional principles of equality to the extent that it does not allow for a tax neutral asset transfer between partnerships with identical partners with the same partnership interest percentages.
Under section 6 (5) sentences 1 and 2 ITC, asset transfers between different businesses of the same taxpayer are tax neutral. Furthermore, section 6 (5) sentence 3 ITC (which is under review) allows for a tax neutral asset transfer between a partnership and its partners and between the partners of a partnership, provided the asset is allocated to the partnership based on German tax accounting rules for partnerships. However, a tax neutral asset transfer between partnerships having identical partners with the same partnership interest percentages is not covered by the wording of section 6 (5) sentence 3 ITC.
Facts of the case
In the case at hand, a German limited liability partnership (KG) sold real estate to another partnership having identical partners with the same partnership interest percentages. The sale was performed at tax book value, resulting in the taxpayer reporting no taxable gain from the sale. The tax authorities were of the opinion that the sale must be performed at fair market value for tax purposes (resulting in taxable gain) and argued that section 6 (5) sentence 3 ITC does not cover the transfer of assets between partnerships having identical partners with the same partnership interest percentages.
The lower tax court of Baden-Wuerttemberg decided in favor of the taxpayer, reaching the conclusion that section 6 (5) sentence 3 ITC must be interpreted based on constitutional principles and applied analogously for the transfer of assets between partnerships with identical partners holding the same partnership interest percentages. The lower tax court cited an earlier decision from the federal tax court (BFH) that expressed strong doubts about the compatibility of section 6 (5) sentence 3 ITC with constitutional principles and that an open question remained as to whether the provision is in compliance with such constitutional principles.
Within the appeals procedure, the BFH referred the case to the BVerfG to decide about the conformity of section 6 (5) sentence 3 ITC with constitutional principles, arguing that an interpretation in compliance with these principles is not possible for the BFH, as the tax neutral asset transfer between partnerships having identical partners with the same partnership interest percentages is clearly not covered by the wording of the law and was intentionally left out by the legislator.
Decision of the BVerfG
In its decision, the BVerfG reached the conclusion that section 6 (5) sentence 3 ITC violates article 3 (1) of the German Constitution regarding equality before the law to the extent that it does not allow for the possibility of a tax neutral asset transfer between partnerships with identical partners holding the same partnership interest percentages. In line with the reasoning of the BFH, the BVerfG concluded that a broadened interpretation of the existing rule in line with constitutional principles is not possible as the tax neutral asset transfer between partnerships having identical partners with the same partnership interest percentages was intentionally left out of the provision by the legislator. According to the BVerfG, the different treatment of an asset transfer between partnerships with identical partners holding the same partnership interest percentages, which could result in taxable gain as compared to the other scenarios in section 6 (5) sentence 3 ITC where a tax neutral transfer at tax book value is allowed, is not justified as there are no valid reasons for a difference in treatment. Arguments that the narrow rule of section 6 (5) sentence 3 ITC serves as an anti-abuse rule and its application must be limited to the scenarios as provided in the law were rejected by the BVerfG.
Comments
As a result of the decision by the BVerfG, the legislator is now obliged to retroactively introduce amended provisions for asset transfers between partnerships having identical partners with the same partnership interest percentages for periods after 31 December 2000 to address the unconstitutional character of the current version of section 6 (5) sentence 3 ITC. Until the amended provision comes into effect, section 6 (5) sentence 3 ITC must be applied in a way that generally allows an asset transfer at tax book value between partnerships having identical partners with the same partnership interest percentages.
