In addition to the legal persons of private law, there are also the legal persons of public law. This includes in particular cities and municipalities. It is therefore hardly surprising that, as corporations, they are also subject to general taxation. However, there are some divergent rules in the taxation of cities and municipalities. For example, cities and municipalities pay only 15% instead of 25% capital gains tax on profit distributions. In addition, they are exempt from the taxation of hidden distributions of profits if they have permanently loss-making activities for certain legal reasons. Furthermore, it is possible for cities and municipalities to create reserves and make tax-neutral payments from tax deposit accounts. Finally, they are also able to offset profits and losses tax-optimized. Otherwise, cities and municipalities pay taxes quite regularly, even if, curiously enough, they basically pay their business tax to themselves.

So far in our series of contributions we have dealt with either the taxation of companies or private individuals. But there is another group of taxpayers in Germany that we would like to introduce to you for the first time, namely the public sector. Because cities and municipalities are also tax subjects and thus pay taxes. At least in certain aspects, they are tax-equal to other private-law corporations. After all, cities and municipalities are also corporations, but under public law. This is their legal dress, with which they also come before the Treasury to give an account.

However, they are also accountable in many other respects. In particular, there is an obligation towards the public to use taxpayers' money properly in the performance of the tasks that cities and municipalities are legally responsible for. It is therefore hardly surprising that public companies can also be obliged to comply with the respective requirements for commercial accounting and auditing by an auditor.

Now cities and municipalities primarily have a mission to fulfill for the benefit of the general public. A profit-making intention, as is the rule for commercial companies or sole proprietors, is subordinated to this general task, if it exists at all.

You can distinguish between three areas of activity of cities and municipalities.

2.1.1. Self-government tasks of the public authorities

On the one hand, there are tasks that are only for the municipalities. Therefore, these official activities constitute the exercise of public power. These are, for example, the disposal of waste water, the safeguarding of public order in the context of the activities of the public order office or fire protection. In fact, cities and municipalities are obliged to perform these municipal self-government tasks. Therefore, there are usually no commercial enterprises competing with the municipal administration for the award of contracts relating to these public tasks.

2.1.2. Voluntary self-government tasks of public authorities

On the other hand, cities and municipalities can also take on voluntary self-government tasks. This includes economic, cultural and social tasks, such as the establishment and maintenance of public transport, an opera or retirement homes. It should be noted that a profit-making intention or a participation in general trade is not of fundamental importance, so strictly speaking, there are no commercial enterprises. However, sustainable economic activity with the aim of generating revenue is quite relevant.

The three examples just mentioned deliberately focus on such institutions that can also expect competition from the commercial side. These voluntary municipal enterprises are referred to in the Corporate Tax Act as enterprises of a commercial nature. Only activities in the agricultural and forestry sector are exempt from this by law. It should be noted that § 4(2) second sentence KStG requires a strict separation of governmental activities and companies of a commercial nature in income tax considerations.

Furthermore, cities and municipalities can also maintain businesses in other ways. For example, it is possible to set up a management company, an own company, an institution under public law or even a corporation under private law, such as a GmbH, gGmbH or an AG. However, these undertakings may focus on profitability and participation in general trade. This also depends on whether public or private enterprises are considered to be enterprises of a commercial nature for tax purposes or whether they are to be considered independently.

2.1.3. Asset management by public authorities

In addition, there is also the asset management of the public sector. This includes activities related to generating revenue through the use of assets. So this includes the classical transfer of capital to take interest, as well as the rental or lease of real estate assets. Whether and to what extent the achievement of dividends from the participation in companies belongs to asset management, we consider separately.

Based on this, one can distinguish different forms of enterprise with which cities and municipalities can participate in general economic transport.

2.2.1. Registrations

First there are the so-called directors. It is distinguished by the fact that they are basically only a department within the municipal administration. Thus, they are not an independent enterprise, because they lack their own organization. In doing so, they may perform official tasks or appear as companies of a commercial nature. Of course, the taxation of their income depends on this.

2.2.2. Own holdings

Own-owned enterprises are also municipal institutions and in this respect resemble the state-owned enterprises. However, owned companies have an independent organisation, so that they are more indirectly than directly under the municipal self-government. In this self-organization, which is far-reaching compared to public companies, it can be observed that self-organization is characterized by a combination of different elements in this regard. For example, a company can represent special assets of a city or a municipality. In addition, an independent management body can bear the responsibility for its own operations, but still remains directly subordinate to the local administration. A third possibility of self-management of own enterprises is the independent organization of their workforce.

Nevertheless, a company is by no means legally to be regarded as an independent company. However, the self-sufficiency that has been highlighted here, although limited, has an impact on their taxation.

2.2.3. Holding companies

Of course, cities and municipalities can also set up companies to develop commercial activities with them. However, they are limited to the establishment of or co-entrepreneurship in companies that are limited in liability. This prevents direct public liability. Otherwise, there would be a risk that cities and municipalities could slip into insolvency, which in turn could prevent them from being able to fulfil their sovereign tasks.

