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Unsuccessful constitutional complaint against trade tax liability on profits from the sale of shares in a co-entrepreneurship
Press Release No. 20/2018 of 10 April 2018
Judgment of 10 April 2018
1 BvR 1236/11
The introduction of a trade tax liability on profits from the sale of shares in a co-entrepreneurship (Mitunternehmerschaft) by § 7 second sentence no. 2 of the Trade Tax Act (Gewerbesteuergesetz – GewStG) in July 2002 does not violate Art. 3(1) of the Basic Law (Grundgesetz – GG). It does not violate the ability-to-pay principle (Leistungsfähigkeitsprinzip) that the partnership (Personengesellschaft) as a co-entrepreneurship is liable for trade tax, even though the profits from the sale of the co-entrepreneur’s share remain with the partner selling the share. The retro-active implementation of the provision for the assessment period of 2002 is also compatible with the Constitution. This was decided by the First Senate of the Federal Constitutional Court in its judgment pronounced today. It thus rejected the constitutional complaint of a limited partnership (Kommanditgesellschaft) that had to pay trade tax on the profits from the sale of limited partners’ shares (Kommanditanteile) that remained with the sellers.
Facts of the case:
1. Trade tax is levied on the objective amount of trade earnings of a commercial business (Gewerbebetrieb). Unlike for income tax, not only natural and legal persons, but also partnerships may be liable for trade tax. Corporations (Kapitalgesellschaften) are liable for the trade tax resulting from their trade earnings. According to former settled case-law, partnerships and individual entrepreneurs only became liable for trade tax when they took up their “active” commercial activities, their liability ended when these activities ceased. Therefore, profits from the sale of a business, a partial business or shares in a co-entrepreneurship were, in principle, not subject to trade tax until § 7 second sentence GewStG was introduced. By contrast, all profits of corporations have been, and still are, subject to trade tax in principle. Yet regardless of the legal fiction of § 2(2) first sentence GewStG, courts assumed that profits from the sale of shares in partnerships – even if corporations sold their shares – were not subject to trade tax. By introducing § 7 second sentence GewStG, the legislature ended this legal situation for co-entrepreneurships and also largely subjected to trade tax profits from the sale of their business, a partial business or of shares of a partner. The introduction of § 7 second sentence GewStG was intended to eliminate the risk of abuse arising from the strategies of influencing income and corporation tax liability under the legal situation at the time.
2. The complainant is a company with global operations in the brewing industry. It is a limited partnership; its general partner (Komplementär) was a general partnership (Offene Handelsgesellschaft) in 2001 and 2002, the decisive years for the present case. Two limited liability companies (Gesellschaften mit beschränkter Haftung) were the partners of the general partnership. The complainant’s limited partners (Kommanditisten) were two further limited liability companies, a foundation, four limited partnerships, and natural persons. Apart from one limited liability company, all limited partners of the complainant sold their shares in 2001 and 2002. In order to prepare this sale, the partners concluded a partnership agreement in July 2001. They commissioned a steering committee to conclude an agreement for the sale of their shares on behalf of the partners. In August 2001, an acquisition and transfer agreement was concluded between the steering committee, on behalf of the limited partners selling their shares, the complainant, the buyer and its group parent company. On 1 September 2001, an extraordinary partners’ meeting gave its consent to the acquisition and trade agreement and approved the proposed transfer of the limited partners’ shares in February 2002. In its trade tax return for 2002, the complainant declared current losses for both incomplete fiscal years and profits from the sale of approximately EUR 663m pursuant to § 7 second sentence GewStG. The tax office set the trade tax assessment base at almost EUR 26m and the trade tax at almost EUR 107m. The complainant’s objection was unsuccessful.
3. The action the complainant brought before the Finance Court (Finanzgericht) was only partially successful. Based on its subsidiary application, the profits from the sale were not fully taxed. However, the Finance Court rejected the complainant’s submission that § 7 second sentence GewStG was unconstitutional due to impermissible retroactivity and violation of the guarantee of the right to equality and that the profits from the sale were thus not to be taxed. The appeal on points of law before the Federal Finance Court (Bundesfinanzhof) was unsuccessful. The constitutional complaint challenges this decision.
Key considerations of the Senate:
The constitutional complaint is unfounded. § 7 second sentence no. 2 GewStG in the version of 23 July 2002 violates neither Art. 3(1) GG nor the prohibition of laws that impose burdens retroactively (Verbot rückwirkend belastender Gesetze). The judgment of the Federal Finance Court does not violate the complainant’s procedural rights equivalent to fundamental rights either.
I. The complainant indirectly challenges § 7 second sentence no. 2 GewStG, arguing that the provisions violate the right to equality. Measured against the general guarantee of the right to equality in its manifestation for tax law, they are constitutional; concerning the amendments in 2002, the legislature remained within its leeway to design.
