Thomas Sauter, KPMG Frankfurt
For editorial cut-off date, disclaimer, and notice of copyright see end of this article.
1. Legislative history and general purpose
The German government introduced the Act for the Further Development of Business Tax Law (Gesetz zur Fortentwicklung des Unternehmenssteuerrechts) in the Federal Parliament (Bundestag) in August 2001. Following revisions in early November 2001 by the Parliamentary Finance Committee, the bill encountered the expected opposition in the Federal Council (Bundesrat). A compromise version drafted by a conference committee was ratified by both Parliament and the Federal Council in mid-December. The legislation was signed and promulgated as the law of 20 December 2001.1
The Business Tax Development Act arises out of recommendations contained in a report presented to the German parliament by the Federal Ministry of Finance on 18 April 2001. Broadly speaking, the objective is to adjust German tax law in light of the increasing internationalisation of the German economy and to improve the tax treatment of business reorganisations, particularly reorganisations by small and medium sized businesses. Other measures are intended to block undesirable tax schemes and to address technical problems or question marks arising from recent prior legislation.
This article discusses the major provisions of the new law and highlights the principal changes made to the bill during the legislative process. The summary is necessarily selective.
2. Principle changes during the legislative process
2.1 Political qui bono
While the German constitution divides political power between the federal government and the German States (Länder), it generally does not permit the States to levy taxes. The proceeds of taxation are apportioned between the federal government and the various State governments in accordance with detailed constitutional and statutory rules that differ depending on the tax involved. The proceeds of certain taxes, such as the value-added tax, are in principle reserved to the federal government, while the proceeds of other taxes are payable to state government (e.g. the real estate transfer tax) or to local government (the municipalities – e.g. the trade tax). While all major tax legislation is federal, the consent of the Federal Council is required where it impinges the tax revenues of the States and municipalities. The Federal Council is composed of delegates appointed by the various state governments.
Important concessions were made in order to carry the Business Tax Development Act in the Federal Council. These concessions increase the tax revenue allocable to State and local government.
2.2 Trade tax: dividends received
The most important concession affects the trade tax treatment – but not the corporation tax treatment – of dividends received. No change was made in the tax treatment of capital gains.
The 100 % dividends-received exemption enjoyed by corporations under the landmark 2000 tax reform2 has been modified so that dividends received by a German corporation (or by the domestic permanent establishment of a foreign corporation) are subject to trade tax unless the receiving corporation holds at least 10% of the shares in the distributing corporation and meets the other requirements of § 9 nos. 2a or 7 of the Trade Tax Act (new § 8 no. 5 GewStG).
Dividends taxable to individuals are treated analogously. That is, the 50% dividends received exemption which existed under prior law for all dividends received does not apply for trade tax purposes to dividends received as commercial business income unless the holding requirements of § 9 nos. 2a or 7 GewStG are met.
These changes apply from the 2001 trade tax assessment period onwards and, in effect, reinstate the trade tax law that applied to dividends prior to enactment of the 2000 Tax Reduction Act. See, however, sec. 2.3 below regarding foreign dividends and the issue of tax treaty pre-emption.
2.3 Holding requirements of § 9 nos. 2a and 7 GewStG
The cited provisions of trade tax law define the conditions for trade tax exemption of domestic and foreign dividends received. Both provisions require that a stake of at least 10 % must be held from the beginning of the trade tax assessment period in which the dividends are received.
Additional requirements apply for foreign-source dividends under the new version of § 9 no. 7 GewStG. The practical importance of these requirements will be limited if the trade tax addback of foreign dividends not meeting the requirements of § 9 no. 7 GewStG is pre-empted by the participation privilege of an applicable tax treaty. Such pre-emption was the rule prior to the recent changes in trade tax law. There is uncertainty whether the new trade tax law is subordinate to tax treaty law in this respect.3
At least in non-treaty situations, the requirements of new § 9 no. 7 GewStG must be met. The foreign dividend-paying subsidiary must derive all or virtually all of its income from some combination of
- business activities defined in § 8 (1) nos. 1 - 6 AStG (Foreign Transactions Tax Act) and
- equity stakes of at least 25 % in companies that derive all or virtually all of their income from activities of the defined types, provided (i) the companies are resident in the same jurisdiction as the foreign subsidiary or (ii) the foreign subsidiary holds the stakes in connection with its own activities of the defined types.
