German tax law is based on a number of fundamental principles. These in turn are outflows of the Basic Law. For example, Article 3 GG states that all people are equal before the law. Therefore, the performance principle and the accompanying tax justice are attributed to this constitutional principle. But we also know an objective net principle and a subjective net principle. The objective net principle stipulates that the State must take into account certain individual factors when taxing taxable persons. Thus, the objective net principle limits the main tax revenues of the State by granting tax deductions, for example in the form of advertising costs and depreciation.

1st Objective Net Principle – Introduction

German tax law is a modern one. It follows certain principles that many other states apply when taxing their taxpayers. In fact, this is true even for most states, especially the leading industrial nations. Nevertheless, the general public is at best fragmentedly aware of the principles according to which the collection of taxes is permitted. One such guiding principle is the objective net principle. What this is all about, we now clarify in this article.

Objective net principle: only net income is taxable

Basically, the heading of this chapter already explains the crux of the objective net principle. As a rule, the state should only tax net income. Because purely hypothetically, the Treasury could instead tax the turnover of a merchant or the gross salary of employees. Of course, at first glance, gross salary is definitely the subject of income taxation. However, this only applies if no other tax-permissible deductions can be set. The objective net principle requires that taxpayers be allowed to deduct from their gross income the expenses necessary to obtain their income. Thus, linguistically speaking, it is actually net income rather than gross income that workers and employees tax.

Application of the objective net principle to employees and workers

Since we are already talking about the objective net principle in the taxation of income from self-employment: the advertising costs of taxpayers are particularly relevant here. This includes the expenses you pay to cope with the distances from home to work, also better known as commuter lump sum. Other examples of advertising costs in this area are expenses for a home office or a home study. Even a second home and associated family home trips are tax deductible.

However, the Treasury strictly ensures that no costs of private living are included in the advertising costs. Anyone who wants to set costs for professional clothing, for example, should know that the tax office only takes them into account for tax purposes if private use is excluded. A cooking hat or protective goggles are thus removable. A suit for a bank employee, on the other hand, is excluded in his advertising costs, because the taxpayer could also use it for private purposes. Whether this is actually the case and whether this can perhaps even be demonstrably excluded is irrelevant for the tax office.

4th Objective Net Principle in Manufacturing

On the other hand, the objective net principle is particularly relevant in the taxation of manufacturing companies. Because they also have to use raw materials to produce their products. In addition, they must first invest in technical plants and machines as well as in the associated buildings, so-called fixed assets. However, expenses incurred in connection with administration and distribution also reduce economic and thus taxable success. Therefore, before taxation, the objective net principle also provides for the deduction of most profit-related expenditure.

This distinguishes direct expenses from depreciation. Direct expenses are those that directly relate to production. They therefore include the raw materials and auxiliary materials for their production as well as the personnel costs throughout the company. This also includes advertising and other marketing measures. On the other hand, all costs relating to aspects that are generally necessary for production in the long term, i.e. the costs of equipment and machinery, buildings and other infrastructure, are regularly depreciated over the period of their expected use.

A certain exception is the recognition of financing costs. Although loans are often of a long-term nature, you can set the accrued interest directly as an expense tax. Other financing costs, such as a premium premium, usually have to be deducted over the entire term. A brokerage commission, on the other hand, can be set directly in full.

The provisions of the Commercial Code (HGB) are groundbreaking. This is because it lays down very similar rules that standardise the preparation of trade balances. After all, trade balances are the basis for an externally visible presentation of the profitability of a company. This also includes determining a company profit according to uniform criteria. This is, among other things, the basis for the distribution of profits in partnerships and corporations. However, potential creditors should also receive a reliable source of information in this way in order to be able to make sensible decisions about the granting of loans.

Objective net principle for other types of income

However, the application of the objective net principle is by no means uniform. It is true that it applies to most types of income, especially those that make profits from the sale of goods and the provision of services, as well as from renting and leasing. However, as regards income from capital assets, advertising costs are only partially compatible with the objective net principle. For, on the one hand, we are familiar with the savings lump sum, which applies, for example, to interest income, but which, on the other hand, also excludes the application of actual advertising costs in taxation.

Another notable departure from the objective net principle takes place when the profit determination according to § 5a EStG is applied, better known as tonnage taxation. This is because the actual costs incurred play as little role as the actual profits generated. Therefore, in extreme cases, a loss can occur and a tax can still be incurred. The tax base for determining the profit on tonnage taxation depends solely on the size of a shipping company’s ships and on the number of days per year in which it was used economically. However, tonnage taxation is generally designed in such a way that shipowners usually only have to pay a very low tax in relation to the actual profit.

6th Objective Net Principle – Conclusion

6.1. How about taxation without an objective net principle?

The fact that we know an objective net principle and apply it in general in taxation is reassuring. The idea that companies would have to tax their profits on the basis of their turnover would lead to comparatively unfair taxation even at low tax rates. For example, companies with low operating expenses would have an enormous tax advantage over cost-intensive companies. The cost-intensive companies, especially the manufacturing industries, would have to pay a relatively high tax in addition to their pure production costs and all other expenses. This would force them to include the significantly higher tax in the selling prices of their products. This, in turn, would be anything but conducive to the sale of the goods.

6.2 Economic effects of taxation without objective net principle

In any case, the margin would be very small. Consequently, investments would hardly be possible. This would also affect the ability to develop innovation. This would give foreign competition a head start, which should ultimately lead to an extinction of production in Germany. This, in turn, can hardly be in the interest of the state, because thus also disappeared a so far important source of income (actually even several).

Why the State has an interest in taxation based on the objective net principle

Thus, the objective net principle is a requirement that allows, in particular, entrepreneurs a realistic taxation according to their actual performance. Therefore, the performance principle is closely linked to the objective net principle.

At the same time, the objective net principle is also a basis for the state to describe its tax collection as fair. After all, the state must also comply with the constitutional requirement to ensure justice in the field of taxation within the meaning of Article 3 of the GG.

Moreover, the objective net principle also offers him the opportunity to introduce certain politically motivated tax advantages. It goes without saying that legislators also achieve a steering effect within the framework of their tax legislation, with which they can influence the behaviour of citizens. In extreme cases, even the departure from the objective net principle can develop the desired steering (see tonnage taxation, which was introduced in Germany to maintain a national merchant fleet). However, this is only the case in special situations. No one can hope for further exceptions of this kind.

On the other hand, the state can also deviate from the objective net principle in order to tax certain revenues more. This is the case, for example, by restricting loss offsetting in the income tax law. Restricting the takeover of loss carry-forwards in the acquisition of companies also means a departure from the objective net principle. Here, however, the prevention of abusive design is in the foreground. In order to safeguard its right to tax, the State is even entitled to tax a fictitious capital gain on the basis of a company valuation under the Valuation Act when collecting the exit tax. This is also astonishing in that the objective net principle applies to the taxation of real capital gains.