Germany: German Tax Reforms of 2002 & 2001: A Summary for Foreign Investors

Co-written by Alexa Starosta

Originally published in the March issue of Practical European Tax Strategies.

On October 23, 2000, the much-discussed and far-reaching Tax Reform was adopted and came into effect on January 1, 2001, including the Supplementary Tax Reduction Act, which passed the upper house of German parliament on December, 1 2000. The new legislation contains some long-expected cuts in personal and corporate income taxes, as well as some new changes, such as the systematic change from tax credit system to a partial exemption system.

On August 15, 2001, the Federal Government voted for a draft bill of the Further Tax Development Act (Unternehmenssteuerfortentwicklungsgesetz), which continues the development of tax reduction and contains further modifications on taxation of corporations. The act provides for further tax relief for partnerships and sole proprietorships. It also closes some unintended loopholes of the Tax Reform 2000. In December 2001, the parliamentary process was finalized. Some of the recent changes will become effective retroactive as of January 1, 2001.


A. Highlights of the Tax Reform 2000

  • The rate of corporate income tax was reduced from 30 percent – 40 percent down to 25 percent.
  • The tax imputation system was abolished. Intercompany dividends between German corporations are exempt from tax. Individual shareholders are only taxed on 50 percent of the dividends received from corporations.
  • A national participation exemption was introduced. All capital gains realized directly or indirectly by a German corporation from the sale of shares in a German subsidiary are exempt from tax. (Previously, such exemption was available only in a sale of shares in a non-German subsidiary.)
  • German thin capitalization rules for foreign investors were tightened.
  • The depreciation of assets was restricted.
  • The "conversion model", which enabled a step up in basis upon a conversion of a corporation into a partnership, was abolished.

  • The quota for a material holding in a corporation was reduced from 10 percent to 1 percent. Consequently, the gain resulting from the sale of shares in corporations is tax exempt if the seller owns less than one percent of the corporation (previously less than 10 percent).

B. Highlights of the Tax Reform 2001

  • The requirements for a fiscal unity for trade tax purposes have been adapted to the requirements for a fiscal unity for corporate tax purposes.
  • The transfer of assets between partnerships and partners and vice versa is tax neutral under certain conditions.
  • Partnerships and sole proprietorships are entitled to a tax free rollover of capital gains up to € 500,000 from the disposal of corporations if such capital gains are utilized for the investment in another corporation.
  • No tax relief is available for the disposal of only a part of a partnership interest by individuals.
  • Portfolio dividends (participation of less than 10 percent) are subject to trade tax. Expenses connected to such dividends are deductible for trade tax purposes.
  • Capital gains by corporations from the disposal of partnership interests are subject to trade tax.
  • Dividends and capital gains are defined as active income in the context of CFC regulations.
  • Dividends and capital gains are tax exempt if the income of a CFC was subject to tax.


A. Reduction of Corporate Income Tax Rate

Under the old German system of income taxation of corporations, retained earnings were taxed at a rate of 40 percent, while distributed earnings were taxed at a reduced rate of 30 percent. If retained earnings are distributed in subsequent years, the corporation was entitled to a 10-percent tax credit.

Under the new corporate income tax legislation, profits of corporations are taxed at a rate of 25 percent, regardless of whether those profits are distributed. Based on a comparison of corporate income tax rates (including the 5.5-percent German solidarity surcharge) imposed on retained earnings, Germany has now one of the lowest corporate tax rates of all industrialized countries. Even if the trade tax, which is imposed on German businesses and corporations on a regional basis, is factored into this comparison, German corporate taxes on income are lower than the aggregate taxes imposed upon a corporation operating in New York City.

The same tax rates are applicable on German permanent establishments of foreign corporations and on foreign corporations being a partner in a German partnership.

B. Repeal of Tax Imputation System

Under the new corporate tax law, the imputation system is replaced by the so-called half-income system. Individual shareholders receiving dividends no longer benefit from a tax credit for corporate income taxes paid. Instead, only 50 percent of the dividends received by individual shareholders are considered taxable income for purposes of computing their individual income tax. Intercompany dividends received by German corporations from their German as well as foreign subsidiaries are exempt from corporate income tax. This exemption will apply regardless of the extent of interest held in the German subsidiary.