Since the same piece of legislation amends the Foreign Transactions Tax Act to include dividends received and certain capital gains on the sale of corporate stock in the "active" list of § 8 (1) AStG (new nos. 8 and 9 – see sec. 6 below), it is inconsistent to draw the participation privilege of § 9 no. 7 GewStG so narrowly as to exclude dividends paid out of these types of active income. Furthermore, § 9 no. 7 GewStG presently allows an exemption only for dividends from second and third tier subsidiaries, which likewise runs counter to the trend of the changes to the Foreign Transactions Tax Act.4
2.4 No change in capital gains exemption
No change is made in the exemptions created by the 2000 Tax Reduction Act for capital gains realised on the sale of shares in corporations. The Federal Council had initially sought a similar extension of trade tax to capital gains on the sale of corporate shares.
2.5 Real estate transfer tax
To obtain the Federal Council's consent, the government also relinquished the real estate transfer tax exemption included in the original measure to facilitate tax-neutral reorganisations within controlled groups. Hence, intra-group real estate transactions will continue to trigger real estate transfer tax, the proceeds of which go to state government.
2.6 Expenses related to tax-exempt income: § 3c EStG
As introduced in August 2001, the bill would also have abolished the prohibition on deduction of expenses directly related to tax exempt foreign-source dividends received by corporations (draft § 8b (5) KStG). This measure was not enacted. Instead, § 3c (1) EStG continues to apply.
After passage of the 2000 Tax Reduction Act, it was argued that § 3c (1) EStG was pre-empted with respect to tax exempt foreign-source dividends received by corporations by the special rule treating 5 % of such dividends as taxable income (§ 8b (5) KStG). The legislature's failure to adopt the amendment weakens this argument since, if it were valid, the proposed amendment to § 8b (5) KStG would have been merely declaratory in nature, i.e. a clarification of the law as it already existed. The argument is further weakened by the re-wording of § 8b (5) KStG in the final bill, which now achieves the same result as before (5 % rule) while avoiding the language which made it plausible to treat the provision as lex spezialis with regard to § 3c (1) EStG. The reworded 5 % rule of § 8b (5) KStG now applies to constructive dividends as well as declared dividends.5
Proponents of the defeated measure had argued that the foreign dividends in question were not tax exempt as an economic matter since corporation tax has been definitively imposed at the level of the foreign distributing corporation.
Since it appears prudent to assume that § 3c (1) EStG can apply to foreign source tax exempt dividends in addition to the 5 % rule of § 8b (5) KStG, taxpayers should structure their investments accordingly. The primary device used in the past to avoid non-deductible domestic expenses is ballooning, i.e. concentration of dividend income in tax periods in which little or no related expense accrues.6 Other devices include tax consolidation, shifting interest expense abroad, e.g. to the foreign subsidiary in question, and financing the subsidiary with debt instead of equity.7
The Business Tax Reduction Act originally contained an amendment to § 8 no. 7 GewStG that would have modified the provisions governing addback of sums paid to rent or lease movable fixed assets to take account of the Eurowings decision of the European Court of Justice.8 These amendments were, however, deleted from the final version of the bill. Further study is planned of the economic and fiscal consequences of the contemplated amendments. Accordingly, the old version of § 8 no. 7 GewStG, which the ECJ declared to violate European law, remains in effect, formally speaking. As a practical matter, the Federal Ministry of Finance directive of 28 April 20009 provisionally suspends the addbacks in question pending amendment of the statute.
3. Corporation tax
3.1 Amendments to § 8b KStG
§ 8b (1) KStG exempts dividend income (income described in § 20 (1) no. 1, 2, 9, and 10 (a) EStG) from corporation tax. A second sentence has been added to this provision stating that income from the sale of dividend coupons and the assignment of dividend rights is covered by the exemption.
§ 8b (2) sent. 1 KStG exempts capital gains from the sale of shares in other corporations from corporation tax. This provision has been revised to make clear that the exemption includes income derived by a corporation from the sale of its own shares, from the sale shares in corporations that are consolidated for corporation tax purposes (Organgesellschaften), and from a deemed sale pursuant to § 21 (2) UmwStG of shares taken in a tax-preferred reorganisation.
