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The German 1997 Annual Tax Act
The German 1997 Annual Tax Act (Jahressteuergesetz 1997) was enacted into law in December of 1996 and has since entered into force. Most, but not all, of its provisions take effect on 1 January 1997. Please note that this article is one of a 14-part set of articles describing the 1997 Annual Tax Act.
I. INCOME TAX LAW
1.1 INCOME TAX RATES
The 1997 Annual Tax Act does not alter the income tax rate structure. The 1996 income tax rates thus remain in effect in 1997. The increase in the income tax zero bracket amount originally scheduled to take effect in 1997 has been postponed until 1998.
1.2 CHILD SUPPORT CONTRIBUTIONS AND STANDARD DEDUCTIONS FOR CHILDREN
The new law enacts the scheduled increases in government child support contributions (Kindergeld) and the standard deduction amounts for dependent children (Kinderfreibetrag) effective 1 January 1997:
- The child support contribution for the first and second child rises from DM 200 to DM 220 per child per month.
- Child support contributions for additional children remain unchanged (DM 300 per child per month for the third and fourth child, DM 350 per child per month for children numbers five and upwards).
- The standard deduction for children, which is granted optionally instead of child support deductions, has been increased from DM 522 to DM 576 per month.
1.3 CHILD CARE EXPENDITURE
It has previously been possible for single parents to deduct their child care costs as extraordinary personal expenses if certain conditions are met. In such cases, the expenses were deductible in full.
From 1997 on, the deductible amount is reduced by a sum which the taxpayer is deemed reasonably able to bear.
1.4 SPECIAL DEPRECIATION AND ANTICIPATED SPECIAL DEPRECIATION FOR SMALL AND MEDIUM-SIZED BUSINESSES UNDER SEC. 7G ESTG
- Special depreciation allowances
Previously, businesses with a standard assessed value for net worth tax purposes of up to DM 240,000 and, if applicable, trade capital not exceeding DM 500,000 were permitted, subject to certain requirements, to take special depreciation allowances of up to 20 % per year (based on the asset's cost) in the year of purchase or production of a new moveable fixed asset and in the four years which follow. The 1997 Annual Tax Act changes the basic requirements for availability of these depreciation allowances as follows:
- For professional service businesses (primarily the liberal professions, doctor, lawyer, architect, etc.) and commercial businesses (trades), qualification for the benefit is now determined with respect to the net business assets according to income tax principles, and the limit amount is set at DM 400,000. Taxpayers who determine their taxable income using the method prescribed by sec. 4 par. 3 EStG (essentially, cash basis taxpayers) are automatically deemed to be under the limit. - For agriculture or forestry enterprises, the standard assessed value at the end of the preceding fiscal year continues to apply; the limit amount is DM 240,000.
- Anticipated special depreciation
Previously, it has been possible to claim special anticipated depreciation (Ansparabschreibungen) with respect to moveable fixed assets which the taxpayer plans to buy or manufacture in the future. A reserve of up to DM 300,000 can be set up as a charge against income in an amount not exceeding 50 % of the cost of such assets if their purchase or production is probable by the end of the second fiscal year following that in which the reserve is first established.
The new legislation contains an improvement for the founders of new businesses, who can now set up the reserve in question as long as the asset's purchase or production is probable by the end of the fifth year following that of its establishment. The maximum amount is increased to DM 600,000.
The law defines "founder of a new business" as an individual who, during the five years preceding that in which his business commenced operations, owned no interest in a corporation exceeding 10 % (either directly or indirectly) and derived no income within the meaning of sec. 2 par. 1 nos. 1 - 3 EStG (agricultural and forestry income, commercial business income, or professional service income). Provided all of their shareholders are natural persons meeting the preceding requirement, corporations can also qualify as "founders of a new business", as can partnerships under the same or similar conditions.
The benefit for founders of new businesses constitutes a subsidy within the meaning of Art. 92 of the European Community Treaty and hence requires the consent of the European Commission. This has been applied for, but not yet granted.
1.5 SPECIAL DEPRECIATION FOR COMMERCIAL SHIPS AND AEROPLANES
It has previously been possible to take special depreciation on the cost of commercial ships and aeroplanes of 40 % and 30 % respectively over a five year period, provided the asset constitutes business property (sec. 51 par. 1 no. 2 (w) EStG; sec. 82f EStDV).
Such special depreciation is now limited to ships and aeroplanes purchased or constructed prior to 1 January 1999 pursuant to a contract entered into prior to 25 April 1996. For (essentially) partners in commercial partnerships (sec. 15 par. 1 no. 2 and par. 3 EStG) who join the partnership after conclusion of the construction contract (signature of the main contract), the special depreciation is only permitted if they join prior to 1 January 1999.
