What is trade tax in Germany? Basics for businesses

What is trade tax?

Trade tax is a tax on commercial income. It is levied by the city or municipality in which a commercial enterprise has its registered office. If a business has more than one location, its income is divided between these locations in order to calculate the trade tax payable to the relevant municipality. Trade tax is a real tax according to § 3 AO and is regulated by the trade tax act (GewStG).

Trade tax in a nutshell

The trade tax rate is a composite of a uniform tax rate of the basic rate of 3.5% and an assessment rate 💬Hebesatz, depending on where the company’s PEs are located. Municipalities with a population of at least 80,000 currently levy trade tax at a rate of between 8.75% (250% assessment rate) and 20.3% (580% assessment rate).

The basis for this tax is the profit adjusted for corporation tax purposes: in particular, 25% of all financing costs exceeding €200,000, including implicit financing costs in leasing, rental and licence payments, are added back to taxable income.

Who has to pay trade tax?

All businesses that generate commercial income as soon as they’re active, such as:

• Commercial traders
• Corporations (UG, GmbH, AG, Holding, gUG, gGmbH etc.)
• Partnerships (GbR, GmbH & Co. KG etc.)

Who doesn’t have to pay trade tax?

Freiberufler are not considered to be commercially active and therefore do not have to pay trade tax. And, of course, businesses that do not make a profit don’t have to pay trade tax either, because there is no tax base.

Is there a trade tax allowance?

Yes, there is a €24,500 tax-free allowance for individuals, commercial traders and partnerships and €5,000 for associations. There is no allowance for corporations.

When & how to pay trade tax

1. Like VAT, trade tax is paid in advance. As a trader, you inform the tax authorities of your profit forecast. When you have completed your trade registration, you can do your tax registration online via ELSTER. There you can enter your expected profit.
2. On the basis of this information, the tax office calculates the amount of your trade tax advance payments. Your local tax office will send you a trade tax notice stating how much you have to pay and when.
3. You have two options to pay it: Either give the tax office a direct debit authorisation or pay the trade tax by bank transfer.
4. At the end of your business year, you file a trade tax return. The tax office will then calculate the final trade tax bill for the year and offset your advance payments against it. If the advance payments exceed your trade tax liability, you will receive a refund – a small consolation for the small profit.

5. Other important types of tax for entrepreneurs:

   • Corporate income tax
   • Capital gains tax
   • Wage tax
   • Income tax

How to account for trade tax

How do you calculate your trade tax liability?

You need four variables:

1. Profit forecast
2. Tax-free allowance (usually €24,500)
3. Tax rate (national rate is 3.5%)
4. Trade tax assessment rate for your place of business (each municipality sets its own rate)

How to calculate a business’s trade tax burden

This example refers to a commercial trader. For these, a trade tax allowance of €24,500 applies. The example is based on an operating profit (income minus operating expenses) of €75,000 and a trade tax assessment rate of 360%.

If you were to locate your business in a municipality with a tax rate of 200%, your trade tax would be reduced to €3,353; with a tax rate of 500%, it would rise to €8,837.50. The location of your business therefore plays a significant role in the subsequent tax burden due to trade tax.

What is the trade tax assessment rate?

The trade tax assessment rate is set by the municipalities by law. It is a multiplier for calculating trade tax. In simple terms, it is calculated as profit multiplied by the tax rate multiplied by the assessment rate. If you want to delve deeper into the topic, the federal statistical office 💬Statistisches Bundesamt  publishes data on the average trade tax assessment rate in Germany on its website. To find out the current assessment rate for your municipality, check out its website or talk to your local trade office.

FYI: The federal government has set a minimum trade tax assessment rate of 200% to prevent tax havens being set up in Germany that attract businesses with tax dumping.

Top 10 highest trade tax assessment rates in Germany*

The following table shows the ten municipalities with the highest rates. Contrary to expectations, the top municipality is not one of the big cities, but the quiet village of Dierfeld in Rhineland-Palatinate, with a whopping 900%. The village is part of the Wittlich-Land municipality and has just ten inhabitants. Attracting commercial industries is probably a lower priority there. These are the top 10 highest assessment rates in Germany:

Source: Federal Statistical Office, as of 2017

Top 10 lowest trade tax assessment rates in Germany*

The most favourable trade tax assessment rates exist in the younger federal states. But, two Bavarian municipalities are among the top ten cheaper places to do business.

*Quelle: Statistisches Bundesamt, Stand 2017

Location competition through tax rates

Trade tax is one of the most important sources of income for many cities and municipalities. Currently, there are two opposing strategies at the municipal level: some set the rates as high as possible in order to collect as much tax as possible. Others try to attract new businesses through low business rates and increase business tax revenues through the number of businesses.

When the candy manufacturer Haribo moved from Bonn to the neighbouring municipality of Grafschaft, the trade tax assessment rate was undoubtedly a factor. In 2016, this rate was 490% in Bonn, but only 330% in Grafschaft.