§ 8b (3) KStG precludes deduction of losses arising out of shares the sale of which potentially results in a tax-exempt capital gain. This provision has been reworded to cover all such losses instead of merely certain enumerated types.
§ 8b (6) KStG addresses situations in which corporations derive income of the sorts exempted under § 8b (1) and (2) KStG through a business partnership of which they are a partner. § 8b (6) KStG has been reworded by the new legislation to make clear that a corporation's gain or loss on the sale or liquidation of its interest in a business partnership as well as its distributive share of partnership income and loss qualify for the exemptions of § 8b (1) and (2) KStG and are subject to the terms of § 8b (3) - (5) KStG to the extent the gain, income, or loss is attributable to corporate stock held by the business partnership in question or to corporate stock held by a downstream business partnership.
3.2 Domestic permanent establishments of non-resident corporations
In conjunction with § 11 KStG, § 12 (2) KStG requires the realisation of gain inter alia when the assets of a domestic permanent establishment of a non-resident corporation (or other foreign entity subject to corporation tax) are transferred en bloc to a new entity pursuant to a transaction (such as a foreign reorganisation) that does not qualify for tax preferred treatment under the German Tax Reorganisation Act. The new version of § 12 (2) KStG creates an exception to this rule for transfers en bloc taking place in other jurisdictions at book value, subject to two conditions: (i) the transaction must be comparable to a merger with another corporation under § 2 UmwG (German Business Reorganisation Law) and (ii) Germany's right of taxation must be preserved. Like the previous version of § 12 (2) KStG, the new version is without prejudice to the provisions of the Tax Reorganisation Act.
3.3 Corporate equity accounts
The new legislation makes numerous technical changes in the mechanics of the corporate equity accounts under the new system of corporation taxation established by the 2000 Tax Reduction Act. The details are beyond the scope of this article.
4. Tax consolidation rules
The amendments to the tax consolidation rules contained in the draft bill were by and large incorporated into the final legislation. The primary changes made during the legislative process affect loss treatment within consolidated groups10 and consolidation for trade tax purposes.11 The tax consolidation changes compared with prior law are summarised below.
4.1 Consolidated groups with multiple lead companies
Consolidated groups with multiple lead entities have been accepted under German corporation and trade tax law in the past without explicit statutory authority where the multiple lead entities joined together in a decision-coordinating partnership. The Federal Tax Court precipitated changes in this area by holding that losses attributed to a non-commercial decision-coordinating partnership (civil law partnership – GbR) under the consolidation agreement flowed through to the partners for trade tax purposes.12
Previously, it had been thought that the losses stopped for trade tax purposes at the partnership level. The changes in corporation and trade tax law are essentially intended to reverse the result reached by the FTC and ensure that the partnership, not the several partners, is treated as the lead entity in the future for trade tax purposes. The legislative changes ostensibly apply to all open cases (see details below on entry into force) and are widely considered to violate the constitutional prohibition on retroactive tax legislation with respect to assessment periods 2000 and earlier.
The prior version of § 14 (1) sent. 1 KStG permitted consolidation for corporation tax purposes where a stock corporation or a partnership limited by shares with principal place of management and legal seat (registered office) in Germany (consolidated company – Organgesellschaft) agreed, pursuant to a profit and loss pooling agreement as defined in § 291 (1) AktG, to transfer its entire profits to another commercial enterprise (lead entity – Organträger). The new legislation amends the statute, which applies to GmbHs and other corporations by virtue of § 17 KStG, to require transfer of profits to a single other commercial enterprise. The addition of the words "single commercial enterprise" to § 14 (1) sent. 1 KStG prevents the decision-coordinating partnership from avoiding commercial status or being treated as a group of individual partners (separate enterprises).
A consolidated group with multiple lead entities is formed where two or more commercial enterprises that each qualify as the lead entity of a consolidated group under new § 14 (1) no. 2 KStG and that together satisfy the requirements of new § 14 (1) no. 1 KStG with regard to the consolidated company join together as partners in a partnership formed solely for the purpose of uniform decision-making with regard to the consolidated company. If these requirements are met, the partnership is treated as a commercial enterprise, provided every member of the partnership is engaged in a commercial business. Moreover, the following additional conditions of new § 14 (2) no. 2 KStG must be met for consolidation under multiple lead entities:
- Every partner in the partnership must have held a stake in the consolidated company without interruption since the beginning of its fiscal year and the partners must control a majority of the voting rights as defined in § 14 (1) no. 1 KStG (financial integration).