Furthermore, in the case of interests in ships, sec. 15a EStG will in the future apply generally to distributive shares of losses arising in fiscal years beginning after 31 December 1995 (sec. 52 par. 19 sent. 3 no. 3 b EStG). The tax deductibility of such losses will thus be limited to 100 % of the investment amount, instead of the previous 125 %. Here again, there is an exception if the ship construction contract was entered into prior to 25 April 1996. For partnerships owning such ships, new partners can as before deduct losses of up to 125 % of their capital investment provided they acquire their partnership interest by 31 December 1998 (and fulfil other requirements) and provided the losses arise in fiscal years ending prior to 1 January 2000.
1.6 LIQUIDATION TAXATION OF CORPORATE SHAREHOLDERS
Under sec. 16 par. 1 no. 1 EStG, the sale by an individual (directly or through a partnership) of a 100 % interest in a corporation held as business property can qualify for the benefits accorded to personal business termination gains (exemption amount, taxation at half of the taxpayer's normal rate). The same is true if the corporation is liquidated. A change in the law now denies such preferential treatment to the extent the sums distributed in liquidation of the corporation are of the type which, viewed in isolation, would constitute income on capital within the meaning of sec. 20 par. 1 nos. 1 and 2 EStG (essentially, retained earnings, which are taxed as dividend income).
1.7 TAXATION OF GAINS UNDER SEC. 17 ESTG FROM EK 04
Gains on sale of interests in corporations not held as business property are subject to taxation if sold within the speculation period (6 months - sec. 23 EStG) or if part of a material ownership interest (over 25 % - sec. 17 EStG). Gains taxable only under sec. 17 EStG qualify for benefits similar to those discussed above (exemption amount and reduced rate of taxation). Liquidations and reductions in capital are treated as events which can lead to gains taxable under sec. 17 EStG on advantageous terms, though here again not to the extent the sums distributed are of the type which would constitute income on capital.
The new legislation provides that a distribution, in liquidation or otherwise, of sums from the corporate equity account (basket) EK 04 also leads to gain to the extent the sums repaid exceed the taxpayer's basis in his shares. A similar change in the Tax Reorganisation Act (sec. 21 par. 2 sent. 1 no. 3 UmwStG) provides that distributions from EK 04 with respect to so-called "contribution-generated shares" (einbringungsgeborene Anteile) in a domestic corporation will likewise trigger tax to the extent they exceed the taxpayer's basis in the shares. Contribution-generated shares are received in tax-free (or partially tax-free) reorganisations involving the contribution of a business as a whole, a branch of activity, a partnership interest, or (under certain conditions) shares in a corporation to a receiving domestic corporation in return for new shares in this corporation. EK 04 is the equity basket in which domestic corporations must record shareholder contributions in excess of their stated capital.
1.8 TAXATION OF LIFE INSURANCE POLICIES
The interest earned by individuals on whole-life insurance policies is tax free under certain conditions. The new law makes changes aimed at the recently publicised practice of purchasing so-called "used" life insurance policies ( sec. 10 par. 1 and 2 and sec. 20 par. 1 no. 6 sent. 2 EStG). The amendments made ensure that the purchasers of such policies will no longer be able to claim premiums as special personal deductions and, most importantly, will be denied the tax exemption for the interest earned by the policy, whether contractually guaranteed or performance-related.
1.9 CUSTOMER LOYALTY PROGRAMS
Under the new sec. 3 no. 38 EStG, non-cash benefits conferred by an enterprise on its customers are tax exempt up to an amount of DM 2,400 per calendar year if received by the customer free of charge for his personal use of the enterprise's services as part of an established general plan open to all and designed to promote customer loyalty (literally: to attach or tie the customer more closely to the enterprise).
Furthermore, new sec. 37a EStG authorises the tax authorities to permit enterprises upon request to remit a flat rate tax of a mere 2 % on the value of non-cash benefits so conferred to domestic taxpayers in excess of the exemption amount. By so doing, the enterprise satisfies any income tax liability the customer may have with respect to the benefit.
1.10 PENSION ACCRUALS
It is no longer possible to set up a pension accrual to the extent the pension claim is contingent upon future profit-related remuneration (revised sec. 6a par. 1 no. 2 EStG). The amendment applies to all fiscal years ending after 29 November 1996 (sec. 52 par. 7a EStG) and hence covers fiscal years ending on 31 December 1996. Pension accruals for such years may thus have to be adjusted accordingly.
1.11 HOUSEHOLD EMPLOYEE EXPENSE
Expense for household employees (sec. 10 par. 1 no. 8 EStG) can be deducted up to an amount of DM 18,000 (increased from DM 12,000) provided (as before) the mandatory contributions to the domestic social security system are remitted. From 1997 on it is no longer necessary that the household include one or more young children or persons unable to care for themselves.
In case of temporary employment, the ceiling amount is divided by 12 and applied on a monthly basis to the months in which employment took place.
If the wages paid to the household employee do not exceed DM 1,500 per month, the employer can avail himself of a simplified reporting and remitting procedure (so-called household check-writing). This requires authorising the authorities to debit the employer's bank account for the amount of insurance contributions and other sums due.
