Germany’s basic tax principles are similar to other EU member states and industrialized countries: Some countries even adopted some of Germany’s loss limitation rules. Major changes in German tax law are expected to be mainly driven by joint international initiatives as well as adoption of taxation rules to new business models such as digital transformation and distributed ledger technology, the promotion of individual measures in the context of environment and digitalization, as well as EU jurisprudence.
Corporations with business activities in Germany are in general subject to corporate income tax (CIT) and trade tax (TT) in Germany.
CIT assessment basis is generally the income received by the corporation within the calendar year, or a different fiscal year. With a few exceptions, a corporation’s taxable income is based on the annual profit pursuant to commercial balance sheet provisions subject to certain adjustments provided for in the tax law. The CIT tax rate is 15.8%, including a 5.5% solidarity surcharge, and applies to retained and distributed earnings, whether the corporation is subject to unlimited or limited tax liability in Germany.
Corporations that have their statutory seat and/or place of management, or a permanent establishment in Germany, are subject to TT on their German-source trade income. The assessment basis is the taxable income determined for CIT purposes increased by certain non-deductible expenses; for example, a portion of the interest expenses, rental expenses, losses in a domestic or foreign partnership. It is also reduced by certain statutorily determined amounts; for example, under certain conditions, income from the administration and the use of own real estate property, profit share in a domestic or a foreign partnership. The TT rate depends on the applicable municipal levy rate and generally varies between 7% and 18%.
Capital gains from the disposal of fixed assets are generally subject to the above rules, whereas capital gains from the sale of shares in a corporation by a corporation is effectively 95% tax exempt irrespective of the holding quota.
Dividends received by a corporation from a corporation are effectively 95% tax exempt both from the CIT and TT, subject to certain requirements with respect to minimum holding quotas (10% for CIT and 15% for TT purposes), holding period (beginning of calendar year), and non-deductibility at the level of the distributing corporation. The same rules apply to so-called hidden dividends to shareholders because of transactions rendered between shareholder and company at non-arm’s-length terms.
Transparent legal entities (partnerships) are not subject to CIT; their income is taxed on the level of each shareholder. However, trading partnerships (including deemed trading partnerships) are subject to TT for their German-source trade income.
Direct Tax Rules for Companies
- Tax losses carried forward
Tax losses of a corporation can be carried back into the preceding year up to 1 million euros ($1.07 million) for CIT but not for TT purposes and carried forward for both CIT and TT purposes into future years without limitation as regards time and quantity. However, tax losses carried forward (TLCF) can only be offset with future profits without limitation up to 1 million euros and any exceeding amount only at 60% of the respective taxable income resulting in a so-called minimum taxation at effectively 12% CIT. Due to the Covid-19 pandemic the cap was increased to 10 million euros for fiscal years 2020 and 2021, which is expected to be extended to fiscal years 2022 and 2023.
TLCF and current tax losses both for CIT and TT purposes are forfeit if a single acquiror or a group of acquirors with common interest, directly or indirectly, acquires more than 50% of the nominal capital, profit participating rights or voting rights within a five-year period (harmful acquisition). As an exemption, there is no forfeiture of TLCF and current tax losses in case of: intra-group transactions with a common 100% shareholder, to the extent the TLCF are covered by hidden reserves that are subject to taxation in Germany, or in case of share transfers for the purpose of restructuring the corporation.
As a further exemption, tax losses are preserved upon application regardless of a harmful acquisition, provided that the corporation maintained the same business operations since its formation or, if later, since the beginning of the third assessment period preceding the harmful acquisition, and no “harmful event” occurred and will occur in the future. This includes, inter alia, the suspension, change or addition of business operations, a participation in a trading partnership, tax grouping or absorption of assets at a tax value below its fair value (so called continuous-bound TLCF).
Corporations that are fully taxable in Germany can, by forming a tax group, consolidate their income for CIT and TT purposes. There are certain prerequisites for a tax group to be formed—for example, the conclusion of a profit and loss transfer agreement for minimum period of five years, and recognized for tax purposes—for example, the transfer of the entire profit/assumption of loss. Careful structuring and annual monitoring is therefore necessary.
