German Business Tax Reform 2008 Wilma Ehlert (Certified Tax Adviser) Benno Lange (German CPA, Certified Tax Adviser) DHPG Dr. Harzem & Partner KG, Bonn/Gummersbach.

German Business Tax Reform 2008

Wilma Ehlert(Certified Tax Adviser)

Benno Lange(German CPA, Certified Tax Adviser)

DHPG Dr. Harzem & Partner KG,Bonn/Gummersbach

NEXIA European Tax Group Meeting

Lisboa, September 28, 2007

Folie 2 © DHPG 2007

Overview

German Business Tax Reform 2008

I. Survey

II. Tax Law Changes for corporations and partnerships

III. Counter-Measures for Financing


I. Survey

Background of the Business Tax Reform


I. Survey

38,70%

29,83%

0,00%

5,00%

10,00%

15,00%

20,00%

25,00%

30,00%

35,00%

40,00%

45,00%

Background of the Business Tax Reform - European company tax rates 2007 -


I. Survey

Effective Dates

Calendar year taxpayers: January 1, 2008

Deviating fiscal year: FY 2007/2008

Changes in taxation of dividends and interests: January 1, 2009



A. New Regulations for corporations

B. New Regulations for partnerships

C. Summary


1. Taxation of the corporation

Trade tax

Base rate trade tax 5 % 3,5 %

Municipal levy rates 200 – 500% 200 – 500%

Trade tax 9,10 – 20,00 % 7,00 – 17,50%

Present rate New rate

Corporate income tax

Corporate income tax 25 % 15 %

Solidarity surcharge 5,5 % 5,5 %

Combined rate 26,38 % 15,83 %

Rate cuts

Total company taxes 33,08 – 41,10 % 22,83 – 33,33 %


1. Taxation of the corporation

2007

Earnings before taxes 100,00

Municipal levy rate trade tax 400 % - 16,67

Basis for corporate tax 83,33

Corporate tax + Solidarity surcharge - 21,98

Company taxes -38,65

Earnings after taxes 61,35

Company taxes

Trade tax is not deductible any more

Application for reducing the prepayments is possible

2008

100,00

- 14,00

100,00

-15,83

-29,83

70,17


2. Taxation of the shareholder

26,3828,4923,7423,74Income tax 45 % + Sol. Surcharge

26,3826,5922,1622,16Income tax 42 % + Sol. Surcharge

Flat WHTScaleScaleScaleTax rate

100,0060,0050,0050,00Subject to income tax

100,00100,00100,00Dividend income

PrivateBusiness*

200920082007

Income tax on dividends - individuals

• Maximum income tax rate 42 %,

•̀ Rich people‘s´ income tax rate 45 % (taxable income > 250.000 €)

• Flat withholding tax: • income related expenses are not deductible• will also be applied on capital gains on the disposal of shares

100,00

* Without trade tax


3. Overall view

2007 2009

Business* Private

Earnings before taxes 100,00 100,00 100,00

./. Taxes on Income - 38,65 - 29,83 - 29,83

= Earnings after taxes 61,35 70,17 70,17

Taxable income shareholder 30,68 42,10 70,17

./. Income tax + Sol. (45% / WHT) - 13,81 - 19,99 - 18,51

Net income shareholder 47,54 50,18 51,66

Total tax 52,46 49,82 48,43

Total tax

* Without trade tax





C. Summary


Trade tax Lowering of the trade tax base rate from 5 % to 3,5 % Elimination of lower base rates for low level earnings

(until 2007: 0 – 4% on earnings up to 72.500 €) Elimination of trade tax deductibility

Income tax `Rich people‘s´ income tax rate 45 % also on business income Income tax reduction by trade tax credit

– Increase of trade tax credit to multiplier 3,8 on the basis for trade tax (until 2007: 1,8)

– Limitation of maximum credit to actually payable trade tax Preferential taxation on retained earnings

1. Survey


2. Taxation without preferential taxation of retained earnings

1,741,51Solidarity Surcharge+

33,4429,01Income tax partner=

20082007

47,4445,68Total tax

7,50Trade tax credit 2007: 5% x 83,33 x 1,8./.

45,0035,00Income tax

86,0083,33Earnings after trade tax=

14,0016,67Trade tax (400 %)./.

100,00100,00Earnings before taxes

(45 %)(42 %)

Taxes on business income

13,30Trade tax credit 2008: 3,5% x 100 x 3,8./.