1. Art. 3(1) GG requires that all people be treated equally before the law. Yet it does not prevent the legislature from differentiating. However, any differentiation must be justified by factual reasons adequate to the aim and extent of the unequal treatment. The principle of equal burdening (Lastengleichheit) constitutes the basis for equality considerations in the field of tax law. Taxpayers must, de facto and de jure, be equally burdened by a tax law. The right to equality leaves a wide margin of appreciation to the legislature, both regarding the selection of the taxable object and the determination of the tax rate. After an object of taxation has been chosen and thus, a decision on a tax burden has been made, deviations from such a decision must, however, be in accordance with the right to equality. Accordingly, such deviations require a specific factual reason that can justify unequal treatment. In this context, the requirements for the reason justifying the deviation increase in line with the extent of the deviation and its significance for the overall distribution of tax burdens.
The principle of taxation in accordance with financial capacity of organisations also applies to trade tax, as it is levied on the objective amount of trade earnings of commercial businesses.
2. Even after introducing § 7 second sentence GewStG, the legislature was allowed to hold on to its decision to assign tax liability to the partnership, as expressed in § 5(1) third sentence GewStG, without violating the principle of taxation in accordance with ability to pay. The legislature may still uphold the trade tax liability of the partnership in the cases of § 7 second sentence no. 2 GewStG, even though the profit from the sale of the share remains with the partner selling the share. Ultimately, it does not violate the ability-to-pay principle that the partnership is liable for trade tax in this case.
In any case, there is no drastic conflict with the ability-to-pay principle, since the shares in the assets sold by way of the sale of the co-entrepreneur’s shares remain with the co-entrepreneurship as the buyer enters the partnership; in principle, the economic capacity of the partnership remains unchanged. To the extent that the co-entrepreneurs selling their shares obtain proceeds from this sale by disclosing hidden reserves, the buyer takes over the higher balance sheet value in a supplementary balance sheet in the co-entrepreneurship. If the partnership sells these assets later, the liquidation of the supplementary balance sheet for the partner who entered the partnership prevents double-taxation with respect to the hidden reserves.
In addition, the legislature was free to assume that the trade tax liability of the partnership pursuant to § 5(1) third sentence GewStG does not result in insurmountable difficulties in the cases of § 7 second sentence GewStG if the trade tax is distributed in a manner that serves all interests within the co-entrepreneurship. It is for the partnership to arrange for the internal distribution of profits and losses, also taking into account tax liabilities. For a partner who leaves the partnership by selling his or her share, possible exemption obligations with regard to taxes levied on the partnership can be stipulated in a partnership agreement.
Art. 3(1) GG is also not violated by the fact that the profits from selling or giving up a co-entrepreneur’s share in the business are subject to trade tax pursuant to § 7 second sentence no. 2 second half-sentence GewStG, while the profits from the sale attributable to natural persons who directly participate in the co-entrepreneurship are exempt from trade tax. This provision disadvantages co-entrepreneurships with participations of partnerships and corporations compared to co-entrepreneurships with direct participations of natural persons. The sufficiently significant reason to justify this situation is the prevention of tax avoidance arrangements. The legislature was free to assume that natural persons who participate directly have lower potential for avoiding tax from the outset than corporations and partnerships. In addition, considerations relating to facilitating administrative implementation support the preferential treatment.
II. The complainant’s expectations of not being burdened with retroactive laws in an impermissible way, constitutionally protected under Art. 2(1) in conjunction with Art. 20(3) GG, are not violated. The prohibition of laws that impose burdens retroactively protects trust in the reliability and predictability of the legal system.
1. Insofar as the legislature draws on past facts for future legal consequences in the course of an ongoing assessment or levying period, it must sufficiently take account of the constitutionally required protection of legitimate expectations. Quasi retroactivity (unechte Rückwirkung) is only compatible with the principle of protecting legitimate expectations if it is suitable and necessary for promoting the purpose of the law and if the limits of what is reasonable are observed in an overall balancing of the significance of the frustrated expectations and the urgency of the reasons justifying the change in the law. Expectations are particularly worthy of protection if the persons concerned had a consolidated expectation of asset growth that they would obtain and realise or would have been able to realise under the old legal framework at the time when the revision was promulgated. This holds true especially if benefits were already obtained on the basis of current law before the retroactive law was promulgated. In addition, the expectations of the persons concerned are particularly worthy of protection if they have made binding commitments before the new law was introduced in the Bundestag.
