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Previous articles have presented the basic changes made by the 1996 Tax Act in the system of tax incentives for the New German States. In response to inquiries we wish, however, to provide more detail on two of the most important measures in effect.

Investment Subsidy Act (Investitionszulagengesetz)

Under the current Investment Subsidy Act, capital expenditure for new moveable fixed assets in the New German States can qualify for subsidies if the investments are completed by the end of 1996. It is a condition of all subsidies that the subsidised asset be used in a permanent establishment in the New German States for at least three years after acquisition. Cars and aeroplanes do no qualify, nor since 1993 does fixed asset investment by banks, insurance companies, electricity and gas utilities, wholesalers, and retailers. Furthermore, investments in West Berlin have not been eligible since 1992.

The subsidy currently amounts to 8% if the investment was commenced prior to 1 July 1994 and 5% on investments commenced after 30 June 1994. Small and medium-sized undertakings in the manufacturing sector and the craft trades receive an increased investment grant of 10%, subject to additional conditions.

The 1996 Tax Act has resulted in the following changes to the Investment Subsidy Act:

Basic 8% subsidy: The deadline for completion, but not commencement, of investments qualifying for this subsidy has been extended for a further two years. Investments commenced before 1 July 1994 will therefore be subsidised provided they are completed by the end of 1998.

Basic 5% subsidy: This grant currently applies to investments commenced after 30 June 1994 and completed by the end of 1996. For manufacturing businesses only, it has been extended to investments completed by the end of 1998. Investments in other branches of the economy will only be subsidised if the investment is completed by the end of 1996.

Increased 10 % subsidy: This investment subsidy is available under two different sets of conditions.

-- Firstly, manufacturing businesses and craft/artisanal businesses with not more than 250 employees qualify up to a limit of DM 5 million per year on investments commenced after 30 June 1994 and completed by the end of 1998 (previous deadline 1996). This subsidy is also available to businesses in West Berlin from 1996 on. For West Berlin, however, a limit of 50 employees applies (instead of 250). Subsidies are otherwise unavailable to businesses in West Berlin. (Previously, West Berlin was excluded entirely.)

-- Secondly, small wholesalers and retailers with not more than 50 employees qualify up to a limit of DM 250,000 per year on investments commenced after 31 December 1995 and completed by the end of 1998 provided the business is not located in an area zoned for commerce or industry (Industriegebiet, Gewerbegebiet, Sondergebiet). This basically limits such subsidies to wholesalers and retailers in urban residential areas. Wholesalers and retailers were previously excluded from all subsidies.

Development Areas Act (Foerdergebietsgesetz)

a) Current rules

The current version of the Development Areas Act provides for three basic types of investment subsidies within a subsidy period expiring at the end of 1996:

-- Special depreciation on depreciable moveable and immoveable property of up to 50% in the first five years in addition to the straight-line depreciation normally allocable to such years;

-- A deduction from profits of up to DM 4,000 for farmers and foresters;

-- Special deduction of up to DM 40,000 for construction and repair costs on owner-occupied residential buildings.

The above benefits all require acquisition or improvement of qualifying assets for use in the New German States. Acquisition may be by purchase or self-production. If an existing asset is improved, the taxpayer may do the work himself ("self-improvement") or pay for it to be done. An asset is acquired when delivered (if purchased) or when production is complete (if self-produced). Payments on account within the subsidy period are sufficient to qualify to the extent thereof, as is the incurrence of expense with respect to self-produced assets. Payments on account and expense incurred in connection with the improvement of assets is treated analogously.

Accordingly, one of the following events must occur within the subsidy period to qualify for the benefit:

-- Delivery of the asset, following purchase or improvements commissioned;
-- Completion of self-production or self-improvement;
-- Payments on account of purchase or improvements commissioned;
-- Incurrence of expense for self-production or self-improvement.

Hereinafter, the first two of the above events will be referred to as "completion" of the investment and the latter two as "partial completion".

Qualifying assets are as follows:

-- Depreciable moveable property (tangible personal property, e.g. equipment), other than aeroplanes, constituting a fixed asset for the owner. To be a fixed asset, the property must be part of a business (commercial business, independent profession, or agriculture/forestry).

-- Depreciable immoveable property (essentially, buildings). If benefits are claimed by reason of purchase (i.e. not by reason of production or improvement), the building must either be new (purchased in its year of completion) or the building must be actively used in the purchaser's business for five years following the purchase.

With regard to special depreciation, the economically most important of the benefits, it goes without saying that this is only available on property used to produce income either in a business, or through rental to third persons ("rental property").

b) Changes resulting from the 1996 Tax Act

The subsidy period for the above benefits has been extended by two years from the end of 1996 to the end of 1998.

The amount of special depreciation has, however, been reduced starting in 1997 from 50 % to 40 %, 25 %, or 20 % depending on the type of investment.

50 % rate: On investments completed or partially completed by the end of 1996.

40 % rate: On investments completed or partially completed in the years 1997 and 1998 relating to the following:

-- Acquisition or improvement of qualifying moveable assets;
-- Acquisition of buildings actively used in a manufacturing business for at least five years following acquisition; and
-- Improvements to all buildings, including improvements by the seller of a building after conclusion of contract of purchase (treated as if improved by the buyer after purchase).

25 % rate: For investments completed or partially completed in the years 1997 and 1998 involving acquisition of residential rental buildings, provided the building is used for residential purposes in the five years following the acquisition.

20 % rate: For investments completed or partially completed in the years 1997 and 1998 involving acquisition of all other buildings, i.e. buildings which fail to qualify for the 40 % or 25 % special depreciation rate because of the type of use (e.g. in non-manufacturing business) and/or the insufficient duration thereof (i.e. less than the required five years).

Like the Investment Subsidy Act, the Development Areas Act contains special, more restrictive provisions for West Berlin. Under the present law, benefits for West Berlin expired at the end of 1994 except for residential rental property (conditional on use as such for five years following acquisition). The new law extends the benefits for such property through 1998. In addition, special depreciation on investments in West Berlin has been reintroduced for the following property:

-- Moveable assets purchased or produced which belong for at least three years to the business of a taxpayer who is registered in the craftsmen's roll or in the register of businesses similar in nature to the craft trades;

-- Moveable assets purchased or produced which belong to a manufacturing enterprise and remain in such business belonging to the taxpayer for at least a three year period;

-- Immoveable assets which are actively used for at least five years following their acquisition in a manufacturing enterprise.

The preceding three benefits are conditional on the company not having more than 50 employees. The applicable special depreciation rate follows the general rules set forth above. Please note that, as regards West Berlin, improvements to assets do not qualify for benefits.

The deduction from profits for farmers and foresters and the special deduction for owner-occupied residential property have also been extended for an additional two years until the end of 1998.

c) Development Areas loans

Lastly, a new provision has been added to the Development Areas Act for persons making loans strengthening the risk capital of small and medium-sized enterprises. The tax subsidy consists in a reduction of the lender's income tax, in the year in which the loan is granted, by 12% of the amount of the loan, or a maximum of 50% of the income tax owing. Only resident individuals (individuals subject to tax in Germany on their worldwide income) may qualify. Such individuals must make a loan at a low rate of interest in the years 1996 through 1998 to one of two institutions (Kreditanstalt fuer Wiederaufbau or Deutsche Ausgleichsbank). Development Area loans have a term of at least 10 years, are repayable at term in a single amount, and are not subject to prior termination.

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. 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.