3. Preferential taxation of retained earnings

Effective as of January 1, 2008 or fiscal year 2007/2008

Individual Sole proprietorships Individual investor in a partnership, if minimum

interest > 10 % or prorated earnings > 10.000 € Resident or non-resident persons

Business, self-employed or agriculture and forestry income

Only accrual-basis accounting (not cash-basis accounting)

Application filed by each partner for the retained amount


Example

A is 50 % partner of AB OHG; the second partner is B-GmbH

Earnings before trade tax AB-OHG in 2008: 1.000.000 €, Trade tax 140.000 €

Prorated earnings A = 500.000 €

(Withdrawal ./. allocation ) A = 200.000 €

A applies for preferential taxation of maximum amount in 2008



Example K €

Prorated earnings A 2008 500,0

./. Trade Tax - 70,0

./. Withdrawal - 200,0

Retained earnings 230,0

Preferential tax rate 28,25 % + Sol. Surch. - 68,6

Remaining retained earnings 161,4

Distributed earnings (trade tax + withdrawals) 270,0

Income tax 45 % ./. Trade tax credit 58,0

Total Taxes 2008 196,6 = 39,3 %



3. Preferential taxationof retained earnings

Continuing Example Earnings before trade tax AB-OHG in 2009: 0 € Withdrawal A = 161.400 €

K €

Remaining retained earnings 2008 161,4

Withdrawal 2009 = distribution - 161,4

Remaining retained earnings 2009 0,0

Flat WHT 25% + Solidarity Surcharge 2009 42,6

+ Taxes 2008 196,6

Total tax 2008 and 2009 239,2 = 47,8 %

Total tax 2008 without privilege taxation 237,2 = 47,4 %





C. Summary


III. Counter-Measures for Financing

A. Changes in rules for depreciation

B. Earnings stripping rules

C. Modifications to trade tax addbacks

D. Tightened change-of-control rules

E. Transfer pricing/base shifting


Current regulation: option for depreciation of movable fixed assets

straight-line depreciation declining-balance depreciation (at most 30 % of residual

book value)

New regulation declining-balance depreciation only for assets aquired or

produced before January 1, 2008 only straight-line depreciation for assets aquired or

produced after December 31, 2007

Changes in rules for depreciation


General rule and definitions replaces thin-capitalization rules (§ 8a KStG) Net interest expense is deductible only up to 30 % of Tax-

EBITDA Net interest expense = difference between interest income

and interest paid Interest = All interest payments, receipts and/or accruals

whether to or from related party or third parties In the case of group taxation the whole group would be

treated as a single entity Disallowed net interest expense can be carried forward

indefinitely

Earnings stripping rules (Interest deduction limitation)



Differences Current rule: § 8a KStG New rule: § 4h EStG/§ 8a KStG

Creditor shareholder > 25 % related parties back-to-back

every type of creditor (shareholder, related party, bank)

Borrower corporations every type of business association

Save haven Equity-loan-ratio

1 : 1,5

30 % of Tax-EBITDA

Exemptions arm´s-length-test

de-minimis-threshold KEUR 250

- de-minims-threshold EUR 1 Mio. not part of a controlled group if part of a controlled group:

escape clause

Consequence Interest is qualified as a hidden profit distribution to shareholder

Interest is not deductible, may be carried forward



interest paid

- interest income

net interest expense ≤ 0

net interest expense < 1 Mio. EUR

not part of a controlled group?

Escape clause fulfilled?

Interest deduction limitation:only 30 % of Tax-EBITDA deductible,carry-forward of exceeding amount

No

No

No

No

interest expenses are completely deductible

Yes

Yes

Yes

Yes


The escape clause business is part of a group taxpayer must prove that equity ratio of the business is

not more than 1 percent less than that of the controlled group as a whole

equity ratio is calculated according to IFRS (alternatively German or US-GAAP)

corporations additionally:– escape clause only applies if the remuneration on

shareholder debt does not exceed 10 percent of the net interest expense

– shareholder debt is only counted if shown as liability in the consolidated accounts

– escape clause denied even if the 10 percent threshold is exceeded by only one group company




