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Exemption from trade tax for the self-employed and farmers and § 15.3 no. 1 of the Income Tax Act constitutional
Press Release No. 58/2008 of 28 May 2008
Order of 15 January 2008
1 BvL 2/04
The First Senate of the Federal Constitutional Court was asked for a decision on two trade tax-related issues based on a submission from the Finance Court of Lower Saxony (Niedersächsisches Finanzgericht) and came to the following conclusion:
It is consistent with the principle of equality before the law that the earnings of independent professionals, other self-employed persons, and farmers and forestry managers are not subject to trade tax. Likewise, the fact that in accordance with § 15.3 no. 1 of the Income Tax Act (Einkommensteuergesetz - EStG) the entire income of a partnership is regarded as business profits and is thus liable to trade tax even if only part of it arises from commercial activity (known in German as the Abfärberegelung) does not constitute a violation of the principle of equality before the law.
In essence, the decision is based on the following considerations:
I. When reaching its decision regarding whether independent professionals, other self-employed persons, and farmers and forestry managers are to be subject to trade tax in the same way as other trade professionals, the legislature did not exceed the margin of discretion and appreciation afforded to it. There are still sufficiently tenable grounds for drawing this distinction.
1. Not subjecting the independent professions to trade tax reflects a legal tradition which stretches back more than 70 years. The legislature may continue to distinguish between trade professionals and independent professionals in this way, as has been the tradition over such a long period, until such time as it becomes obvious that differences no longer exist between the two groups as regards taxable object and key tax features. This is, however, not the case. Even though it is necessary to define typical facts, the generally academic or comparable, specialised vocational qualification or creative talent which is a precondition for learning or exercising an independent profession, the particular significance of the fact that the work is performed in person, under one's own authority and independently, linked to the oftentimes highly personal relationship of trust with clients, as well as the specific government regulations applicable to numerous independent professions, and the fact that regulations are often established autonomously by the profession, especially as regards professional obligations and terms and conditions regarding fees, still reveal significant differences between independent professionals and trade professionals even today.
These differences bear an objective relation to the traditional justification for trade tax resulting from the principle of equivalence. Accordingly, the decision to exempt the independent professions from the liability to pay trade tax is not arbitrary. The idea still holds that trade tax compensates in a general fashion for the specific infrastructure burdens caused by the establishment of commercial enterprises. The assumption that the independent professions typically give rise to infrastructure burdens on municipalities to a lesser extent than trade professionals do suggests itself. The similarities between the job descriptions of a number of independent professions on the one hand and trade professionals on the other hand does not alter the fact that the independent professions can justifiably be categorised as generally requiring less personnel and production means. Drawing a distinction based on this assumption is above all also justified bearing in mind that the tax-free allowances for trade tax on earnings and - up until 1993 - for trade tax on business capital have been increased on several occasions. This has meant that over the past few years only around 30 per cent of trade professionals have actually been liable to pay trade tax. Thus, smaller commercial enterprises, which can best be compared with the independent professions in terms of their use of infrastructure services, are not subject to the tax, although high-earning enterprises, i.e. generally medium-sized and large commercial enterprises which typically give rise to greater infrastructure burdens, are.
2. There is one key aspect which distinguishes farmers and forestry managers from trade professionals, namely the production factor land, which is of particular relevance on account of these operations being bound to the land and their economic success being dependent on weather conditions. In addition, they are subject to a special tax, namely land tax. The Federal Constitutional Court has thus in the past felt that it is within the legislature's margin of discretion not to make farmers and forestry managers liable to pay trade tax.
3. Finally, various provisions governing allowances and compensation in the law on income tax which are aimed at reducing or eliminating as far as possible the "double taxation" of commercial enterprises on account of their having to pay both income tax and trade tax considerably mitigate, ultimately, the impact of the resulting unequal treatment of trade professionals and independent professionals, other self-employed persons, and farmers and forestry managers and thus also rule out the assumption that the legislature has acted arbitrarily.
II. § 15.3 no. 1 EStG is consistent with the principle of equality before the law. There are sufficiently substantiated grounds to justify the resulting unequal treatment of mixed partnerships and sole traders, who, in contrast to partnerships, may simultaneously draw income from various sources.
The primary objective of this provision is to simplify the determining of the income of mixed partnerships by defining all forms of income as "income from commercial activity". The objection raised, namely that the difficulties in determining the income and delimiting the sources of income apply in the same way to sole traders, ignores the extent of the problems associated with partnerships. Where an individual is liable to pay tax, various sources of income need to be delimited but there is only one taxable object. In the case of partnerships, by contrast, several sources of income need to be delimited for several persons liable to pay tax, and the amounts of the income can vary. This opens up multifarious possible combinations of activity and assets plus sources of income and persons liable to pay tax within a partnership which go well beyond the possibilities open to a sole trader. Further, there are a number of special tax features associated with determining the earnings of a partnership which a sole trader lacks. In view of these difficulties, it is constitutionally unobjectionable that the legislature has felt that there is, in the case of partnerships, an important need to simplify the determination of income.
A further legitimate objective of the provision is that it safeguards trade tax revenue. The provision set out in § 15.3 no. 1 EStG aims to prevent commercial income not being subject to trade tax on account of the insufficient means of distinguishing between various activities within one enterprise.
The disadvantages arising for partnerships which are associated with the definition of typical facts under § 15.3 no. 1 EStG stand in justifiable relation to the objectives of the provision. Although the concomitant unequal treatment of partnerships is indeed of considerable consequence, the burden is above all mitigated on account of the possibility of circumventing the aforementioned provision by means of choosing a corporate structure which is not associated with any significant burdens or risks.