Option to use the partial income method when selling company shares

Capital income from a shareholding of at least 25 % in a corporation is not subject to final taxation at the separate rate for income from capital assets if the taxpayer submits an application for taxation at the standard rate in accordance with section 32d (2) no. 3 of the German Income Tax Act (EStG) together with the income tax return for the respective assessment period at the latest. As long as the application is not revoked, the partial income method also applies to this capital income in the following four assessment periods without the application requirements having to be proven again. In its ruling of July 17, 2024 (case no. VIII R 37/23), the German Federal Fiscal Court (BFH) had to clarify whether debt interest incurred in connection with the acquisition of a previous shareholding in a limited liability company (GmbH) can be taken into account as subsequent income-related expenses, even though the taxpayer is no longer the shareholder of the company.

In the case in dispute, the taxpayer held a one-third share in the share capital of the GmbH, but sold this shareholding in the course of 2010. In this year, he applied for the partial income method to be applied to the income from the shareholding and for the subsequent debt interest incurred to be deducted from his income from capital assets. The tax office assessed the application as requested. In the following assessment periods, however, it denied the further deduction of income-related expenses following a tax audit. This is because, from the tax office’s perspective, the legislator only provides for a simplification of the burden of proof for the application requirements in the four assessment periods following the application, but the statutory regulation does not imply these.

Both the first-instance tax court and the BFH in the subsequent appeal proceedings considered the requirements for the application of the partial income method to be fulfilled despite the sale of the shareholding. The sale of the shareholding during the year does not prevent an effective application request for the partial income method if the applicant held a sufficient stake in the corporation at any time during the year in question until the sale. The abstract possibility of being able to generate investment income from the shareholding is sufficient.

The existence of the substantive legal application requirements in accordance with section 32d (2) no. 3 EStG is therefore only mandatory in the year in which the application is submitted; in subsequent years within the statutory period, these are to be assumed by the tax office. The fact that the taxpayer was no longer a shareholder of the GmbH after the effective application for the 2010 assessment period is therefore irrelevant for subsequent years. The taxpayer can thus claim 60 % of the disputed debt interest as income-related expenses in accordance with the partial deduction ban. This is also in line with the purpose of the regulation. That is because the legislator excludes income from ‘entrepreneurial investments’ and the related expenses from final withholding taxation, including the prohibition on the deduction of income-related expenses, through the option of the partial income method. This applies even if such expenses are not offset by any investment income during the application period.