Treatment of Loans to U.S. Partners Under the U.S.-Germany Tax Treaty

By Rüdiger Urbahns, Certified Tax Adviser, Hamburg, Germany (Not Affiliated with Baker Tilly International)

Editor: Anthony S. Bakale, CPA, MT

The Bundesfinanzhof, Germany’s federal tax court, ruled in a recent decision that interest payments received by a U.S.-resident partner on a loan to his German partnership can be taxed only in the United States in accordance with Article 11(1) of the U.S.-Germany income tax treaty and are exempt from German taxation (Bundesfinanzhof, October 17, 2007, IR 5/06, March 19, 2008).


Under German domestic tax law, interest payments for loans made by partners to their partnership have historically been treated as special business income of the partner (Sonderverguetungen). Such payments are taxed as part of the business profits of the partnership (Einkommensteuergesetz (Income Tax Law) §15, ¶1, Sentence 1, No. 2).

Note: Under German tax law, partnerships are (partly) transparent for tax purposes, i.e., business profits are assessed at the partnership level but taxed at the partner level for income tax purposes, whereas trade tax is always levied at the partnership level (which in many cases makes up half of the total German income tax liability after Germany’s 2008 corporate tax reform, at least where the partner is a corporation).

In a recently published draft interpretation note (“Application of Double Tax Treaties to Partnerships,” Section 5 (May 10, 2007)), Germany’s federal financial oversight body (Bundesfinanzministerium) took the position that only the German approach needs to be applied in (international) partnership cases and that interest payments are therefore to be classified as part of the business profits in cross-border situations. Those interest payments are then taxable in Germany under Article 5 (Permanent Establishment) and Article 7 (Business Profits) of the U.S.-Germany income tax treaty. The tax administration gave the following illustration:

Example: A is a partner of a German partnership to which he made a loan. A is not resident in Germany. In accordance with German tax law, the interest income will be treated as special business income of the partnership, taxable in Germany at the partner level under Article 7 of the tax treaty. If A’s country of residence classifies the interest payment according to Article 11 of the tax treaty, that country has the duty to avoid double taxation.

International tax law, in contrast, views such payments as ordinary interest payments and not as business profits. Therefore, in line with Article 11(1) of the U.S.-Germany income tax treaty, such interest payments should be taxable only in the contracting state where the partner is a resident (i.e., the United States). The Bundesfinanzhof decision supports the international view and clarifies not only the application of these principles regarding the U.S.-Germany tax treaty but for all tax treaties concluded by Germany—at least where no explicitly contrary rule has been incorporated into the treaty (as is the case, for example, in the German tax treaties with Austria and Switzerland).


The German tax administration was fully aware of the pending Bundesfinanzhof case when it published its draft interpretation note. Now it seems that the tax administration needs to take into account the conflicting view of the Bundesfinanzhof when publishing the final interpretation note.

U.S. resident partners of German partnerships with loan relationships should review their past tax positions in all open cases, at least where the interest income of a U.S.-resident partner has been treated as business income. The same may apply to royalties from license agreements because they are subject to similar rules. However, whether such a shift in the German tax treatment is beneficial for the U.S. partner will need to be decided according to the individual facts and circumstances of each case and U.S. domestic tax law.


Anthony S. Bakale is with Cohen & Company, Ltd. Baker Tilly International in Cleveland, OH

Unless otherwise noted, contributors are members of or associated with Baker Tilly International.

If you would like additional information about these items, contact Mr. Bakale at (216) 579-1040 or

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