Germany: 080. Repeal Of The Trade Tax On Capital And Other Tax Reform Developments

Last Updated: 1 October 1997
KPMG Germany Webpage
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As previously reported, the German government introduced several pieces of major tax legislation earlier this year. The bills require the approval not only of the German Parliament (Bundestag), but also of the Federal Council (Bundesrat) to become law. Since the Government has a majority only in Parliament, the bills have been blocked in a conference committee of Parliament and the Federal Council for most of the summer.

Agreement has now been reached on one of the measures pending, the "Act for the Further Reform of the Taxation of Enterprises". In the revised form recommended by the conference committee, this bill passed the Federal Council on 5 September 1997 after being ratified by Parliament one month before.

As this is being written, the political deadlock which has blocked passage of the Government's major tax reform legislation appears insurmountable. Barring some unexpected development, fundamental tax reform will be postponed at least until after the national elections in the autumn of 1998. Reduction of the solidarity surcharge from currently 7.5 % of corporate or personal income tax to 5.5 % effective 1 January 1998 does, however, seem all but certain. The Government can enact this tax reduction with its majority in Parliament without the consent of the Federal Council because the German states receive no share of the revenue from the solidarity surcharge.

Repeal of the trade tax on capital

The most important provision in the bill which has been passed is the repeal of the trade tax on capital effective from 1998 onwards. The bill also extends through 1997 the non-collection of the trade tax on capital with regard to property attributable to permanent establishments located in the new German states.

The trade tax on earnings is unaffected by the new legislation. Indeed, enactment is expected of a constitutional amendment requiring a two thirds majority in Parliament and the Federal Council for any future change to the trade tax on earnings. The constitution is also to be changed to guarantee to local government a larger share of VAT revenue to compensate it for the repeal of the trade tax on capital, the revenue of which went to towns and cities.

Constitutionality of the trade tax on capital

A controversy has arisen concerning the constitutionality of collection of the trade tax on capital for 1997 in the old German states. It is argued in particular by Borggraefe (DB issue no. 30, 25 July 1997, p. I) that non-collection of the trade tax on capital in for 1997 in the new German states precludes collection of the tax in the old German states as well under the principle of equal taxation.

Other important changes in the tax law

Other important changes made by the new law are summarised below. They will take effect upon publication of the bill in the Federal Gazetteer (expected before year's end) unless otherwise noted.

  • Repeal of the tax exemption for recapitalisation gains on waiver of debt - effective for fiscal years ending from 1997 on.
  • Denial of tax deduction of provisions (accruals) for future losses relating to ongoing contracts - effective for fiscal years ending from 1997 on. Provisions set up for prior fiscal years must be reversed within six years (minimum of 25 % in the fiscal year ending in 1997 and 15 % each in the succeeding five fiscal years).
  • Reduction from DM 30 million to DM 15 million for tax years 1998 to 2000 and to DM 10 million from 2001 onwards in the amount of "extraordinary" income qualifying for a special tax rate available to individuals (e.g. for capital gains on the sale of businesses or material shareholdings). For 1997, the old limit of DM 30 million applies to gains realised through July 1997 (pre-August gains) and the new limit to gains from August to December (post-July gains). However, any pre-August gains further reduce the limit for post-July gains.
  • Extension of the anti-avoidance provisions of sec. 50c Income Tax Act (preventing writedowns in the value of shares by reason of dividends paid where the shares have been acquired from persons not entitled to the corporation tax credit) to apply following purchase of shares from persons which, while entitled to the credit, are not liable to tax on the sale of the shares. The same applies when the shares have been acquired without consideration or contributed to a domestic business entity unless a hypothetical disposition would have triggered tax.
  • Tightening the definition of the "economic identity" which a corporation must maintain in order to offset its past operating losses against future earnings. Previously, economic identity was destroyed if inter alia more than 75 % of the corporation's shares changed hands and it then recommenced business with primarily new capital. Under the new law, economic identity fails if more than 50 % of the shares change hands and the business is merely continued with primarily new capital. An exception is created, however, if the new capital is used solely to recapitalise the business activities which generated the losses in the first place and the corporation continues to operate this branch of the business on a similar scale, viewed economically, for the following five years.
  • Imposition of loss utilisation restrictions for reorganisations of corporations into partnerships and into other corporations. These apply to transactions entered in the Commercial Register from 1 January 1997 onwards. On transfers to partnerships, realisation of reorganisation losses is denied tax effect to the extent due to the negative value of the assets transferred and is otherwise spread over 15 years. On transfers to other corporations, the receiving corporation will only be permitted to use the losses of the transferring corporation if it continues to operate the business activities which generated the losses in the first place on a similar scale, viewed economically, for the following five years. Previously, it was sufficient if the transferring corporation had not yet ceased trading at the time of the reorganisation.

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.

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