Germany: Tax Reform Compromise Enacted

Last Updated: 22 December 2003
Article by Andrew Miles

The tax reform compromise reached by the parliamentary Reconciliation Committee was passed by both chambers of parliament on December 19. The four bills will therefore take effect on January 1, 2004

The four bills of the tax reform compromise reached by the parliamentary Reconciliation Committee on December 14 were passed by Bundestag and Bundesrat on December 19. Their formal enactment with the signature of the federal president and promulgation are expected well in time for entry into force as of January 1, 2004. They are:

Left-overs from the 2003 Tax Concessions Pruning Act ("Basket II")

Thin capital rules on related-party finance
• The rules will apply to all companies, regardless of ownership or residency

• Partnerships also fall into the net if at least one of the partners is a corporation holding more than 25%

• Companies with a total annual related-party interest expense of no more than € 250,000 will be exempt

• There will be a common safe haven debt/equity ratio of 1.5:1. The current (2003) 3:1 ratio privileging holding companies will be dropped

• All related party interest expense of financing acquisitions within a group will be a "hidden distribution" by definition.

Loss relief
• The maximum offset in any one year from losses brought forward will be € 1m plus 60% of the taxable income over € 1m. In other words, losses brought forward will not shelter 40% of the annual income over € 1m from immediate taxation

• The restrictions on natural persons on offsetting losses from one source against profits from another are to be abolished

• Silent partnership losses from holdings of one corporation in another can only be relieved against profits from the same silent partnership holding.

Non-deductible expenses directly connected with tax-free dividend income and capital gains
• An amount equivalent to 5% of the tax-free dividend income and capital gains realised by a corporation is to be added back to taxable income. This legal fiction of "directly connected" expense is to be irrefutable even where it is patently false. It extends the 2003 rule applicable to dividends of foreign source only.

Loopholes in The Foreign Tax Relations Act closed
• The passive income attribution rules will henceforth apply even if a double tax treaty would preclude a charge to tax under the Foreign Investment Funds Act if the income were remitted

• An "active" business must henceforth be conducted directly, as opposed to through a subsidiary.

Other changes
• Fixed assets purchased during the year will be depreciated at onetwelfth of the annual amount for each month of operation

• The provisions for taxing life assurers and health insurers are to be tightened.

Trade Tax Reform

The original proposals for reconstituting trade tax as a new "community business tax" have been pared down to only three amendments to the Trade Tax Act.

• Relief for losses brought forward will follow the corresponding income/corporation tax rules given above

• Related-party interest disallowed for corporation tax under the thin capital rules will no longer be allowed for trade tax

• An Organschaft subsidiary will no longer be able to deduct its pre- Organschaft losses.

Budget Accompanying Act - income tax rate cuts

• The rate cuts for 2004 will be slightly less generous than the original plan to bring the 2005 scales forward by a year. The 2004 general allowance will be increased to the 2005 level of € 7,664 per person, but the rate scale will run from 16% to 45%. The 2005 rate scale of 15% to 42% will remain on the statute book for that year.

• The lump sum business expense allowance for travelling between home and work will be 30 cent/km

• Own-home grants are to be curtailed.

Tax amnesty

• The proposed tax amnesty allowing taxpayers to declare previously unreported income from the years 1993-2001 against a lump sum payment of 25% in full settlement of all tax liabilities (35% if the declaration is not made until the first quarter of 2005) will be enacted with some modifications to prevent abuse of the government's generosity. In particular, taxpayers will be required to specify the year and source of the income now reported, as a measure to prevent them from declaring a small amount now "in blank" in the hope of being able to cover anything discovered later.

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.

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