- The partnership must have been in existence without interruption since the beginning of the consolidated company's fiscal year.
- The profit and loss pooling agreement must be entered into with the partnership and the requirements of § 14 (1) no. 3 regarding this agreement must be met with regard to the partnership.
- The instrumentality of the partnership must ensure that the coordinated will of the partners is in fact translated into management decisions at the level of the consolidated company.
New § 14 (2) KStG applies from the 2001 assessment period onwards.13 However, an only slightly relaxed version of the new law applies to assessment periods 2000 and earlier.14 This version of the law is equally inconsistent with the Federal Tax Court decisions described above. Constitutional challenges are therefore to be expected with respect to this part of the new legislation.
Beginning with the 2003 assessment period, an additional condition must be met for consolidation under multiple lead entities.15 Every partner of the partnership must hold at least 25 % of the consolidated company's shares without interruption from the beginning of its fiscal year and the partners must, as before, control a majority of the voting rights as defined in § 14 (1) no. 1 KStG (financial integration).
4.2 Elimination of double domestic nexus requirement
New § 14 (1) no. 2 sent. 1 KStG provides that the lead entity in a tax consolidated group must be a (i) resident individual subject to German tax on his or her worldwide income, (ii) a non-tax-exempt corporation, association, or fund within the meaning of § 1 KStG (i.e. a corporate entity subject to German tax on its worldwide income) with its principal place of management in Germany, or (iii) a partnership within the meaning of § 15 (1) no. 2 EStG (business partnership) with its principal place of management in Germany. The previous requirement that the lead entity must in addition have its legal seat (registered office) in Germany is thus eliminated from the 2001 assessment period onwards.16
It should be noted, however, that current German choice of law principles determine the company law applicable to corporations and other entities with respect to the location of their principle place of management. A foreign corporation with its principle place of management in Germany would thus be subject to German corporate law, which requires a German legal seat and, in general, compliance with German incorporation procedures. German courts of general jurisdiction may refuse to recognise the separate legal identity of corporations managed from Germany, but not duly incorporated in accordance with German law. This exposes the shareholders of such entities to personal liability. See, however, the article in KPMG German News no. 1/2002 p. 21 (article no. 244) discussing the possible incompatibility of German choice of law rules with European law (Überseering).
4.3 Limitation on loss offset for consolidated group
New § 14 (1) no. 5 KStG provides that the lead entity's negative income shall be disregarded for German tax purposes to the extent a foreign tax jurisdiction takes this negative income into account for purposes of taxation comparable to Germany's taxation of the lead entity. Lead entities are subject to this limitation on the offset of dual consolidated losses from the 2001 assessment period onwards.17
4.4 Declines in the value of shares in consolidated companies
Where persons subject to personal income tax derive tax exempt income from shares in corporations or other corporate entities, § 3c (2) sent. 1 EStG precludes deduction of half of the related expenses. The new version of § 3c (2) sent. 2 EStG extends the scope of the 50 % tax deduction denial to include declines in the value of shares in consolidated companies that are not attributable to profit distributions. The entry into force of the amended statute is coordinated with that of the 50 % exemption for dividends received and capital gains on the sale of corporate stock.18
4.5 Remittance surpluses or shortfalls
New § 27 (6) KStG deals with the tax treatment of amounts by which the income allocated to the lead entity of a consolidated group for tax purposes exceeds or falls short of the income remitted by the consolidated company as determined by its commercial accounts. Sentence 1 of the statute states that the capital surplus account of the consolidated company is increased by the amount of any remittance shortfall and decreased by the amount of any remittance surplus, provided the cause of the surplus or shortfall arises in the consolidation period. Sentence 2 of the statute cites transfer of part of the consolidated company's net income for the year to revenue reserves (cf. new § 14 (1) no. 4 KStG) as an instance in which a remittance shortfall arises. Release of such reserves results in a remittance surplus (sentence 3 of the statute). Pursuant to sentence 4, sentence 1 applies mutatis mutandis to other remittance surpluses and shortfalls.
