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Germany: Deduction of foreign partner’s interest expense



Dr Thomas Schänzle

Christian Birker

On September 26 2014, the Finance Ministry revised its comprehensive circular on the treatment of partnerships under the tax treaties. Of particular interest are its remarks on partners' interest costs incurred in connection with their partnership holdings. The fundamental principle behind the German computation of partnership income is that all income flowing to a partner is deemed to be part of that partner's profit share and thus does not reduce the partnership's profit as a business expense (loan interest, service fees and so on) and that all expenses incurred by a partner in respect of his investment or activities in the partnership are deductible from his share of the partnership income. This principle is reaffirmed by a treaty override provision in the Income Tax Act which applies unless the treaty explicitly states otherwise.

The revised circular now seems to be casting doubt on the continued application of the general principle, in particular in respect of loan interest incurred by a foreign partner. It states that such interest may only be deducted from the German source partnership income if it is effectively connected with that income. It then mentions the financing cost of an interest-free loan to the partnership as an example of a lack of the necessary connection. However, it is silent as to whether the same applies in cases where the partner's equity is refinanced.

Deduction of a partner's financing costs for the acquisition of a partnership share is a fundamental building block of many inbound partnership structures. Although it is and continues to be based on German partnership taxation principles, recourse to the courts may now be necessary.

Dr Thomas Schänzle ( and Christian Birker (


Tel: +49 69 9585 6477 and +49 69 9585 6061


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