Capital Expenditure Deduction and Profit Threshold: What You Need to Know

The investment deduction under Section 7g of the Income Tax Act (EStG) is a way to provide tax incentives for investments in depreciable movable assets classified as fixed assets prior to their actual acquisition or production.

However, there is an important condition here: The profit may not exceed €200,000 in the year the investment deduction is claimed. But which profit counts in this context? We take a look at the relevant information and the differing perspectives of the tax authorities and the tax court.

The Profit Limit

The Annual Tax Act of 2020 introduced a profit limit of €200,000, which is independent of the method used to determine profit. The calculation of this limit is based on the profit determined in accordance with Section 4 or Section 5 of the Income Tax Act (EStG); specifically, it does not take into account the reduction in profit due to investment deductions already claimed or the increase in profit due to investment deductions reversed in accordance with Section 7g(2) of the Income Tax Act (EStG). Internal changes in book value also influence the calculation.

Determination of the Initial Tax Base “Profit”

The legislature has not explicitly defined the term “profit” in Section 7g(1) of the German Income Tax Act (EStG). According to the tax authorities’ interpretation (BMF letter dated June 15, 2022), this refers to taxable profit. This means that off-balance-sheet adjustments to the tax balance sheet or adjustments in the cash-based accounting method must be included.

The differing opinion of the tax court

The Baden-Württemberg Tax Court, however, sees things differently. According to its court order dated May 2, 2023, the term “profit” in Section 7g(1), sentence 2, no. 1 of the Income Tax Act (EStG) refers to the balance sheet profit and not the taxable profit under Section 2(2), sentence 1, no. 1 of the Income Tax Act (EStG). This means that off-balance-sheet items such as non-deductible business expenses or tax-exempt income are not taken into account.

Why is this important?

The idea behind Section 7g of the German Income Tax Act (EStG) is to promote the willingness of small and medium-sized enterprises to invest. Whether a business meets the €200,000 threshold should therefore be assessed based on its economic capacity. Non-deductible business expenses and tax-exempt business income do not affect economic capacity and should therefore be excluded from the special profit calculation under Section 7g(1) of the German Income Tax Act (EStG).

Conclusion

Since the tax authorities hold a different view, an appeal against the tax court’s decision has been filed with the Federal Fiscal Court (BFH) (Case No.: X R 14/23). Until a final decision is issued by the BFH, similar cases should be kept open. This anticipated BFH decision could be particularly important when it comes to profit increases resulting from tax audits.

We are keeping a close eye on current developments for you and provide detailed advice on all tax matters. With our offices in Düsseldorf and Oberhausen, we offer you direct points of contact. Contact us to schedule a consultation. We look forward to meeting you.