New § 27 (6) KStG applies beginning with first the assessment period to which the new corporation tax law enacted by the 2000 Tax Reduction Act applies.19
The changes arguably mean that a negative capital surplus account is possible in theory for consolidated companies in the future.20 Some commentators construe the term "other remittance surpluses and shortfalls" as referring to surpluses and shortfalls occurring prior to the effective date of a consolidation arrangement.21 While this interpretation favours taxpayers by avoiding treatment of pre-consolidation remittance surpluses as taxable dividend distributions (so-called "other distributions"), it is supported by neither the logic nor the wording of the statute.
4.6 Consolidation for trade tax purposes
New § 2 (2) sentences 2 and 3 GewStG provide in essence that consolidation exists for trade tax purposes if – and only if – it exists for corporation tax purposes. Accordingly, a corporation constituting a consolidated company for corporation tax purposes under §§ 14, 17, or 18 KStG is deemed to be a permanent establishment of the lead entity for trade tax purposes. In case of multiple lead entities (new § 14 (2) KStG), the decision-coordinating partnership is treated as the lead entity. This complete alignment of trade tax consolidation with corporation tax consolidation applies from the 2002 trade tax assessment period onwards.22
A transition provision applies for the 2001 trade tax assessment period according to which trade tax consolidation will exist if a company is integrated financially, economically, and organisationally into a lead entity. Direct and indirect shareholdings of a lead entity in a consolidated company are aggregated for purposes of the financial integration test.23
Treatment of the partnership as the lead entity in consolidation situations involving multiple lead entities (new § 2 (2) sent. 2 GewStG) applies to trade tax assessment periods prior to 2002 as well.24 Hence, the retroactive aspects of the corporation tax consolidation rules (see sec. 4.1 above) apply as well for trade tax purposes and have the intended effect of preventing consolidation losses from flowing through to the various partners of a decision-coordinating partnership in cases of consolidation under multiple lead entities. As noted, the constitutionality of these changes is questionable for assessment periods prior to 2001 (potential unconstitutional retroactivity).
5. Tax Reorganisation Act
5.1 Exemptions for individuals on contribution of partnership interests
Changes have been made in the rules of § 24 UmwStG governing contributions of interests in business partnerships to other partnerships. New § 24 (3) sent. 3 UmwStG makes operation of the tax preferences for individuals contained in §§ 16 (4), 34 (1) and (3) EStG contingent inter alia upon contribution of the transferor's entire interest in the partnership at going concern value. Only then does the gain realised qualify for the cited one-time exemption provisions. Contribution of only part of the transferor's interest in a business partnership at going concern value will not be sufficient to entitle the transferor to the cited tax benefits in the future. New § 24 (3) sent. 3 UmwStG applies to contributions made on or after 1 January 2002.25
A corresponding change has been made in new § 20 (5) sent. 3 UmwStG regarding contributions of interests in business partnerships to corporations. This provision likewise applies to contributions made on or after 1 January 2002 (new § 27 (4c) sent. 1 UmwStG) and again affects only individuals because only they can qualify for the benefits in question.
5.2 Contributions of shares in EU corporations
Under new § 26 (2) sent. 1 UmwStG, the relief provided by § 23 (4) UmwStG for contributions of shares in EU corporations is retroactively denied if the contributed shares are directly or indirectly sold or transferred to a third party during the 7 years following the contribution. The previous version of the statute applied only to direct sales by the receiving EU corporation. No change is made to the exception to the rule by which the shares received may be the object of an additional contribution in kind at book value pursuant to laws equivalent to § 23 (4) UmwStG in another Member State of the European Union. The reworded statute is intended to retroactively deny tax relief to so-called chain transfers. The new version of § 26 (2) sent. 1 UmwStG applies to all sales or transfers taking place after 15 August 2001.26
5.3 Reorganisations affecting domestic permanent establishments
See sec. 3.2 above regarding changes in the Corporation Tax Law that affect reorganisations involving domestic permanent establishments.
6. CFC regime
The revisions to the Foreign Transactions Tax Act (Außensteuergesetz) proved largely uncontroversial in the course of the legislative process.
