Germany: 070. Status Report - German Tax Reform

Last Updated: 7 July 1997
KPMG Germany Webpage
Click on the above link to visit the KPMG Germany webpage on the Mondaq website
For disclaimer and copyright see end of this article.

The political struggle over the Government's tax reform proposals, reported on at length in articles nos. 59 and 60, is continuing. The Government pushed the major reform bills through Parliament at the end of June 1997, but they cannot become law without the consent of the Federal Council, which rejected them in early July. This is only the end of the round, not the entire fight, however. The tax legislation will go to a conference committee where the real work of seeking a compromise will take place. With the summer break impending, it may be sometime in the autumn before the fate of the Great Tax Reform is known.

1. Summary of developments to date

The following is a summary of the main events through July 1997:

  • In late January 1997, a government commission issued the so-called Petersberg Tax Proposals, which called for cuts in the corporate and individual income tax rates by around 25 % and a package of measures to broaden the tax base. The measures were divided into two phases, one to take effect in 1998 and the other in 1999. The overall decrease in income taxes resulting from these proposals was put at just under DM 44 billion (a figure referring to taxes owed for 1999 without regard to actual cash flow). The Government indicated that increases in unspecified indirect taxes, probably VAT or the tax on petrol, would also occur, leaving a net tax reduction of some DM 30 billion. Concurrent with the release of the Petersberg Proposals, the Government also affirmed its intention to repeal the trade tax on capital and reduce the solidarity surcharge by two percentage points (from 7.5 % of personal or corporate income tax to 5.5 %).
  • The opposition Social Democrats immediately rejected the Government plans and criticised the tax revenue estimates on which they were based, stating that the tax reduction (before increase in indirect taxes) would be at least DM 10 billion higher than the Government's projection.
  • In February and March 1997, the Government introduced three separate pieces of legislation, one each for the 1998 and 1999 phase tax reductions and one for repeal of the trade tax on capital. The increase in indirect taxes remained unspecified as to tax or amount and was not included in any of these measures.
  • All three measures require the consent of the Federal Council (Bundesrat) in addition to that of the German Parliament (Bundstag). The Social Democrats (SPD) are viewed as having a fairly certain majority in the Federal Council, which is an assembly of representatives of the German states in which each state has weighted representation. Of the total of 69 votes, 35 are held by states in which the Social Democrats are currently in office (in some cases in coalition with the Green Party). Only 16 are directly controlled by the Government parties, the remainder being held by states governed by coalitions between the SPD and certain Government parties (CDU or FDP). The coalition agreements would oblige such states to abstain from voting in the Federal Council on issues as to which the coalition members are divided. The Social Democrats have been adamant in opposing the 1998 and 1999 tax reforms as proposed by the Government and have insisted on conditions which the Government has so far not accepted for repeal of the trade tax on capital.
  • The bill repealing the trade tax on capital (with notably a 5 point reduction in the accelerated depreciation rate for movable fixed assets as a revenue-increasing countermeasure) has since been ratified by the German Parliament and, predictably, rejected by the Federal Council. The bill is currently in conference committee. The chances for ultimate passage of this bill appear fairly good (cf. Handelsblatt of 4 June 1997, page 6).
  • On 23 April 1997, a Government delegation headed by Helmut Kohl met briefly with senior representatives of the Social Democrats led by Oscar Lafontaine to explore possibilities for a tax compromise. The talks collapsed within less than an hour after their commencement.
  • New estimates of the revenue to be expected from the taxes currently in effect were released in mid-May 1997. These indicated receipts for federal and local government some DM 18 billion below previous forecasts for 1997 and almost DM 32 billion below forecasts for 1998. At the same time, high unemployment was projected to cause some DM 20 billion in unbudgeted outlays.
  • In late May 1997, the Social Democrats unveiled their long-awaited counterproposals for comprehensive tax reform. These proposals are by and large revenue-neutral (see summary in sec. 2 below).
  • In June 1997, the Government amended its proposed legislation to reduce the net tax relief it would confer (see summary in sec. 3 below).
  • The 1998 and 1999 tax reform acts were ratified by the German Parliament over the votes of the Opposition on 26 June 1997 and sent to the Federal Council. The Federal Council promptly rejected the bills, causing them to be sent to a conference committee which will attempt to arrive at a compromise.