Businesses should carefully weigh up the pros and cons of their location. Taxes may be lower in rural areas, but skilled workers are scarce.

How can I reduce my trade tax burden?

The best tax advice is always tailored to your individual case and comes from your trusted tax advisor. However, there are a few common sense things you can do to save tax:

Find the best district to register in

When you start a new business, of course, you need to decide where to locate it. This decision will have multi-dimensional implications. For one, you should check the local trade tax rates. Smaller municipalities often offer lower trade tax rates, and local business and economic development agencies will do their best to help you.

However, you should also consider other factors when deciding where to locate your business, such as where your customers are, where you can find good staff, what transport links are available, affordable working space, and whether the internet bandwidth is sufficient for your purposes.

Keep your Freiberufler & commercial business activities separate

If you work as a liberal professional 💬Freiberufler and your business activity includes commercial activity keep them separate from each other. If you mix them up in your accounts, you will usually have to pay trade tax on all your business income.

A fail-safe way to avoid this pitfall is to set up a separate business structure for the commercial part, with its own name, bank account, etc. If the commercial part of the income is very small, the tax courts sometimes decide that it does not affect the total income. But it is better not to get into trouble in the first place.

Set up a holding company

If your business is a corporation you should consider setting up a holding structure to optimise your company’s trade tax burden. If there is a profit transfer agreement, the taxation of the subsidiaries is shifted to the parent company. Conversely, losses of subsidiaries are offset against profits of other subsidiaries with a profit transfer agreement.

A holding company structure also offers other interesting tax structuring options, which can be worthwhile even for smaller companies. For example, when a subsidiary is sold, 95% of the sales proceeds are tax-free. Only 5% is used as the tax base. If this is taxed at around 30%, only 1.5% of the proceeds are taxed (Section 8 (1) KStG). To be exempt from trade tax under this provision, the holding company must hold a 15% stake in the subsidiary (see § 9 (2a) GewStG).

As an entrepreneur, you can reinvest the money remaining in the holding company in subsidiaries or pay it out to yourself in tranches, thus taking advantage of tax allowances and other tax benefits. The entire profit from the sale is taxed at only about 1.5%. So if you are planning to sell your business in the next few years, you would be well advised to set up a holding company.

Use investment deductions & loss carryforwards

The Investitionsabzugsbetrag (IAB) is an investment allowance that allows entrepreneurs to postpone income to a future financial year. This has a profit-reducing effect and therefore also reduces trade tax. Conversely, a Verlustvortrag can also be used. This is when losses are postponed to future years by carrying them forward.

Credit trade tax against income tax

If you have a partnership or sole proprietorship as a commercial trader you can use a trade tax credit that has a net tax-reducing effect. They can reduce their standard income tax by 3.8 times the amount of the trade tax assessment. In principle, this is a credit of trade tax against income tax (§ 35 EStG.). The credit does not apply to corporations.

Prerequisite for the trade tax credit

1. Income tax due for business income
2. Income tax actually paid

Note: The former graduated tax rate for partnerships and commercial traders has now been abolished, as has the deductibility of trade tax as a business expense.

Additions and deductions

According to § 8 GewStG, trade income is increased by certain additions and reduced by certain deductions. Losses carried forward from previous years can also be deducted from profits. The aim is to determine the actual amount of profit from a business’s commercial activities. That is, a business’s basis of assessment.

This basis of assessment has to do with the fact that trade tax is what’s called a real tax. Real taxes are a group of taxes – including property tax and trade tax – linked to tax objects that don’t take into account the personal circumstances of the owner or other beneficiary. It’s opposite is personal taxes. Here you can find an overview of the taxes business have to pay.

Tax base additions

The additions include, for example, one-quarter each of the company’s financing costs (interest expenses, pensions and permanent charges).

Also included are expenses for the temporary transfer of rights and profit shares of silent partners, as well as 20% of the rent for using movable assets and 50% of the rent for using immovable assets, subject to an annual allowance of €100,000. You would therefore have to pay very high rent to exceed this amount.

Tax base reductions

Note that the rules for reducing the trade tax base are complex.
Here are some examples of possible exemptions:

• Income from permanent establishments abroad
• Donations and grants
• Shares in the profits of domestic and foreign partnerships or corporations
• 1.2% of the standard value of the company’s own property under certain circumstances.

These items may be exempt from trade tax up to a certain limit. Details are set out in § 9 GewStG.

Trade tax calculators

Some IHKs (and also other organisations and companies) provide trade tax calculators on the Internet. For example, you can order a trade tax calculator for the whole of NRW from the Cologne IHK. This not only contains the assessment rates of all 396 cities and municipalities in North Rhine-Westphalia, but also shows how the trade tax assessment rates have developed over the last 30 years.