One of the primary changes is the reduction of the ownership threshold at which a domestic shareholder becomes liable for tax on designated passive intermediary income (Zwischeneinkünfte mit Kapitalanlagecharakter) derived by a controlled foreign corporation (ausländische Zwischengesellschaft). The ownership threshold for look-through taxation of such income is lowered from 10 % to 1 % (new § 7 (6) sent. 1 AStG). If the CFC's income is composed exclusively or almost exclusively of gross amounts based on designated passive intermediary income, look-through taxation applies even with respect to shareholders with stakes of less than 1 % (new § 7 (6) sent. 3 AStG), unless the CFC's principle class of stock is regularly traded in significant volume on a recognised stock market (new § 7 (6) sent. 4 AStG).
The new legislation expands the list of sources of "active" business income for purposes of the CFC regime to include corporate dividends received and certain capital gains (new § 8 (1) nos. 8 and 9 AStG). The special tax rate of 38 % for taxable CFC income is abolished. Instead, items of income resulting from look-through taxation are assigned to the normal income categories (new § 10 (2) AStG) and hence constitute income from capital under § 20 (1) EStG or income from a commercial business, an agricultural or forestry business, or an independent personal services business if the shares in the CFC are held as business property.
The lower look-through thresholds of new § 7 (6) AStG apply for income tax, corporation tax, and trade tax purposes to income derived by a CFC in its fiscal years beginning after 15 August 2001.27 Treatment of corporate dividends and certain capital gains as "active" income not subject to look-through taxation under new § 8 (1) nos. 8 and 9 AStG applies for income tax, corporation tax, and trade tax purposes to income derived by a CFC in its fiscal years beginning after 31 December 2000.28
7. Business partnerships and sole proprietorships
The Business Tax Development Act includes a number of provisions affecting the tax treatment of businesses operated in non-corporate form (commercial partnerships, agricultural and forestry partnerships, independent service partnerships, and sole proprietorships).
7.1 Reorganisation of non-corporate businesses: § 6 (5) EStG
Following its abolition in 1999, the so-called Co-Entrepreneur Directive was by and large reinstated by the 2000 Tax Reduction Act effective 1 January 2001, though without the old option of choosing between book value and going concern value. The relevant provision – § 6 (5) EStG – has now been revised by the 2001 Business Tax Development Act, in part for improved clarity and in part to ensure construction in keeping with the positions taken by the tax authorities. New § 6 (5) sent. 3 EStG makes a carryover basis mandatory for certain transfers of individual assets (as opposed e.g. to entire branches of activity) involving changes in asset ownership. The statute covers the following transfers of business assets:
transfers from a business partnership to a separate business of a partner, and vice versa, if gratuitous (without consideration) or in return for partnership interests received or relinquished;
- transfers from a business partnership to a partner as the latter's special business property in either the same or a different business partnership, and vice versa, if gratuitous or in return for partnership interests received or relinquished;
- transfers of assets held by a partner as special business property in a partnership to another partner who takes the asset as special business property in the same partnership, if gratuitous.
The prior version of the statute did not unequivocally limit a carryover basis to transfers without consideration or in return for partnership interests received or relinquished.29 While neutral for purposes of taxes on income, the above transfers may trigger gift tax.
A transfer is retroactively deemed to have taken place at the going concern value of the transferred asset (potential realisation of gain) where the transferred asset is sold or withdrawn from the receiving business during a 3 year waiting period, unless the unrealised appreciation at the time of the transfer has been previously allocated to the transferring partner(s) by means of a supplementary balance sheet. The waiting period ends 3 years after the filing of the tax return of the transferring party for the assessment period in which the transfer took place.30
The revised statute contains a so-called "corporation clause"31 intended to prevent direct or indirect transfer of unrealised appreciation (hidden reserves) to corporations as a result of the described transactions, which would open the door to a partially or completely tax exempt sale of the shares in the receiving corporation. A transfer is therefore retroactively deemed to take place at going concern value if a corporation (or other entity subject to corporation tax) acquires a direct or indirect interest in the transferred asset or increases its pre-existing interest as a result of the transfer or for any other reason during the 7 years following the transfer.
Although part of the Income Tax Act, § 6 (5) EStG applies equally to corporations as partners in business partnerships, thus permitting them to transfer individual assets within the limits prescribed by the aforementioned corporation clause. Because of the potential for abuse this creates, changes were made in the trade tax treatment of gain on the sale of partnership interests (see sec. 8 below).
