Cities and municipalities also have to pay VAT when calculating the services they provide. There are many details that play a role here. At present, however, this matter is even more complex for another reason. Because the previous legal situation, according to which cities and municipalities had to issue their invoices with VAT, was in contrast to requirements of the EU. This is why the new § 2b UStG has been introduced in order to adapt the legal situation in Germany to the EU directives. However, the legislature provided for a transitional period and further regulations, according to which the cities and municipalities could decide whether they wanted to consider sales tax according to the old or the new legal situation. But from 01.01.2023 at the latest, all cities and municipalities in Germany are obliged to calculate sales tax according to the new law.

Cities and municipalities have the task of providing certain services to their inhabitants. These include, for example, waste disposal, wastewater recycling or fire protection by setting up a fire brigade. In addition to these tasks, which they are obliged to undertake, municipalities can also offer their citizens other services on their own. For example, they can maintain social or cultural institutions in order to make them accessible to the general public. Often, however, the latter offers can hardly be financed via the regularly available budget, so that cities and municipalities demand a fee for these services. Whether this remuneration is the subject of sales tax, however, depends on some factors that we would like to discuss in the next step.

2nd Cities and Municipal Sales Tax: Taxable Sales

In the case of the sales tax of the cities and municipalities, you have to consider other areas in addition to the sovereign affairs and the self-responsible offers. For example, services provided in cooperation or as support between two public-law bodies are also considered in principle. One speaks of so-called assistance services, for example, when a municipality makes its construction yard available to a neighboring municipality. Services in the context of asset management can also be covered by VAT law. This refers in particular to rental income from the public sector. However, all these special cases are generally irrelevant for the calculation of sales tax of cities and municipalities.

In Germany, we are currently dealing with a transitional phase, because the provisions of the VAT Act will change in this respect until the end of 2022. However, we prefer to proceed step by step. That is why we will first describe the current regulation and then discuss the new situation. Of course, we also give details about the transition phase.

Until now, the VAT Act has been governed by the Corporate Income Tax Act with regard to the question of whether cities and municipalities have to calculate services subject to VAT. After all, cities and municipalities are public corporations and thus the subject of the Corporate Tax Act. So far, it has been stated that the public sector is taxable only in certain situations. This is the case when it generates income through enterprises of a commercial nature, that is, those which have no connection with the compulsory public tasks assigned to them.

3.2. Requirements for the existence of a business of a commercial nature

It is important to note that a business of a commercial nature also depends on the amount of sales. Because if a branch of the public sector has less than EUR 45,000 in annual turnover on a private law basis (it used to be EUR 35,000) and is not in any major economic competition with other providers, then it is also irrelevant for sales tax purposes.

3.3 Exemptions for VAT-free services

Exactly in this private-law context, so far also those services of the cities and municipalities for which the Sales Tax Act basically sets a sales tax. Nevertheless, there is also a whole series of exemptions in the VAT Act, which actually exempt taxable services from the public sector. They refer, for example, to services for cultural offers or those that serve education.

3.4. Other services provided by cities and municipalities

On the other hand, this also means that all areas of the cities and municipalities other than those mentioned above do not provide services subject to VAT. In this respect, the public sector has not been an entrepreneur in the sense of VAT law. This also applies to services in the context of asset management. Thus, rents and similar charges in this context were unrecognised in the sales tax of the cities and municipalities.

3.5. Assistance between cities and municipalities

And if a municipality provided assistance to another, this was only relevant for VAT if it provided one business of a commercial nature to another. On the other hand, in the case of assistance provided between two publicly owned establishments, VAT was excluded.

3.6 Application of the Small Business Regulation

In addition, the VAT small business regulation applies to cities and municipalities, although it is rare for this to apply.

However, it turned out that German VAT law in this respect violates the EU VAT system directive and thus European law. Indeed, this linking of entrepreneurial status to the existence of an enterprise of an industrial nature was a condition which gave the cities and municipalities a market advantage. After all, it distorts competition if the public authorities have the opportunity to tax certain services differently than a commercial entrepreneur.

That is why the legislature refined the VAT Act by introducing § 2b UStG. In this way, it stipulates that taxable services of cities and municipalities are always available if they do not constitute state services. Therefore, all services under private law, in particular those of companies of a commercial nature, are automatically taxable.

If, among the services provided on a private law basis, those which are exceptionally regarded as tax-free under the Sales Tax Act, then another criterion is decisive. Because only if such a tax-free service is equipped with a right to vote according to § 9 UStG, which allows an optional taxation, a sales taxation comes into question.

In addition, state services may also be subject to VAT if there are major distortions of competition. The law only sees a greater distortion of competition than given if a municipality receives more than EUR 17,500 for services of the same kind in the calendar year. Furthermore, services provided by cities and municipalities in connection with land surveying, if they do not constitute administrative assistance, are also regarded as services subject to VAT.

Changes in VAT law have also occurred in the area of asset management. If a municipality expects a maximum of EUR 17,500 in revenue for the respective services in the calendar year, then these are excluded from sales taxation.

How cities and municipalities also save taxes.

5th Cities and Municipal Sales Tax – Transition Period

In the new regulation of the Sales Tax Act for public corporations, the legislature has granted a transitional period (§ 27 paragraph 22 UStG). Thus, the municipalities should be open until 31.12.2020 the possibility to follow the old rule when it comes to VAT. However, they had to announce the application of this option to the competent tax office by 31.12.2016. If a municipality chose this option, the decision was binding from 2017 at least for the current calendar year. So if it wanted to revoke this option in order to apply the new regulation from now on, it had to inform the tax office in the previous calendar year. What is always excluded, however, is the restriction of the application of the exception to certain activities or services.

In the meantime, the deadline to use this option has been extended by one year due to the COVID-19 pandemic. Thus, cities and municipalities can continue to calculate their services under the old regulation with or without sales tax (§ 27 paragraph 22a UStG), if they opted to do so.