Tax treatment of initial training expenses is constitutional

Press Release No. 2/2020 of 10 January 2020

Order of 19 November 2019
2 BvL 22/14, 2 BvL 27/14, 2 BvL 26/14, 2 BvL 25/14, 2 BvL 24/14, 2 BvL 23/14

The fact that expenses for the taxpayer’s initial vocational training (Erstausbildung) or initial academic studies (Erststudium) that also serve as an initial form of professional training are not deductible as income-related expenses (Werbungskosten) under the Income Tax Act (Einkommensteuergesetz – EStG) does not violate the Basic Law. This decision was rendered by the Second Senate of the Federal Constitutional Court in an order published today in response to referrals by the Federal Finance Court (Bundesfinanzhof). In its reasoning, the Second Senate held that the challenged provision is based on sound objective reasons. It found that the legislator may define such expenses as (at least partly) personal and assign them to the category of special expenses (Sonderausgaben). Such initial vocational or academic training received immediately after leaving school goes beyond simply imparting occupational knowledge – it shapes people in a broader sense by providing them with an opportunity to develop their talents and abilities and to acquire general skills that are not necessarily specific to any particular occupation they might pursue later on. It is thus closely associated with personal development. Furthermore, it is not objectionable under constitutional law that the annual amount of initial training costs deductible as special expenses was limited to a maximum of EUR 4,000 in the years at issue.

Facts of the case:

Pursuant to § 9(6) EStG, expenses for the taxpayer’s initial vocational training or initial academic studies that also serve as an initial form of professional training are generally excluded from the scope of income-related expenses. While § 9(1) first and second sentence EStG sets out the general tax-deductibility of income-related expenses, the foregoing provision further specifies that expenses for initial training are never deemed work-related (beruflich veranlasst) and are thus not deductible in unlimited amounts, nor may they be carried back or forward to other tax years as negative income. Instead, as special expenses, they merely reduce any taxable income in the year in which they were incurred – up to the annual amount of EUR 4,000 in the years at issue and up to EUR 6,000 annually as the law stands today. By contrast, expenses for further professional training and initial professional training received within an employment relationship can – like other expenses for acquiring, securing and maintaining income – be deducted as income-related expenses provided that they fulfil the ‘work-related’ criterion. According to the case-law of the Federal Finance Court, this is the case if there is an objective link with the person’s occupation and if the expenses are incurred subjectively to further occupational purposes. In order for income-related expenses to be deductible, it is not required that the taxpayer already generates revenue. It is however necessary that the expenses have a sufficiently specific and objectively ascertainable connection (Veranlassungszusammenhang) to generating income.

The plaintiffs in the six initial proceedings sought deduction of their expenses – for initial academic studies and (initial) professional pilot training respectively – as income-related expenses. At the appeal instance on points of law, the Federal Finance Court stayed the proceedings and referred to the Federal Constitutional Court the question whether § 9(6) EStG in its version of the Act of 7 December 2011 (Beitreibungsrichtlinie-Umsetzungsgesetz) is compatible with the Basic Law (Grundgesetz – GG) when it stipulates that a taxpayer’s expenses for their initial vocational or academic training that also serves as an initial form of professional training are not income-related expenses if such vocational or academic training is not received within an employment relationship and if there are no other income tax law provisions that allow for the deduction of said expenses from the income tax base.

Key considerations of the Senate:

I. The general guarantee of the right to equality in Art. 3(1) GG requires that the legislator accord equal treatment to matters that are essentially alike, and unequal treatment to such matters that are essentially different. It binds the legislator to the principle of equitable taxation and to the requirement that taxation be based on economic capacity. In conjunction with Art. 1(1), Art. 20(1) and Art. 6(1) GG, it obliges the state to exempt a person’s income from taxation to the extent that the person needs this income to secure the minimum standard of living in accordance with human dignity for themselves and their family. The legislator measures economic capacity according to the objective net income principle (with regard to the business/occupational sphere) and the subjective net income principle (with regard to the personal sphere). When evaluating and weighing life circumstances that touch on both the occupational and the personal sphere, the legislator has a considerable amount of leeway under constitutional law – subject to other limitations arising from fundamental rights – in the legislative design and typification underlying the applicable legal regime.