The new version of § 6 (5) EStG applies retroactively to transfers (sent. 3 - 5) and asset interests acquired or increased (sent. 6) on or after 1 January 2001.32
7.2 Gratuitous admission of individuals to non-corporate businesses
The new version of § 6 (3) EStG permits tax neutral gratuitous transfer of an interest in a business partnership to an individual (natural person). Tax neutral treatment is also accorded where an individual is gratuitously made co-owner of an existing sole proprietorship, thereby creating a business partnership. Such transactions may trigger gift tax, however. The new statute codifies the long-standing practice of the tax authorities. Where the new partner's interest does not extend to all assets of the business (because certain assets are held as special business property by the prior owner or owners), tax neutral treatment is forfeited retroactively if the new partner sells or liquidates his or her gratuitously acquired interest in the 5 years following the transfer.33
New § 6 (3) EStG applies from the 2002 assessment period onwards. No special provision on entry into force is contained in § 52 EStG because the statute merely codifies prior administrative practice.
7.3 Reinvestment reserve for individuals
New § 6b (10) EStG permits taxpayers who are not subject to corporation tax to offset gain realised on the sale of shares in corporations against the cost basis of corporate stock, buildings, or depreciable movable assets acquired in the year of sale. The offset is subject to a limit of Euro 500,000; for business partnerships, the limit is Euro 500,000 per partner. The entire amount of the gain is offset against the cost basis of newly purchased corporate stock, whereas only the taxable amount of the capital gain under § 3 no. 40 sent. 1 (a) and (b) EStG in conjunction with § 3c (2) EStG may be offset against the cost basis of newly purchased buildings or movable depreciable assets.34
If a capital gain on the sale of corporate stock is not offset in the year of sale, it may be placed in a tax-free reserve (new § 6b (10) sent. 5 EStG), to be accounted for as a "special item with an equity component". Offset of the reserve is permitted against the cost basis of corporate stock or depreciable movable assets acquired in the next two fiscal years or against the cost basis of buildings acquired in the next four fiscal years (new § 6b (10) sent. 5 in conjunction with sent. 1 EStG). Offset of the portion of the capital gain that is exempt under § 3 no. 40 sent. 1 (a) and (b) EStG in conjunction with § 3c (2) EStG is again only possible if new corporate stock is purchased (new § 6b (10) sent. 6 EStG). If other replacement assets are purchased, § 6b (10) sent. 7 EStG stipulates that the reserve must be released to the extent of the tax exempt amount (§ 3 no. 40 sent. 1 (a) and (b) in conjunction with § 3c (2) EStG) contained in the used portion of the reserve.
Any reserve remaining at the close of the fourth fiscal year following that in which the reserve was established must be retransferred to revenue (new § 6b (10) sent. 8 EStG). "Interest," in the form of increased income in the year the reserve is released, accrues at a rate of 6 % on the non-tax-exempt portion of the reserve for each complete fiscal year the reserve is carried.35
The new version of § 6b EStG applies to sales occurring on or after 1 January 2002 (new § 52 (18a) EStG).
7.4 Partition of partnerships
Changes made to sent. 2 - 4 of § 16 (3) EStG extend tax neutral treatment for partition of partnerships to include cases in which individual assets (as opposed e.g. to entire branches of activity) are transferred to non-corporate businesses operated by former partners of a business partnership. Deferred taxation is only permitted, however, to the extent ultimate taxation of unrealised appreciation is assured. The transferee in such situations is required to take a carryover basis in the assets transferred.36
A business partnership may thus now be partitioned by transferring any combination of branches of activity (Teilbetriebe), interests in business partnerships, and individual assets at book value to businesses operated by the various partners. Where partition involves the transfer of individual assets, subsequent sale or withdrawal of land, buildings, or material business assets within a 3 year waiting period causes the original transfer to be retroactively recalculated at fair market value.37 The waiting period ends 3 years after the partnership files its tax return for the assessment period in which partition took place.
Tax neutral treatment is permitted for transfers of individual assets as part of partition of a business partnership only to the extent the assets are not transferred directly or indirectly to an entity subject to corporation tax. Such transfers take place at fair market value (new § 16 (3) sent. 4 EStG).
