Trade business or self-employed work: the features and the line between them

Two neighbours in Leipzig set up on their own in the same month, and both expect a profit of about 70,000 € a year. One is an engineer advising builders on structural design; the other resells software licences bought from a vendor. The engineer writes to the tax office and is done. The reseller needs a trade registration, checks her trade tax and receives letters from the chamber of commerce. The difference is not the profit but the category of income.

Seven categories of income, three of them measured as profit

German income tax law has no general category for the self-employed. Section 2(1) EStG lists seven categories of income, and sentence 2 of that provision says that sections 13 to 24 decide which category a given item of income belongs to. Working for your own account therefore does not automatically make you a trader.

Three of those categories are open to the self-employed: agriculture and forestry, trade business and self-employed work. For all three, section 2(2) sentence 1 no. 1 EStG defines the income as the profit. Inside income tax, traders and liberal professionals therefore sit much closer together than many founders assume.

The big differences arise outside income tax. Trade tax reaches only the trade business, the bookkeeping duty of section 141 AO only commercial entrepreneurs and farmers, and the notification under section 14 GewO only a trade. Compulsory membership of the chamber of industry and commerce is also tied to trade tax.

This module therefore answers one question only: where does the line run between a trade business and self-employed work? The second module shows why, in a partnership, even a small commercial part can change everything, and works through the consequences. Agriculture and forestry stay outside this course.

The four features of a trade business

Section 15(2) sentence 1 EStG defines the trade business in one long sentence. It requires an activity that is independent and sustained, carried on with the intention of making a profit, and that takes the form of participation in general economic commerce. If even one of these four features is missing, there is no trade business.

• Independence: the activity is not performed under instructions inside someone else's business. Case law mainly asks whether the person bears entrepreneurial risk and can take entrepreneurial initiative.
• Sustained activity: the activity is designed to be repeated. According to case law, what matters is the intention to act again, not the number of deals already closed.
• Profit intention: the activity is meant to produce a surplus over time. Under section 15(2) sentence 2 EStG, a reduction of income taxes expressly does not count as profit.
• Participation in general economic commerce: the service is offered on the market for payment. Case law accepts that a single customer can be enough if the offer is open in principle.

A dentist meets these four features just as a baker does. That is why the same sentence ends with a negative carve-out: the activity is a trade business only if it is to be regarded neither as agriculture and forestry, nor as the practice of a liberal profession, nor as other self-employed work.

The test therefore runs in two stages. First the four features are checked. If one is missing, there is no business income at all but, for example, employment income. If all four are present, the next question is whether one of the three priority areas applies. Only what is left after that is a trade.

Two clarifications follow in the same subsection. Under sentence 2, a reduction of income tax caused by the activity is not a profit; anyone who only wants to collect losses for the tax return lacks a profit intention. Under sentence 3, by contrast, it is enough that making a profit is only a secondary purpose.

The same yardstick applies to self-employed work. Section 18(4) sentence 2 EStG declares section 15(2) sentences 2 and 3 applicable accordingly. A liberal professional who makes nothing but losses over time therefore does not become a trader. Case law calls this a hobby activity, and the losses are ignored for tax purposes.

Three routes into a liberal profession

Section 18(1) no. 1 EStG puts income from a liberal profession first among the forms of self-employed work. Sentence 2 fills the concept in three different ways. Anyone who meets one of them and also shows the four features of section 15(2) earns income from self-employed work and not commercial income.

The first route describes activities rather than professions: independently performed scientific, artistic, literary, teaching or educational activity. What counts is not a degree or a chamber but what is actually done. A private tutor without a teaching qualification teaches within the meaning of the statute just as a trained schoolteacher does.

The second route is the list. It names professions whose independent practice is always a liberal profession, and it does not sort them. Health professions, legal and business advisers, technical professions and media professions sit side by side in one enumeration. The following table groups them for orientation only; the statute itself knows no such groups.