This is accompanied by a distinction in the way cities and municipalities pay taxes. In simplified terms, income from cities and municipalities is generally subject to unlimited taxation, with capital gains, such as interest, being subject to limited tax liability as exceptions. However, all revenue generated by public bodies in the performance of their public functions is exempt from taxation.

Now we want to take a look at the different taxes that cities and municipalities are obliged to pay.

First of all, we will deal with sales tax. As a rule, both own-owned companies and subsidiaries of the cities and municipalities are to be regarded as independent entrepreneurs within the meaning of the Sales Tax Act if they meet the characteristics of companies applicable under the Sales Tax Act.

However, if municipal enterprises provide services of public authority, then it must be considered whether these possibly lead to major distortions of competition. If the first condition is met and the second criterion can be excluded, the turnover remains without taxation. Therefore, for example, in the case of waste disposal by municipal waste management companies, there is generally no sales tax for the end users.

On the other hand, there are also a number of sales that are exempt from VAT. For example, § 4 no. 20 letter a UStG lists theatres, choirs, concerts, museums and botanical gardens, for which cities and municipalities should not levy taxes on sales. Further exemptions from VAT apply to public services in the context of education promotion and youth welfare, provided they offer them without profit.

As corporations under public law, cities and municipalities are subject to corporate tax. Thus, cities and municipalities regularly pay 15% tax on their profits. A distinction is made between the companies that generate the taxable profit and thus appear as a tax object and the corporation under public law as a tax subject. That’s why cities and municipalities pay the taxes their businesses earn.

Furthermore, another aspect that is often relevant for cities and municipalities is associated with corporate tax. While a private-law corporation is deemed to be profit-making, this is only conditional for the public authorities. Cities and municipalities are also obliged to operate properly. However, the scope of their tasks, which they offer to the public as part of their self-government, can also include a permanently deficient operation. But while the financial administration of a natural person, a partnership or a corporation may consider this to be a hobby, this is different in the case of the public sector. Therefore, there is no danger for them that the tax office could one day demand restructuring, or even that they tax hidden profit distributions resulting from this context.

In general, when companies are linked, it is only possible to offset losses of one company against profits of another company to a limited extent. However, cities and municipalities can actually generate a great advantage for themselves in this regard through tax design. Because through clever structuring, the allocation of loss-making to profitable companies is quite easy to implement. This applies in particular to publicly owned establishments, since they are not legally independent entities.

In this way, cities and municipalities can save taxes, but at the same time offer their citizens a range of services that usually only generate losses. These include such expensive facilities as swimming pools or theatres.

If companies of a commercial nature or own companies achieve profits, then you have to examine more closely whether a profit distribution actually takes place, or whether profits are also carry-forward. In general, it applies to public companies that they always transfer their profits to the respective municipality because there is no strict legal separation between the two parties.

In all other cases where cities and municipalities receive a profit distribution from their companies, they enjoy a tax privilege. The resulting capital gains tax is only 15% instead of the regular 25%. Of course, they are also entitled to make an application for permanent overpayments.

Connected with this is another aspect that should be clear when it comes to taxing the public sector. Indeed, cities and municipalities can in a certain way determine the timing of taxation under the capital gains tax by their companies putting the profits that can be distributed into corresponding reserves.

They can also realize similar advantages if they provide their companies with a lot of capital at an early stage by depositing in the respective tax deposit account. This makes it easy for cities and municipalities to pay out profits without taxes later on by taking the desired amounts from the tax deposit account. However, it must be ensured that no loss carry forward is present in the operation.

In principle, a business tax is imposed on the public authorities if a business of a commercial nature meets the usual criteria of a business: independent, externally recognizable, sustainable activity with a view to making a profit and participating in general trade. If this is excluded, there is no tax for cities and municipalities in this regard. However, if municipal companies meet these conditions, then each company must be treated separately as a tax object.

These are the purely formal requirements that cities and municipalities have to observe. However, since the collection of trade tax is the responsibility of the municipalities, their taxation is a curious situation. Because if cities and municipalities meet the conditions for taxation under business tax, then they pay these taxes to themselves.

Another tax that cities and municipalities have to pay in principle is property taxes. However, property tax only applies to companies of a commercial nature. On the other hand, municipal enterprises that perform sovereign tasks are exempted from property tax. However, if a municipality transfers such tasks to an external company and transfers a piece of land to it for this purpose, that company will also pay property tax if it is 100 % owned by the municipality.

However, since the property tax ultimately flows to the cities and municipalities themselves, there is basically no taxation in this sphere.

Now we come to the last point we want to talk about regarding taxes on cities and municipalities, namely the property transfer tax. In this area, too, there is a legal exception for the public sector. As a rule, there is no real estate transfer tax for cities and municipalities. However, if the acquisition of real estate is intended to serve an undertaking of a commercial nature, the exemption from the real estate transfer tax is excluded; In this case, cities and municipalities pay taxes on a regular basis.