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Germany sharpens competitive edge
April 2007
Dr C. Bleschke, International Trade Today
On the basis of plans from a working group – set up by the governing German coalition between Christian and Social Democrats – a first draft of the Business Tax Reform Bill was presented by the Federal Ministry of Finance in February, with the intention that it will take effect from the beginning of 2008.
Its purpose is in particular to relieve German enterprises from relatively high tax burdens compared with other EU countries and to encourage overseas investments.
German corporations are currently subject to corporation tax, a solidarity surcharge and a local trade tax, which, together, amount to a tax burden of approximately 39 per cent. This combined tax burden would be reduced to less than 30 per cent when the reform takes place. It is also planned that partnerships should pay tax of only about 30 per cent on retained earnings.
In addition, from the beginning of 2009, private capital income, such as dividends received from corporations, private capital gains and interest from capital investment will be taxed at a flat rate of 25 per cent.
In relation to the financing of business, German capitalisation rules currently provide for certain restrictions on the deduction of interest payments paid for shareholder loans by a German corporation. Under these current rules, such interest payments are not tax deductible if the entire remuneration exceeds a tax-exempted threshold in the amount of € 250,000 a year and the debt-to equity-ratio exceeds 60 per cent/40 per cent (the so-called ‘safe haven’).
These rules would be replaced by a general limitation on the deductibility of interest payments, applicable to both corporations and partnerships.
Thereafter, interest on borrowed capital, which is provided by shareholders, related parties or third parties, will be deductible without restriction up to an amount of €1m.
Any payments exceeding this limit would be deductible only at a level of 30 per cent of earnings before interest and taxes. Furthermore, it would be possible to carry forward interest payments that are not deductible in the current year to subsequent years.
The bill will also introduce stricter loss limitation rules for corporations. These will be very important for foreign investors acquiring shares in German corporations. Currently, losses cannot be carried forward if the corporation claiming the loss is not legally and economically identical to the one that suffered the loss.
Economic identity may be lost if 50 per cent of the shares of the corporation are transferred and predominantly new assets are fed into the business. These rules will now be further restricted – eg, the transfer of a holding of just 25-50 per cent may trigger the loss limitation rules.
Where business functions are transferred from Germany to other countries, they will be subject to German taxation rules. In this regard, the German companies will be obliged to keep records on already existing or intangible assets to be developed and would have to submit such records to the financial authorities on request. In addition, profit forecasts will be required in order to establish an assessment basis.
Another draft bill ‘doing the rounds’ is concerned with the introduction of German Real Estate Investment Trusts G-REITs. At the moment, it is not clear if the legislation will come into force retroactively on 1 January 2007 or at a later date in the year.
One of the main purposes for the introduction of G-REITs is to become competive with other countries already having established REITs, in particular the United States and France. Largely, REITS are about creating tax relief on exit-taxation for entities holding real estate with ‘high hidden reserves’ and to introduce a real estate investment vehicle that is completely exempt from German income taxation.
It will be possible to establish a GREIT in the form of a stock corporation (Aktiengesellschaft) having both its seat and place of management in Germany, either through a newly founded stock corporation or by reorganising an existing company.
Special G-REIT status will depend on whether the G-REITs shares are traded on the German stock exchange or in another EU member state or the European Economic Area. At least 15 per cent of the shares will need to be floated publicly – although, at the time of the application for listing, this figure must be at least 25 per cent. Furthermore, no single shareholder will be able to hold 10 per cent or more of the shares.
The draft bill proposes that at least 75 per cent of all revenue should be derived from renting, or selling real estate, and at least 75 per cent of the assets have to consist of real estate. The G-REIT will be obliged to ensure that at least 90 per cent of the distributable profits go to its shareholders.
For tax purposes, the G-REIT will be exempt from German corporation tax (and the solidarity surcharge) as well as from German trade tax and it would, therefore, be treated as ‘transparent’ comparable to the way in which German partnerships are treated.
On the other hand, the dividends will be fully taxable at shareholder level, irrespective of whether the shareholder is an individual person or a corporation. Generally, a withholding tax of 25 per cent applies to such dividends. In case of foreign shareholders, the withholding tax may be reduced in accordance with the applicable double-tax-treaty.
