General administration costs of holding companies in the form of a partnership

The legal form of the partners of a German partnership is decisive for the tax treatment in Germany of profit distributions from a corporation to a partnership as the partnership itself is considered transparent for German tax purposes (so-called look-through-approach). If the partners to whom the profit is attributed by their shareholding are natural persons, the dividend income is 40 % tax-exempt by the so-called partial income method. Correspondingly, 40 % of the expenses that are economically connected with the profit distributions are not deductible for tax purposes (partial deduction ban of Sec. 3c (2) of the German Income Tax Act). The partial deduction ban therefore depends largely on how the term "economic connection" is to be understood.

The German Federal Fiscal Court (“BFH”) has now ruled on the concept of "economic connection" in its judgement of 27 November 2024 (Ref. IV R 25/22) and decided that all general administrative costs of a holding company in the form of a partnership (in this case a limited partnership in the legal form called GmbH & Co. KG), whose activity consists exclusively of holding a share in a corporation, are economically connected to its 40 % tax-exempt dividend income and are therefore partially excluded from the deduction of business expenses to the extent of 40 %. In the case at hand, only the limited partners had an interest in the assets and therefore also in the profits of the GmbH & Co. KG. The general partner, a company in the legal form of a corporation (“GmbH”), on the other hand, did not hold an interest in the assets.

According to the BFH, whether and to what extent expenses are economically related to a type of income depends on the reasons for which the taxpayer incurs the expenses. It is then necessary to examine whether expenses have been incurred by a taxpayer for reasons of partially tax-free income generation, the generation of fully taxable income, or for other reasons outside of income generation. An indirect economic connection is sufficient.

If there is an economic connection with several types of income, some of which are fully taxable and some of which are partially tax-exempt, and if the expenses incurred were not primarily triggered by one of the two types of income, should be apportioned proportionately and within the framework of an evaluative consideration according to the legal and economic substance of the overall transaction.

In the case at hand, the economic connection between the expenses and the partially tax-exempt dividend income is already evident from the fact that the partnership only generated dividend income.

According to the BFH, it is irrelevant whether the expenses are incurred to fulfil a legal obligation provided by law (in this case: costs for the financial statements and mandatory contributions) or a contractual obligation (in this case: legal and consulting costs and banking fees). The economic connection is not disrupted by any legal obligation - contrary to the view held in some literature. Rather, according to the BFH, these obligations and the associated expenses are also the result of the intention to hold shares in other companies to generate dividend income.

Note: Especially in the case of high administrative costs, the choice of legal form for holding companies should be carefully considered, given the broad application of the partial deduction ban by the BFH. If the holding company in the case at hand were a corporation, the dividend income received would be 95 % tax-free. Under Sec. 8b (5) of the German Corporation Tax Act, 5 % is considered a non-deductible business expense - however, the deduction of the actual business expenses incurred is not limited for holding companies in the form of a corporation due to the dividend exemption.