- Interest deduction limitations
Interest expenses are generally tax deductible to the extent they comply with the arm’s-length principle and the interest barrier rule. The interest barrier rule covers all kinds of loans, both shareholder and third-party loans, including standard bank loans. Annual net interest expenses are deductible up to 30% of the tax EBITDA (earnings before interest, taxes, depreciation, and amortization), which is the EBITDA pursuant to the German GAAP rules with certain tax corrections.
Companies that do not belong to a group of companies are not subject to the interest barrier rule. If the net interest expense does not exceed 3 million euros (no deductible), interest expenses are tax deductible for the purpose of the interest barrier rule. An equity escape clause may also apply as a further exemption, if the equity ratio of the corporation is not lower than 2% of the equity ratio of the group of companies to which it belongs. Both the group of companies exemption and the equity escape clause apply where the interest expenses from loans provided by major shareholders (>25% participation) or from intra-group debt financing, including back-to-back financing, do not exceed 10% of the net interest expenses of the respective fiscal year.
Any interest expenses that remain deductible are, however, subject to a 25% add-back for TT purposes.
- License deduction limitation
According to the license barrier rule. deductions for expenses for the use or a right to use an intellectual property right may be limited if the payments are made to a related party in a country with a special low-tax regime for licenses—for example, a patent box. According to this rule a low-tax regime is available where the tax rate is lower than 25%, unless the country has adopted the “nexus approach” according to Action 5 of the Organisation for Economic Co-operation and Development (OECD) BEPS report.
- Reorganization of companies
The German Reorganization Tax Act provides for the tax-neutral reorganization of companies within the framework of, inter alia, a merger, demerger, spin-off, hive-down, contributions of entire businesses or separate branches of activities, share-for-share-exchange, subject to certain conditions.
Further special tax rules provide for additional tax-neutral reorganizations, outside the Reorganization Tax Act, the so-called collapse merger, division of partnerships, etc.
Cross-border or mere foreign mergers, demergers and spin-offs (both in and outside the EU) are mostly privileged under the same conditions as national mergers.
Any supply of goods and services and intra-community acquisitions is generally subject to value-added tax (VAT) if and to the extent they are rendered by an entrepreneur for VAT purposes, and the place of supply is considered to be in Germany, save for specific exemptions. The regular rate of VAT is 19%. A reduced tax rate of 7% applies to supply of certain goods and services—for example, certain foods, drinks, (e)books and newspapers. Medical services and services of financial institutions, in particular, banks and insurance companies, are generally exempt from VAT.
The most common WHTs in Germany are on wages, at the employee’s progressive tax rate; dividends at 26.4% subject to relief pursuant to a DTT or the EU Parent–Subsidiary Directive; license fees and other payments to non-German taxpayers at 15.8% subject to relief pursuant to a DTT or the EU Interest and Royalties Directive; WHT on supervisory board remunerations at 31.7%; and building deduction tax at 15%.
Interest is subject to WHT only in exceptional cases.
Tax Environment for Large Enterprises
For CIT and TT as well as VAT, tax returns must in general be submitted seven months after the end of the tax year, which is usually the tax year—a different fiscal year is possible subject to the approval of the tax office. This deadline is extended if the tax returns are filed by a German tax adviser. If the tax returns are not filed in time, a late payment surcharge can or will be automatically imposed and interest is due. In addition, monthly tax filing obligations exist in relation to wage tax, VAT, WHT, in the form of self-assessed tax returns.
There is no explicit legal obligation to establish a tax compliance management system (TCMS). However, since the Federal Ministry of Finance stated in 2016 that the establishment of a TCMS could be a positive indication in the fulfillment of tax obligations, many companies strive to introduce a TCMS or have already introduced one.
German taxpayers have numerous duties to inform and co-operate with the tax authorities—for example, to keep proper accounts, register new business activities, and provide additional information on cross-border activities. If these duties are not fulfilled, the tax office is entitled to estimate the tax base or deny tax deductions. Taxpayers may be subject to tax audits (for up to five fiscal years) or special VAT audits (for one or more monthly or quarterly advance VAT returns). Large companies are subject to continuous tax audits. Non-compliance could trigger administrative fines or criminal prosecution.
Based on the implementation of the EU mutual assistance directive, the German tax administration is obliged to share information with other EU member states on request, and partly automatically.
Intermediaries and taxpayers are obliged to report certain cross-border tax arrangements to the tax authorities reflecting EU Directive 2018/822 amending the EU directive on administrative cooperation and mutual sssistance (DAC6). A special reporting obligation for digital platforms (DAC7) is required to be transposed into domestic law by the end of 2022.