2. It is not objectionable under constitutional law to apply no. 2 of the second sentence of § 7 GewStG, which was inserted in July 2002, to the complainant’s profits from the sale. This is a case of quasi retroactivity, since the provision was inserted into the Trade Tax Act taking effect as of 27 July 2002 and was first applicable for the assessment period of 2002. The provision has a retroactive effect as of 1 January 2002, as trade tax only arises after the end of the assessment period. The retroactivity of the challenged provision to the assessment period of 2002 does not violate any expectations of a continuation of the old legal situation on the part of the complainant that are worthy of protection. For § 7 second sentence GewStG in the version of the law of 27 July 2002 and also its current version had already been inserted into the Trade Tax Act pursuant to the Corporate Tax Development Act (Unternehmenssteuerfortentwicklungsgesetz) that took effect on 25 December 2001; it was intended to apply for the first time for the assessment period of 2002. However, the provision was inadvertently suspended by 1 January 2002 due to the Act to Continue the Solidarity Pact (Solidarpaktfortführungsgesetz) and could thus not have an effect on tax law at first.
3. The complainant’s expectations of a continuation of the trade tax law that applied before were no longer worthy of protection once the bill of the Corporate Tax Development Act was submitted to the Bundesrat. The revision of § 7 second sentence GewStG that was initially planned and ultimately only implemented by the Fifth Law to Amend the Act on Training Tax Officials and to Amend Tax Laws (Fünftes Gesetz zur Änderung des Steuerbeamten-Ausbildungsgesetzes und zur Änderung von Steuergesetzen) concerns exactly the same legislative purpose with the same contents by the same legislature. Both legislative procedures need to be considered as one. Therefore, not only introducing a draft law in the Bundestag, but also submitting it to the Bundesrat can already have a destructive effect on the legitimacy of expectations.
a) The Federal Constitutional Court recently decided in several cases that introducing a draft bill in the German Bundestag can destroy the legitimacy of expectations of persons concerned and that an amendment may have quasi retroactive effects. From that time, the specific outlines of possible future law amendments are foreseeable. In such cases, taxpayers can no longer expect that the current law will continue to apply without change; they also have the possibility of adapting their business decisions to possible future changes.
b) These considerations equally apply to the submission of a draft law to the Bundesrat by the Federal Government. Submitting a fully formulated draft law to the Bundesrat destroys legitimate expectations as well. Its publication also allows persons affected to adapt to the possible law amendment.
At least with regard to the assessment year 2002, the complainant had to anticipate a change in trade taxation regarding the sale of shares of co-entrepreneurs. After the Federal Government submitted the draft of the Corporate Tax Development Act to the Bundesrat on 17 August 2001, co-entrepreneurships could no longer expect that their partners’ sale of shares would be exempt from trade tax in future.
c) The binding decisions regarding the sale of shares were taken after the draft law was submitted to the Bundesrat.
aa) The draft of the Corporate Tax Development Act was submitted to the Bundesrat on 17 August 2001. Yet the complainant’s partners only consented to the acquisition and transfer agreement at the extraordinary partners’ meeting on 1 September 2001. At that time, the draft law had already been published in a Bundesrat document (Bundesratsdrucksache).
bb) The effect of destroying legitimate expectations, as a result of submitting the draft of the Corporate Tax Development Act, is not strictly limited to the group of co-entrepreneurs concerned by the wording of § 7 second sentence GewStG in the draft law. According to the initial draft law, the profits from selling the share of a partner who is deemed an entrepreneur (co-entrepreneur) should be subject to trade tax in future, “insofar as they are not attributable to a natural person as a co-entrepreneur”. However, the wording that ultimately became law specified that only the profits attributable to “a natural person as a directly participating co-entrepreneur” were exempt from trade tax. After the initial draft version became public, co-entrepreneurs could not rely on the exemption of profits from sales of indirectly participating persons, given the legislature’s goal of subjecting profits from the sale of shares in a co-entrepreneurship to trade tax in order to prevent tax avoidance arrangements.
(cc) The retroactive implementation of § 7 second sentence no. 2 GewStG from the start of the assessment period 2002 is also compatible with the principle of protection of legitimate expectations to the extent that it covers profits from sales which the sellers obtained before the promulgation of the law in July 2002, but which are based on decisions that only became binding after the law had been submitted to the Bundesrat. The complainant does not have an especially consolidated asset position that would be exempt from quasi retroactive access by the legislature deciding on tax matters. Profits from decisions that are only made after the draft law was duly introduced in the legislative procedure and has thus destroyed legitimate expectations do not prevent the legislature from imposing quasi retroactive taxation, even if the proceeds were accrued before the law was promulgated.
III. The procedural complaints against the judgment of the Federal Finance Court and its decision on the complaint seeking remedy for a violation of the right to be heard (Anhoerungsruege) remain unsuccessful. The complainant’s submission does not satisfy the requirements to state reasons under the Federal Constitutional Court Act (Bundesverfassungsgerichtsgesetz – BVerfGG). Moreover, it is within the legislature’s leeway to design the complaint seeking remedy for a violation of the right to be heard in such a way that the adjudicating body deciding on the complaint does not need to be the same as the one that decided in the main proceedings.