2. The Social Democrat (SPD) tax reform proposals

Like tax proposals announced independently by the Green Party roughly one month earlier, the SPD plan is largely revenue-neutral overall, whereas the Government plan provides for large net tax reductions. The SPD plan would take effect almost immediately, whereas the most important measures in the Government plan are scheduled for 1999.

The SPD plan would first of all benefit all wage earners and employers by reducing social charges by 2 percentage points beginning in October 1997 (- DM 30 billion). This is to be partially counterfinanced by a 1 point increase in VAT (+ DM 16 billion) and moderate increases in the taxes on petrol (+ 6 pfennig) and other fuels (total including tax on petrol: + DM 6.5 billion). The SPD stated that the remaining DM 7.5 billion revenue reduction could either be accepted or, if the Government preferred, counterfinanced by postponement of the reduction in the solidarity surcharge.

The SPD plan also includes changes in direct taxes. These alter neither the top personal tax rate (53 %) nor the level at which it commences (DM 120,000 / DM 240,000 for single and joint filers respectively, unchanged since 1987, incidentally). The lowest graduated tax rate would fall from 25.9 % to 22 % and the zero bracket amount would rise steeply by DM 2,000 / DM 4,000 for single and joint filers respectively. Government child support contributions would rise by DM 30 per month per child for each of the first two children. While the Government plan would drop down the lowest tax bracket even further to 15 %, it also contains a sharp jump in rates at the low end of the earnings scale, whereas the SPD rates climb linearly. The SPD's increase in the zero bracket amount is double what the Government proposes. The Government plans no increase at all in child support contributions.

The SPD also stated that it would consider a reduction in the top personal income tax rate if the resulting decrease in revenue was completely counterbalanced by revenue-generating changes. Restrictions on the netting of passive activity losses (in particular, losses from rental of real estate) against other types of income were mentioned as one possibility.

The SPD plan would leave untouched the current tax exemptions for supplements paid to shift workers. It likewise makes no changes in the deductibility of the costs of commuting to work and would not tax the proceeds of existing life insurance policies. All three aspects of the Government plan are highly unpopular with the persons directly affected.

With regard to the taxation of businesses, the SPD plan would repeal the trade tax on capital and lower the corporation tax rate for retained earnings from currently 45 % to 35 %. Both changes are contained in the Government plan as well. However, the SPD would not reduce the corporation tax rate for distributed earnings, which would thus remain at 30 %. The purpose of this is to encourage the reinvestment of business earnings. The proposal is strongly criticised as inhibiting the flow of capital from a business where it cannot be used to one where it can. Furthermore, an unchanged distribution rate would provide no new incentive for foreign investment in Germany, as the profits from such investment would remain subject to relatively high German taxes.

The most innovative proposal of the SPD is to permit partnerships to chose to be taxed as corporations. By so choosing, a partnership could benefit from the low proposed 35 % tax rate on retained earnings, as opposed to personal tax rates for its partners of up to 53 %. The vast majority of German business entities are partnerships.

Under the SPD plan, all reductions in personal or corporate income taxes (- DM 48 billion) are completely counterfinanced by revenue-increasing measures (+ DM 48 billion). A large part (DM 8 billion) of the revenue needed for the above tax-reduction measures would come from reintroduction of a net worth tax for wealthy individuals.

Otherwise, the SPD plan relies largely on measures affecting the taxation of businesses. There is some similarity between certain of these revenue-increasing measures and those contained in the Government plan. A notable difference is that the SPD would not reduce the current rate for accelerated depreciation of movable fixed assets.