The list refers to the professional activity, not merely the job title. What a doctor does as a doctor, or an engineer as an engineer, is a liberal profession. If a doctor sells food supplements in her practice, that selling is not part of her medical activity, even though it happens in the same rooms.

The third route is the similar professions with which the list closes. The statute does not say how similarity is measured. Case law requires the profession to resemble one specific listed profession in its essential points, in training as much as in the work actually done. A vague closeness to the liberal professions as a whole is not enough.

These criteria are case law, not statute, and they explain the many disputes at the border, for instance for IT consultants or for health professions without a listing. Anyone relying on a similar profession should document training and actual work so that the comparison with one specific listed profession can be followed.

Qualified employees: leading and personally responsible

A liberal professional may employ staff. Sentence 3 of section 18(1) no. 1 EStG expressly allows the assistance of professionally trained workers, such as employed engineers in an engineering office or employed tax assistants in a tax practice. The classification then stays liberal, but only under one condition set out in the same sentence.

The professional must act in a leading and personally responsible way on the basis of his own expertise. Leading means he sets the main lines of the work and supervises the staff. Personally responsible means the output carries his personal imprint. The statute gives only these two words; case law has worked out what they demand day to day.

Under that case law it is not enough to run the office and win clients while the professional work lies entirely with employees. The more staff there are and the more uniform assignments run in parallel, the harder it becomes to show personal involvement in each individual assignment.

Sentence 4 provides statutory relief: being represented during a temporary absence does not stand in the way of leading and personally responsible activity. Illness or holiday therefore do not turn a practice into a trade. A permanent arrangement in which the owner only signs, however, is not covered by this exception.

Without leading and personally responsible activity, case law treats the work as commercial as a whole, because the negative carve-out of section 15(2) only protects the practice of a liberal profession. Trade tax, a possible bookkeeping duty under section 141 AO and chamber membership then follow, as the second module shows.

Other self-employed work and temporary activities

Beside the liberal professions, section 18(1) no. 3 EStG covers other self-employed work. The statute gives as examples fees for executing wills, for asset management and for serving as a member of a supervisory board. An executor or a supervisory board member therefore runs no trade, even without practising a liberal profession.

Section 18(2) EStG adds that income under subsection 1 is taxable even when the activity is only temporary. The single expert opinion, the one-off lecture or the short translation done alongside a job therefore remain income from self-employed work, however rarely they occur.

The two remaining numbers of the subsection deal with special cases. Number 2 concerns collectors for a state lottery, number 4 certain fees paid to participants in asset-managing vehicles that acquire and hold shares in corporations. Neither plays a role in an ordinary start-up.

Mixed activities of a sole trader

Many self-employed people do both. The physiotherapist sells training equipment, the translator distributes language-learning software, the architect brokers land for a commission. For the sole trader, income tax law contains no provision that pulls one part into the other. The contagion rule of section 15(3) no. 1 EStG names only partnerships.

Case law therefore assesses the two activities separately if they can be separated in the ordinary view of the market. The same person then earns income from self-employed work and from a trade business side by side, with two profit calculations. Only the commercial part is subject to trade tax and counts towards the thresholds of section 141 AO.

If the activities are so intertwined that each depends on the other, case law assesses them as one, by their centre of gravity. Anyone who wants the separation should make it visible: separate invoices, separate records and, where possible, separate accounts. A separation that exists only in the tax return rarely survives a tax audit.

A last pitfall comes from company law. Section 1(2) PartGG describes the liberal professions for the professional partnership and names some professions missing from the list in section 18 EStG, such as midwives, medical masseurs, graduate psychologists and full-time experts. That list decides the legal form, not the category of income.

For tax purposes the yardstick remains section 18 EStG. A profession named only in the partnership statute may well be a liberal profession for income tax purposes, for instance as a similar profession or through scientific activity. It is not one merely because the partnership statute mentions it.