Finance Court of Schleswig-Holstein: Taxation of interest income from rental profits in cross-border situations

The Finance Court of Schleswig-Holstein recently issued a decision relating to the tax treatment of interest payments to a deemed trading partnership that rented out real property in the U.S. The partners in the partnership were German residents. The cash surplus resulting from the leasing activities was invested and generated interest income. The Finance Court held that the interest income is taxable in Germany at the level of the German resident partners. Applying the interest article in the Germany-U.S. tax treaty, the court held that, from a treaty perspective, the interest income does not fall within the scope of the business profits article due to the fictitious “deemed trading”nature of the KG or under the real estate article. The income is based on the use of capital, not on the use of real property. The court’s conclusions are supported in the tax literature and are likely to be confirmed by the Federal Tax Court. 

Although the case involved an outbound situation, the decision should apply equally to inbound situations. In typical situations where foreign investors hold German real estate for rental purposes through a foreign entity (e.g. Netherlands B.V. or Luxembourg Sarl) or through a partnership deemed to be trading by virtue of law, interest income earned in connection with the real estate should, in principle, be subject to tax outside Germany (at the level of the foreign entity or at the level of the partners in the partnership, respectively).

Contact

Dr. Bettina Lieber | Düsseldorf