The new version of § 16 (3) EStG applies to partitions of business partnerships taking place on or after 1 January 2001.38
8. Trade tax on sale of partnership interests
One of the long-standing idiosyncrasies of German trade tax law is that gain on the sale of partnership interests is not subject to trade tax (A. 38 (3) sent. 3 GewStR). The reinstatement of the Co-Entrepreneur Directive (see sec. 7.1 above) potentially enables corporations that are partners in business partnerships to transfer assets to other partnerships tax free and then sell the interest in the receiving partnership free of trade tax, whereas a direct sale of the asset would have been subject to trade tax.
New § 7 sent. 2 GewStG therefore provides that the capital gain on sale or liquidation of a business, a branch of activity, an interest in a business partnership, or the personally liable shareholder's shares in a partnership limited by shares is subject to trade tax unless allocable to an individual as a co-entrepreneur holding a direct interest.39
The Business Tax Development Act implements few of the recommendations contained in the April 2001 report from the Federal Ministry of Finance that were intended to address the increasing internationalisation of the German economy. The amendment of § 12 KStG with regard to foreign reorganisations affecting domestic permanent establishments (see sec. 3.2 above) is the only such measure contained in the new legislation.40 Fundamental reforms in the Foreign Transactions Tax Act and the Tax Reorganisation Act are therefore still on the legislative agenda.
Editorial cut-off date: 20 March 2002
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1 BGBl I 2001, 3858.
2 See KPMG German News no. 2/2000 p. 2 and 1/2001 p. 28 = articles 209 and 214.
3 Cf. Rödder/Schumacher, DStR 2002, 105, 109/1.
4 Cf. Rödder/Schumacher (Fn. 3).
5 Cf. Rödder/Schumacher (Fn. 3) their Fn. 18.
6 Cf. KPMG German News no. 2/1996 p. 15 = article no. 54.
7 Cf. Rödder/Schumacher (Fn. 3) at p. 108/1.
8 ECJ judgement of 26 Oct. 1999 – C-294/97 – DB 1999, 2246.
9 IV C 7 - G 1422 - 34/00 = StEK no. 16 pertaining to § 8 no. 7 GewStG
10 See sec. 4.3 below.
11 See sec. 4.6 below.
12 FTC decisions of 9 June 1999 – BStBl II 2000, 695 and BFH/NV 2000, 347 – and 26 April 2001 – IV R 75/99 – DStR 2001, 1212; cf. Rödder/Schumacher DStR 2001, 1685, 1686 and DStR 2002, 105, 109/2.
13 New § 34 (6) no. 2 sent. 1 KStG.
14 New § 34 (6) no. 1 KStG.
15 New § 34 (6) no. 2 sent. 2 KStG.
16 New § 34 (6) no. 2 sent. 1 KStG.
17 New § 34 (6) no. 2 sent. 1 KStG.
18 New § 52 (8a) EStG.
19 New § 34 (2a) KStG.
20 Cf. Rödder/Schumacher (Fn. 3) at p. 110.
21 Cf. Rödder/Schumacher (Fn. 3) at p. 110.
22 New § 36 (1) GewStG.
23 New § 36 (2) sent. 1 GewStG.
24 New § 36 (2) sent. 2 GewStG.
25 New § 27 (7) sent. 2 UmwStG.
26 New § 27 (8) sent. 3 UmwStG.
27 New § 21 (7) sent. 3 AStG.
28 New § 21 (7) sent. 4 AStG.
29 Cf. Rödder/Schumacher DStR 2001, 1634 at 1636/2.
30 New § 6 (5) sent. 4 EStG.
31 New § 6 (5) sent. 5 and 6 EStG.
32 New § 52 (16a) EStG.
33 New § 6 (3) sent. 2 EStG.
34 New § 6b (10) sent. 2 and 3 EStG.
35 New § 6b (10) sent. 9 EStG.
36 New § 16 (3) sent. 2 EStG.
37 New § 16 (3) sent. 3 EStG.
38 New § 52 (34) sent. 4 EStG.
39 New § 7 sent. 2 GewStG was inadvertently deleted by subsequent tax legislation. Correction of the drafting error, retroactive to 1 January 2002, is expected momentarily.
40 Cf. Rödder/Schumacher DStR 2001, 1685 at 1986/1.