1.12 NEW REFUND PROCEDURE FOR NON-RESIDENT ARTISTS, PROFESSIONAL ATHLETES, ETC.
The 1996 Annual Tax Act increased the withholding tax rate from 10 % to 25 % for non-resident artists performing in Germany, professional athletes participating in sports events here, and others (sec. 50a par. 4 nos. 1 and 2 EStG). Since in some cases this can lead to excessive withholding, a refund procedure has been introduced to be administered by the Federal Finance Office (Bundesamt fuer Finanzen). Withholding tax will be refunded upon request to the extent it exceeds 50 % of the difference between the revenue earned by the artist, athlete, etc. and the expenses bearing a direct economic relationship to this revenue (new sec. 50 par. 5 no. 3 EStG).
In order to establish the amount of tax withheld, the taxpayer must include with his application the withholding certificate provided for by a new sentence 7 added to sec. 50a par. 5 EStG, which his debtor is required to deliver to him upon request.
1.13 EXEMPTION FROM WITHHOLDING, E.G. UNDER TAX TREATIES
Germany generally uses a refund system to comply with the reduced withholding rates permitted under its tax treaties and the exemption from withholding tax on dividends to EU parent companies. This means that the full withholding tax must first be paid and the appropriate refund then applied for. A procedure does exist, however, by which withholding can take place from the start in accordance with the reduced rate (often a zero rate) provided the Federal Finance Office has issued a written exemption to the taxpayer pursuant to a formal request filed.
The new legislation changes the relevant provision (sec. 50d par. 4 EStG) to provide that, in withholding situations covered by sec. 50a par. 4 EStG (payments to artists, entertainers, athletes, etc., royalties, and payments for the use of tangible personal property), such exemptions may be made contingent upon proof of compliance with the requirements of sec. 50a par. 5 EStG (the basic obligation to withhold, including issuance of the new withholding certificate - sec. 1.12 above) to the extent the payments are "passed along" (weitergeleitet) to other non-resident taxpayers. The change is aimed at situations in which the initial recipient of payments of the sort described is in some sense not their ultimate or beneficial owner. Back-to-back license arrangements are one example in which the new provision might operate; entertainers contracting through a middleman may be another. It is unclear how the new provision will work in practice. Possibly, in order to receive an exemption, the initial payment recipient will somehow have to satisfy the tax authorities that he will withhold in the proper amount to the extent the sums he receives are to be "passed along". Or it may be that the exemption on which the payor is asked to rely will be contingent on his obligee's discharge of any withholding obligation which this obligee (= initial recipient) may have on sums "passed along" to a second recipient (and so on). Such an interpretation, which seems extreme, might expose to subsequent liability payors who make full disbursement in reliance on contingent exemptions.
1.14 REPORTING OF TAX-EXEMPT INCOME ON CAPITAL
Under the previous wording of sec. 45a par. 1 sent. 2 EStG, the return filed to report withholding on income on capital (passive investment income, e.g. dividends and interest) was required to include only specified sorts of income on capital as to which the basic withholding requirement was reduced or eliminated by other provisions of the tax law. This passage has now been changed to require reporting of all income on capital subject to withholding including income all such income which qualifies for reduced or zero withholding. This applies as well to dividends paid by a German subsidiary to its European Union parent, which are exempt from withholding under sec. 44d par. 1 sent. 1 EStG.
This article is one of a 14-part set of articles entitled "The German 1997 Annual Tax Act" in which we have endeavoured to provide a useful overview of what we consider to be the major changes made in the German laws by the 1997 Annual Tax Act and, more selectively, by other recent legislation. To access the other articles in the set please enter 'The German 1997 Annual Tax Act', 'KPMG Tax Advisers' and 'Business Monitor'. We are of course at your disposal to discuss in depth the ramifications of new provisions which are of particular interest to you.
Disclaimer and Copyright
This article treats the subjects covered in condensed form. It is intended to provide a general guide to the subject matter and should not be relied on as a basis for business decisions. Specialist advice must be sought with respect to your individual circumstances. We in particular insist that the tax law and other sources on which the article is based be consulted in the original, whether or not such sources are named in the article. Please note as well that later versions of this article or other articles on related topics may have since appeared on this database or elsewhere and should also be searched for and consulted. While our articles are carefully reviewed, we can accept no responsibility in the event of any inaccuracy or omission. Please note the date of each article and that subsequent related developments are not necessarily reported on in later articles. Any claims nevertheless raised on the basis of this article are subject to German substantive law and, to the extent permissible thereunder, to the exclusive jurisdiction of the courts in Frankfurt am Main, Germany. This article is the intellectual property of KPMG Deutsche Treuhand-Gesellschaft AG (KPMG Germany). Distribution to third persons is prohibited without our express written consent in advance.