II. Measured against these standards, § 9(6) EStG in the version at issue is compatible with Art. 3(1) GG.

1. § 9(6) EStG results in unequal tax treatment of, on the one hand, the taxpayer’s initial training expenses (expenses for an initial vocational or academic training that also serves as an initial form of professional training) and, on the other hand, expenses for the acquisition, securing and maintenance of income, which can also include expenses for a taxpayer’s second or further training as well as expenses for an initial vocational or academic training received within an employment relationship.

a) This differentiation must be measured against the right to equality in its function as a prohibition of arbitrary measures. In the present case, it is not necessary to apply a stricter standard on the grounds that the unequal treatment can affect the exercise of occupational freedom (Art. 12(1) GG). § 9(6) EStG does not have an inherent objective impact on occupations (objektiv berufsregelnde Tendenz). A decisive factor in being able to undertake a particular training or apprenticeship is whether the trainee or student has the requisite financial means to do so. The funding question is heavily dependent on whether and to what extent the persons concerned have income or assets at their own disposal during the training period and whether they are entitled to maintenance or eligible for financial assistance under the Federal Training Assistance Act (Bundesausbildungsförderungsgesetz – BAföG). These funding options are independent of whether expenses for the training can be carried forward to later tax years. The same applies to funding a training through loans given that the granting of a loan is dependent on how potential lenders assess a person’s creditworthiness during the training period.

b) There are objective reasons for assigning expenditure on initial training to the category of special expenses.

aa) The legislator was free to define this expenditure as being primarily incurred for personal (or partly personal) reasons. In the legislator’s view, initial occupational training is typically one of life’s basic prerequisites because it lays the foundations for a person’s future livelihood and helps them to attain a secure and independent position in life. The legislator therefore regards the expenses for initial occupational training – like expenses for school education and other basic needs – primarily as costs of living.

The legislator’s assessment is not objectionable here. Initial vocational or academic training undertaken immediately after leaving school does more than simply impart occupational knowledge – it shapes people in a broader sense by providing them with an opportunity to develop their talents and abilities and to acquire general skills that are not necessarily specific to any particular occupation they might practice later on. It is thus closely associated with personal development.

Categorising the requisite expenses as general costs of living (personal use) is consistent with the fact that parental maintenance obligations extend to initial training. Parents have a duty – within the limits of their economic capabilities – to provide their children with occupational training or education that best suits the skills, motivation and relevant preferences of the individual child. The social welfare benefits designed to cover the gap in cases where parents lack the necessary economic means are accordingly classified as serving educational development and not occupational development.

bb) The legislator was free to make the assessment that, in objective terms, initial training typically bears only a minimal link to a particular subsequent occupation. The challenged provision primarily concerns purely school-based vocational training and university education taken immediately after gaining the general qualification for university entrance. School-based vocational training and higher education usually open up a whole range of different career opportunities. They often take a broader approach, with specialisation only occurring when graduates first start to work or even later in their career. In addition, many degrees are not directly tied to specific fields of employment. Likewise, there are many fields of employment in which the main requirement is simply having a degree while the particular subject is not important.

In the specific case of professional pilot training, it is true that the initial training does indeed have a strong connection to a particular occupation. But as the Federal Government points out in its statement, this is an unusual and numerically insignificant constellation. The low numbers indicate that the legislator could ignore these cases when exercising its power to typify (Typisierungskompetenz), as this power entails that the legislator is generally allowed to base its assumptions on the ‘typical’ scenario and is not obliged to take account of every possible variation via special rules.

cc) This does not ultimately matter, however, because even where an initial training is heavily geared towards a particular later occupation, the expenses are still partly connected to the personal sphere. The fact that work-related circumstances are the main and dominant element does not necessarily mean that the connection to person-related circumstances is negligible, and vice versa. It was in any case permissible for the legislator to regard such expenses as being for ‘mixed use’ with inseparable elements of personal and work-related use. Within the system of income taxation, the legislator was therefore allowed to assign them to the category of special expenses. Even initial training – such as professional pilot training – that is specifically connected to a particular later occupation also serves to introduce trainees to the basic proficiencies required for leading a self-determined life and to impart general life skills.