2007 2009

Dividend Interest Dividend Interest

Tax-EBITDA 120,00 120,00 120,00 120,00

./. Depreciation -20,00 -20,00 -20,00 -20,00

./. Net interest expense -100,00 -100,00

Income after interest 100,00 0,00 100,00 0,00

Taxable corp. tax 100,00 0,00 100,00 64,00

Taxable trade tax 100,00 0,00 100,00 64,00

Trade tax addback 0,00 50,00 0,00 9,00

Corp. tax + sol. levy 21,98 0,00 15,83 10,13

Trade tax (400 %) 16,67 8,33 14,00 10,22

Taxes on income 38,65 8,33 29,83 20,35

Spread 30,32 9,48


Carry-forward of disallowed interest expense no time limitation use is only possible after radical change of profit situation 333 EUR EBITDA necessary to deduct 100 EUR of carry

forward change-of-control rules apply also for net interest expense no carry-forward after restructuring



One fourth of the sum of the following payments will be added back in calculating trade income

loan remuneration (e. g. interest) recurring payments profit shares of a silent partner one fifth of rental/leasing payments for movable fixed

assets three fourths of rental/leasing payments for immovable

fixed assets one fourth of royalty payments de-minimis threshold: 100.000 EUR

Modifications to trade tax addbacks


Present regulation § 8 Abs. 4 KStG (CIT Act) Economical identity is necessary for use of loss

carryforward Economical identity proved by

– share transfer test (> 50 % within 5 years) AND– business asset test (predominantly new assets)

applies also for trade tax purposes not valid for indirect changes in ownership special rules for corp. under restoration no exemptions for listed companies applicable for transfers before January 1, 2008

Tightened change-of-control rules


New regulation § 8c KStG (CIT Act) harmful share transfers trigger forfeiture of loss

carryforward– transfers within 5 years– > 25 %: proportional forfeiture– > 50 %: complete forfeiture– share capital increase = transfer

applies also for trade tax purposes valid for direct and indirect changes in ownership no special rules for corp. under restoration no exemptions for listed companies applicable for transfers after December 31, 2007




M-AG

T1-GmbHT2-GmbH

loss carryforward

T2-GmbH

100 %

30 %

Transfer of 30%

Tax loss carryforward (CIT and trade tax) = 1 Mio. EUR

Consequence: Forfeiture of tax loss carryforward (30% of 1 Mio. EUR = 300.000 EUR) and current loss until harmful share-transfer for CIT and trade tax purposes

100 %

Example:Direct transfer



Tax loss carryforward (CIT and trade tax) = 1 Mio. EUR

Consequence: No harmful transfer because only (30 % of 70 % =) 21 % of the shares are transferred

Example:Indirect transfer

M(non resident)

T-GmbH(loss carryforward)

H(resident)

100 %

70%

Newshareholder

30 %


New rules for transfer pricing Priority methods for transfer pricing

– Comparable uncontrolled price method– Resale price method– Cost plus method

Other methods can be used if standard methods are not applicable

– Transactional net margin method– Profit split method– Comparable profit method is not allowed

If no comparable data is available (base shifting?): hypothetic arm´s length test

Transfer pricing/base shifting


Range of comparative values Federal Tax Court (BFH) decision in 2001:

– there is not one arm´s length transfer price, but always a range of those

– every transfer price within this range is arm´s length– if the effective price is outside the range, the boundary

value is used for taxation New regulations as of 2008

– only narrowed range is arm´s length– if the effective price is outside the narrowed range, the

median is used for taxation



Documentation duties introduced in 2003 facts and circumstances documentation appropriateness documentation

Changes to documentation requirements Exceeded documentation requirements for base shifting,

R & D activities and cost sharing agreements Time limit for submission of documentation is reduced

from 60 to 30 days for extraordinary transactions Correction of transfer price possible if foreign related party

does not submit supplementing information



New rules for base shifting Exit tax charges for transfer of business functions

– Transfer includes all risks and opportunities relating to the function (e. g. production, distribution)

– Individual components have to be evaluated as one package (transfer package)

– Arm´s-length-price: profit potential, determined by discounted cash flows

– Provision for retrospective adjustment Problems:

– taxation on synergy effects – no OECD-rules for base shifting yet– violation of EU law?


German Business Tax Reform 2008 Wilma Ehlert (Certified Tax Adviser) Benno Lange (German CPA, Certified Tax Adviser) DHPG Dr. Harzem & Partner KG, Bonn/Gummersbach.

Documents

income tax partner

trade tax base rate

certified tax adviserdhpg

flat withholding tax

overall viewtotal tax

business tax reform

rich peoples income

taxable income