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Inbound Investments In Germany: Consequences of the 2008 business Tax Reform-Part 1

Wednesday, 01 October 2008   (0 Comments)
Posted by: Author: Felix Waniek
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Inbound Investments In Germany: Consequences of the 2008 business Tax Reform-Part 1

One thing all tax systems around the globe have in common is constant amendments. For that reason it doesn’t come as a surprise that just seven years after the last comprehensive reform the rules regarding the taxation of businesses in Germany have again been modified significantly. 

The principal aim of the 2008 business tax reform has been to enhance Germany’s attractiveness as a business location while safeguarding its tax base at the same time. That has been a difficult task to fulfil and a good reason for South African investors and advisers to take a closer look at the recent developments in a country that is one of South Africa’s most important trading partners. 

Significant reduction of nominal tax burden for corporations

The most positive effect of the reform is a reduction of the nominal tax burden on incorporated businesses run in Germany. As of fiscal year 2008 the overall tax burden on net income of an AG (public limited company) or GmbH (private limited company) will total close to 30%. That is a significant relief when compared to the average 39% in 2007. In general, Germany now occupies the mid-field of corporate taxation in Europe, rather than being ranked right at the bottom, as was the case in the past.

The final tax burden of a business, however, still depends on the level of local trade tax (Gewerbesteuer). While corporate income tax is 15.8% (including a general solidarity surcharge), local trade tax still varies significantly from one municipality to the next. As a general rule, one can say that local trade taxes tend to be higher in larger cities and lower in the outskirts.   

The following table highlights the range of the overall nominal tax burden.

As a consequence, cross border tax planning definitely should take local trade tax into account. 

Corporate income tax   Local income tax Overall tax burden
Corporate,local and overall15.8% 7% 22.85%
Berlin 15.8% 14.35% 30.175%
Cologne 15.8% 15.75% 30.575%
Frankfurt 15.8% 16.1% 32.925%
Hamburg 15.8% 16.45% 32.275%
Munich 15.8% 17.15% 32.975%

Introduction of a 25 % flat tax on capital income for resident individuals

An element of the 2008 reform that appears to be revolutionary for German tax law – and might be of interest to readers because of the current introduction of dividend tax in South Africa - relates to the taxation of capital income for resident individuals. From 2009 all capital income (including dividends) that derives from private assets will be taxed at a flat rate of 25% (26.38% including solidarity surcharge).

The introduction of a flat tax rate will replace the "half income method” that was introduced in the 2001 reform. According to that method, capital income is taxed at the personal income tax rate on 50% of the income received.

The half-income method will remains in part because from 2009 on shareholders will have to pay income tax at the personal income tax rate on 60% of the dividends received (50% before) for shares held as business assets.

For resident corporate shareholders the current provisions regarding the taxation of dividends and capital gains will remain the same (95% exclusion).

Taxation of dividend distributions to South African shareholders

Under German law, dividend payments to foreign shareholders are subject to a 21.1% withholding tax (including solidarity charge). However, dividend payments to South African shareholders are generally limited to a withholding tax of 15% due to the German South African double tax treaty. In the case of a qualified stake (25%) the withholding rate is reduced to 7.5 %. Further reductions can be achieved by means of sophisticated tax structures.

Relief and refunds from the withholding tax paid in excess can be claimed upon special application to the Bundeszentralamt für Steuern in Bonn (

Withholding tax systems in the EU have recently been put under major threat by the ruling of the European Court of Justice (ECJ) in the Amurta case. In that decision, with reference to Dutch tax law, the ECJ held that the freedom of capital provisions did not allow companies resident in another EC member state to be subject to withholding tax on dividends whilst resident companies were exempted.Even though companies outside the EU cannot directly rely on the EU provisions, they might do so indirectly if they have a holding structure in the EU. It has yet to be seen if the German provisions will survive an ECJ decision, but the legitimacy of the current system has to be severely questioned at least.

Retained earnings privilege for partnerships and permanent establishments

Another key point of the 2008 reform relates to retained earnings in partnerships and permanent establishments.

As a general rule, profits arising in partnerships and sole proprietorships are subject to trade tax at the level of the partnership or sole proprietorship. After the profits have been reduced by the trade tax liability, they are then attributed to the partners or sole proprietors, who then have to pay income tax on those profits at their personal income tax rates (up to 47.5%, including solidarity surcharge). 

Because personal income tax rates remained unaffected by the 2008 reform the government had to take steps to secure that tax treatment of retained profits remains neutral in terms of the legal form. Thus a new favourable treatment has been introduced for the retained profits of partnerships and permanent establishments. Retained profits are now taxed –upon application - at a reduced rate of 28.25%. If only trade tax is withdrawn (on the partnership level) and the rest of the profits are retained, the overall tax burden now totals 32.25%. 

As is always the case in tax law, there is a catch: If profits taxed at the reduced rate are withdrawn later those profits will be subject to an "ex-post tax” of 25%. If full profits, except for trade tax, have been withdrawn the overall tax burden will total 48.2% after a withdrawal of the remaining sum at a later date.

Why should a South African investor take note? 

Ex-post tax is triggered not only in the case of withdrawal but also in the case of restructuring or sale of interests in a partnership or permanent establishment. From 2008 on, therefore, sales prices of those interests will potentially include ex-post tax on accumulated profits.

To be continued in Issue 11. The next article will deal with the introduction of an interest cap and the new anti-loss-trafficking rule and changes to the transfer pricing regime.  

Source: By Felix Waniek (TaxTALK)




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