With respect to existing retained earnings of German corporations, the Tax Reform 2000 contains transitional rules pursuant to which available corporate tax credits may be claimed for a 15-year period commencing on January 1, 2001. For that purpose, the total tax credit available for each German corporation will be calculated as at the end of the last fiscal year ending on or after December 31, 2000. In the following years, the tax credit of the corporation can be utilized when dividends are distributed to its shareholders. The corporation tax is reduced by 1/6th of the dividend distributed.

C. CFC Act

An additional tax is imposed in Germany on the profits of the passive activities of a subsidiary resident in a tax-haven jurisdiction, in order to ensure the effective taxation of retained foreign dividends to German shareholders. Therefore, the German CFC Act (Außensteuergesetz) had been amended so that, if the foreign corporation is resident in a jurisdiction imposing less than 25-percent income tax on retained earnings from passive activities, the retained earnings of foreign corporations were taxed as if dividended to German shareholders. The tax rate on such a "fictitious" dividend was 38 percent, irrespective of whether the shareholder had a positive tax basis. The participation exemption was not applicable.

The Tax Reform 2001 makes some changes to the CFC Act.

First, dividend income is now defined as active income. The same now applies to capital gains of foreign corporations. Consequently, dividend income and capital gains of CFCs are no longer taxed in Germany.

The Tax Reform 2001 also abolishes the separate taxation of the passive CFC income at a rate of 38 percent. As a result, the passive income can be netted with losses of the individual shareholder and the individual income tax rate will be relevant. The same applies to corporations.

D. Introduction of National Participation Exemption

While capital gains derived from the sale of shares of foreign subsidiaries have generally been exempted from corporate income tax on German corporations since 1984, capital gains derived by German corporations from the sale of shares in German subsidiaries have always constituted taxable income. Such gains are now tax free after December 31, 2001, at least in most cases.

E. Fiscal Unity (Organschaft)

Under the former legislation, the recognition of a fiscal unity between a parent company and a subsidiary required a financial, organizational, and economic integration of the subsidiary as well as a profit transfer agreement. If such a fiscal unity was desired by both companies, parent company and subsidiary elected such a unity by concluding the relevant contracts (e.g., a profit transfer agreement, Gewinnabführungsvertrag or domination contract, Beherrschungsvertrag).

Under the new law, apart from the requirement of a profit transfer agreement, only the financial integration of the subsidiary is necessary to achieve fiscal unity for corporate income tax purposes. Financial integration exists when the parent company is directly or indirectly majority shareholder of the subsidiary from the beginning of the fiscal year of the subsidiary. Thus, majority participation and a profit transfer agreement will result in fiscal unity for corporate income tax purposes. These changes simplify structuring and reduce substance problems within German holding structures.

The Tax Reform 2001 adapts the requirements for a fiscal unity for trade tax to the requirements for a fiscal unity for corporate income tax. This further simplifies implementation of holding structures.

Additionally, the Tax Reform 2001 simplifies the requirements for a cross-border fiscal unity for corporate income tax purposes as long as the foreign entity is subject to German tax law.

F. Trade Tax

In order to prevent an improper use, the Tax Reform 2001 abolishes the exemption of trade tax on capital gains of a corporation from the disposal of partnership interests. As a result, trade tax exemption will be maintained only on capital gains from the sale of partnership owned by individuals.

The Tax Reform 2001 introduced retroactively as of the tax year 2001 the taxation of portfolio dividends (shareholding less than 10 percent). As a consequence all business expenses connected to such dividends are deductible (long-term interest only at 50 percent).

G. Real Estate Transfer Tax for Intra-Group Transfer of Real Estate

The Tax Reform 2001 was initially supposed to simplify and support the restructuring within a group of affiliated companies by exempting the transfer of real property within a group of affiliated companies from real estate transfer tax. However, this proposal was rejected.