dd) The differentiation between expenditures for initial training and expenditures for secondary or further training also satisfies the right to equality. The classification of expenditures for secondary and further training as income-related expenses is determined by the standards set out in ordinary tax law. Hence, the decisive issue is whether the expenses fulfil the ‘work-related’ criterion in the individual case. The legislative approach is justified by objective reasons because secondary and further trainings are undertaken for such diverse reasons that it is impossible to typify them as belonging mainly to the personal (or partly personal) sphere.

In this context, ‘further training’ encompasses continuing education and training courses that focus on a person’s current occupation or offer specialisation within an existing job. It also includes retraining and training undertaken for the purposes of complete occupational reorientation. The motivation for undertaking secondary training can thus vary substantially. Because secondary training occurs beyond the transitional phase between general schooling and first-time employment, it lacks the common element of initial training in terms of introducing the basic proficiencies required for personal development as well as for finding and consolidating one’s place in society.

ee) Lastly, there is also a sound objective reason for differentiating based on whether initial vocational or academic training is undertaken within an employment relationship or not. Being in an employment relationship means that trainees must take part in both company-based and school/university-based training. During this period, they receive remuneration – including for the school-based part of the training. It is not therefore arbitrary to classify the training costs incurred by the trainees as (also) being expenses for securing the income arising from the training relationship. It is true that initial training undertaken within an employment relationship also serves to introduce trainees to the basic proficiencies required for leading a self-determined life and to impart general life skills. However, the fact that the trainees already perform remunerated work within the training relationship is an objective reason based on which the legislator may subject such training expenses to a different treatment.

2. a) Limiting the amount of initial training costs deductible as special expenses to an annual maximum of EUR 4,000 in the years at issue does not violate the principle that income needed to maintain the minimum standard of living in accordance with human dignity be exempt from tax.

During the initial training period, a trainee’s needs in terms of this minimum subsistence level are covered by the maintenance obligations of their parents under family law. Alternative or supplementary financial support is available under social law, primarily via claims to benefits under the Federal Training Assistance Act. In cases where trainees or students have their own income, the minimum subsistence level is covered by the basic tax-free allowance, which was EUR 7,664 annually in the years at issue (2004 to 2008). Furthermore, pursuant to § 10(1) no. 7 EStG, expenses for initial training were treated as special expenses up to an annual maximum of EUR 4,000 in the years at issue. Since the 2012 tax year, the maximum has been EUR 6,000.

In any case, training costs exceeding this amount cannot be considered as belonging to the minimum subsistence level. The reference point for quantifying the minimum subsistence level is the amount of benefits granted under social welfare law. Expenses within the meaning of § 10(1) no. 7 EStG that exceed the maximum amount of tax-deductible special expenses are covered neither by social welfare nor by the benefits available under the Federal Training Assistance Act.

b) Finally, the maximum deductibility limit is also not objectionable when expenditures on initial training are considered in light of the affected fundamental rights, which the legislator must observe even when it permissibly categorises such expenditures as general costs of living. For the vast majority of cases, § 10(1) no. 7 EStG provides a realistic reflection of the costs necessary for a person’s own initial training. Pilot training is an exception that is not representative of the typical initial training scenario. Moreover, the legislator is granted considerable leeway in designing a framework that gives effect to the liberal employment and education system, which is enshrined as an objective value in the legal order. In any case, Art. 12 GG does not require that initial training costs of any amount be eligible for unlimited tax relief at the public’s expense. In this respect, training costs are distinct from employment-related childcare costs, for example. The latter are a necessary expenditure enjoying special protection under Art. 6(1) GG because the legislator may not confront taxpayers with the argument that their children were ‘avoidable’. However, this does not apply in equal measure to cases of particularly expensive initial training. When determining the tax treatment of training costs, the legislator may take account of the fact that the state already funds training by running a public education system and by providing benefits under the Federal Training Assistance Act.