3. Changes in the Government tax legislation

Changes made in the 1998 and 1999 tax bills would lower the tax reduction from these measures. The 1998 phase reforms are now predicted to increase tax revenue owed for the year 1998 by some DM 6.2 billion (compared with a reduction of DM 1.3 billion under the March 1997 version of the bill). The 1999 reforms are now forecast to reduce tax revenue owed for 1999 by roughly DM 39.8 billion (compared with a reduction of DM 44.7 billion under the March 1997 version of the bill). The Government still has not committed itself on the contemplated increase in VAT or the tax on petrol and other fuels.

The primary changes in the 1999 phase affect certain highly unpopular measures in the original draft legislation:

  • Instead of a 10 % tax on the (currently tax-free) interest proceeds of long-term life insurance policies, the premiums paid on such policies are to be subject to the 15 % insurance tax to the extent attributable to the risk and administrative cost portions of the policy (generally 20 % of the premium).
  • The speculation holding period for tax-free sale of real property which is not part of a trade or business is to be increased to only 5 years instead of to 10 years as originally planned (current holding period 2 years).
  • Wage substitute payments (e.g. unemployment compensation) are not to be made taxable after all. They remain subject to a progression clause.
  • Tax exempt wage supplements paid for work at night, on holidays, and on Sundays will be reduced in stages over several years instead of being eliminated outright.
  • Linear depreciation for residential rental property not part of a trade or business will be increased from 2 % to 3 % per year in partial compensation for the elimination of the current accelerated depreciation.

The changes made in the 1998 phase include several measures which significantly increase tax revenue. The most important of these relates to loss carrybacks and carryforwards and would take immediate effect, hence applying to losses incurred in 1997 and possibly to those carried forward to 1997. The following list describes this and other major changes:

  • Effective 1997, losses may be carried back only one year instead of the current two subject to an unchanged maximum amount of DM 10 million. Losses which cannot be carried back may still be carried forward without time limit. There are no restrictions on the use of the first DM 2 million of such loss carryforwards. However, the loss carryforward amount in excess of DM 2 million which may be netted against positive income in any given year is limited to half of the positive income in excess of DM 2 million for such year. It is at present unclear whether the new limit on use of loss carryforwards in a given year would apply only to losses generated from 1997 on or whether losses carried forward from years prior to 1997 would, starting in 1997, also be subject to the limit.
  • Changes in the laws governing accruals permitted for or generally used by nuclear energy producers would increase taxes sharply for such taxpayers.
  • The 1998 drop in the rate of accelerated depreciation for moveable fixed assets has been whittled down to three percentage points instead of five as originally intended. Including the 5 percentage point cut planned in connection with the separate legislation repealing the trade tax on capital, the accelerated depreciation rate would thus fall from currently 30 % to 22 % in 1998.

The Government in addition now wishes to increase its share of VAT revenue by DM 3.5 billion at the expense of state government (instead of the originally planed DM 1.5 billion) and is reported to be considering further amendments to restrict the transfer of corporate losses via merger.

4. Outlook

As stated at the outset, the real work of seeking a compromise will take place, if at all, in a conference committee composed of representatives of the German parliament and the Federal Council. The differences between the Government and the Opposition remain considerable. While the announcement of the SPD position and the changes made by the Government have brought movement into the discussion and revealed a certain amount of common ground, the two sides remain far apart. The downturn in the revenue forecasts may incline the Government to bow to pressure from the States for further reduction in the amount of net tax relief. The political uncertainty as to whom the voters will blame more if there is no tax reform at all may induce both sides to make concessions.

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.

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

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
Tools
Print
Font Size:
Translation
Channels
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
Password
Confirm Password
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (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 www.mondaq.com

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 Mondaq.com’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.

Disclaimer

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.

Registration

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 unsubscribe@mondaq.com 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.

Cookies

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.

Links

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.

Mail-A-Friend

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.

Security

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 webmaster@mondaq.com.

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 EditorialAdvisor@mondaq.com.

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 enquiries@mondaq.com.

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