A. Reduction of Income Tax Rates

The main reform of personal income taxes relates to the reduction of individual tax rates in the years 2002 through 2005. These changes will have only indirect effects on businesses. The changes are briefly summarized as follows:

Year Reductions in Personal Income Tax

2001 Credit for trade tax paid by individuals operating through a partnership or a sole proprietorship.

Tax-free allowance of individuals increases to Euro 7,235 (DM 14,150); reduction of entrance level of progressive tax rate to 19.9 percent; reduction of marginal tax rate to 48.5 percent.

2003 Tax-free allowance of individuals increases to Euro 7,426 (DM 14,523); reduction at entrance level of progressive tax rate to 17 percent; reduction of marginal tax rate to 47 percent.

2005 Tax-free allowance of individuals increases to Euro 7,664 (DM 14,989); reduction of entrance level of progressive tax rate to 15 percent; reduction of marginal tax rate to 42 percent and downward adjustment of all intermediate tax rates.

B. Taxation of Capital Gains

In the past, German individual shareholders could realize capital gains derived from the sale of non-material shareholdings in corporations free from income tax, unless the capital gain was realized during a six-month speculation period. Effective January 1, 1999, the threshold for non-material holdings was reduced from 25 percent to 10 percent; in addition, the holding period was extended to 12 months. Moreover, existing opportunities for a tax-exempt stock-swap were substantially limited.

The Tax Reform 2000 further diminished the possibilities of a tax-free capital gain by reducing the threshold of non-material holdings to one percent effective January 1, 2002. Consequently, only minor shareholdings mainly in publicly-listed companies may be disposed of tax-free. In contrast to these revenue-raising measures, the income tax on capital gains realized from the sale of material shareholdings or during the 12-month holding period will be imposed only on 50 percent of the gain.


A. Transfer of Assets Between Partners and Partnerships and Vice Versa

Before the Tax Reform 2000 it was possible to transfer assets tax free between partnerships and partners and vice versa. These opportunities were restricted under the Tax Reform 2000. The Tax Reform 2001 contains some clarifications in respect of such asset transfers but also reverses most of the restrictions introduced by the Tax Reform 2000.

Now a tax neutral transfer of assets between partnerships and partners and vice versa is again possible. However, to the extent corporations are partners and undisclosed reserves are transferred to them, such transaction is not tax neutral. To prevent tax avoidance, a holding period of seven years applies in respect to such assets. The transfer of assets will be taxed retroactively if the assets are sold in this period. In certain cases a different holding period of three years applies. This specific period starts in the year in which the relevant tax return is filed with the tax authorities.

B. Taxation of Capital Gains and Reserves

Under former legislation, the partnerships and sole proprietorships are claimants for a specific tax-free reserve. The Tax Reform 2001 provides that in the future, the partner or the sole proprietor is the claimant. Consequently, the partner of a partnership will be able to claim this reserve and to roll over certain capital gains of the partnership to other assets even if these assets belong to another partnership.

The Tax Reform 2001 provides an additional tax benefit by permitting the rollover of capital gains from corporations to an equity investment in another corporation or to land and buildings up to an amount of € 500,000. Therefore a tax-free reserve can be created.

Formerly, the disposal of a part of a partnership interest was tax privileged, while the capital gain from the sale of a part of an individual business was taxed. Because of the comparability of these activities, a different taxation of both cases is not justified. In the future, a disposal of a part of a partnership interest will be taxed as ordinary business income.

C. Trade Tax Exemptions

The Tax Reform 2000 already had introduced a reduction of the tax burden of partnerships and sole proprietorships by crediting the trade tax against the income tax liability of the individual. The trade tax is still deductible as operating expenditure at the level of the partnership or enterprise. The consequence for the majority of partnerships owned by individuals is that they will have a full relief from trade tax.


The German Tax Reform Act has clearly increased Germany’s competitiveness and attractiveness for inward investment by reducing its historically high nominal tax rates to levels more in line with those of its big trading partners. The subsequent Tax Development Act supports this development and gives further incentives for investors to medium-sized businesses. It also closes some loopholes and removes some unintended results of the Tax Reform Act.

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Mondaq Advice Centre (MACs)
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.