- Network of double taxation treaties
Germany has concluded a large network of 90 double taxation agreements (DTAs) covering income tax; DTAs also partially cover inheritance and gift tax, as well as administration and legal cooperation. In principle, Germany has followed the OECD sample agreement in their structure and content, and applies the recommendations of the OECD BEPS report in the negotiations of new DTAs, except for the definition of a permanent establishment.
Germany ratified the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting of November 24, 2016. Its application will have limited scope, as Germany did not opt for the new OECD rules on the taxation of permanent establishments; effectively only 14 DTAs will be amended.
Germany does not generally provide direct tax incentives, especially not to large enterprises, although it promotes startup businesses with certain individual tax benefits in the field of research and development (R&D), loss utilization, and employee participation. Germany also introduced some tax incentives promoting e-mobility, renewable investments and energy saving investments.
Wage tax benefits apply with respect to electric and hybrid cars as company cars.
Based on the Research Subsidies Act (Forschungszulagengesetz) tax subsidies for R&D were introduced as of Jan. 1, 2020. The subsidy consists in an allowance for research companies and is intended to stimulate the research activity of small and medium-sized enterprises. Due to the Covid-19 pandemic, the maximum amount was increased up to 1 million euros until June 30, 2026.
By the Fund Location Act (Fondsstandortgesetz) tax incentives were introduced for employee equity investments, not only to especially support startups but also to increase the ownership ratio of employees in their employer companies. The same law provides certain TT incentives for electricity generation from renewable sources and charging stations for electric vehicles.
According to the jurisprudence of the Court of Justice of the European Union (CJEU), the “old” German anti-treaty/directive shopping rules were not compatible with EU law because they did not allow the taxpayer to prove that there was no purely artificial arrangement for the unjustified use of a tax advantage. Therefore, in 2021 the so-called Withholding Tax Relief Modernization Act entered into force, introducing substantial changes to these rules. However, obtaining treaty relief, especially with respect to multi-tier holding structures, became even more difficult compared to the former rules.
The Anti-Tax Avoidance Directive Implementation Act fundamentally reformed German foreign tax law relating to exit taxation, controlled foreign corporation (CFC) rules and hybrid structures.
With effect from July 1, 2021, the Real Estate Transfer Tax Act was significantly amended. To further restrict structuring possibilities to transfer shares in a real estate owning entity free of real estate transfer tax, the maximum number of shares that can be acquired tax-free is reduced from below 95% to below 90%. In addition, the Act increased existing retention periods and introduced new ones.
Due to the property tax reform, real estate in Germany must be revalued on the valuation date of Jan. 21, 2022. Real estate owners will be requested to electronically submit a property tax assessment form to the tax office between July 1, 2022 and Oct. 31, 2022. This will form the assessment basis for the property tax from calendar year 2025.
The development or creation, enhancement, maintenance, exploitation (DEMPE) concept was transposed into German transfer pricing rules; the ownership of an intangible asset is merely the starting point of a transfer pricing analysis and DEMPE functions should be decisive.
Effective July 1, 2021, the Modernization of Corporate Income Tax Act introduced an option model for German trading partnerships to be taxed as a corporation, comparable to a formal change of legal form. Although the respective administrative guidelines were issued end of 2021, several questions—especially in connection with international structures—are still not clarified.
Effective Jan. 1, 2022, the Tax Haven Defense Act introduced defensive measures against countries and territories that are not cooperative in tax and are on the EU’s blacklist: The law includes WHT restrictions, stricter CFC rules, the suspension of the participation exemption rules and increased cooperation obligations.
Potential Future Changes
The German government agreed to focus its tax policy on promoting measures on the protection of the environment and digitalization, including special depreciation.
Essential parts of the German tax system are pending before the CJEU, such as the German system of VAT grouping, or the German Supreme Court, such as the flat rate WHT. Further, international developments on the reallocation of taxation rights (Pillar One) and global minimum tax (Pillar Two) are expected to lead to major changes going forward.
In general, careful tax planning and cautious action of taxpayers targeting potential new developments will be required.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Björn Demuth is Partner, Head of Tax, Anastasia Papadelli is Counsel, and Jörg Schrade is Partner, with CMS Germany.