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The German tax reform situation remains substantially as described in article no. 151. The present article:
- summarises interim developments;
- supplements certain topics dealt with in our previous article;
- describes significant measures not covered or dealt with only briefly in our previous article; and
- corrects misleading figures in our previous article.
Sections 2 and 3 of this article are based on our client letter regarding the tax reform plans as at 20 November 1998. Interested persons should request the full text of this client letter, which may have been updated by the time this article has been distributed.
1. Interim developments
The new government of Social Democrats and Greens now intends to delay passage of its major new tax reform bill, which was introduced in draft form on 10 November 1998, until the early Spring of 1999. The effective dates of the various measures contained in the bill remain unchanged and will thus be retroactive to 1 January 1999 in many cases. The contemplated effective date of the planned energy tax increases and concomitant reductions in social charges, which are not part of the November draft legislation, has been put back to 1 April 1999, however.
The draft legislation remains highly unpopular with industry and tax experts. Major changes in the draft bill at present appear neither likely nor out of the question.
The tax administration in the State of Hesse has for instance suggested abolishing or reducing the safe havens under Germany's thin capitalisation rules (sec. 8a KStG) instead of eliminating tax recognition for writedowns of fixed and current assets to going concern value. Whether this or other proposed amendments in the draft legislation has any chance of adoption is at present unclear.
Minor tax legislation has passed the Federal Parliament and was ratified by the Federal Council on 18 December 1998. This legislation (two separate measures) relates to the following:
- Adjustments in pension reserves to take account of increased life expectancy
- Extension to 10 years of the period for safekeeping of bookkeeping documents
- Reduction of the lowest marginal income tax rate from 25.9 % to 23.9 %
- Increase in government child support payments from DM 220 to DM 250 per month for the first and second child.
The above would all take effect on 1 January 1999.
Considerable controversy continues to surround the government's plans to abolish flat rate wage taxation for qualifying part-time workers. Instead, social charges are to be deducted from the wages of these part-time workers. The proposals are criticised by the State governments, who would bear part of the lost tax revenue, and to some extent also by social insurance experts, who argue that the social insurance claims of the affected workers would in the long run exceed their contributions.
2. Comments supplementary to our prior article
2.1 Elimination and reversal of writedowns to going concern value
In article no. 151 (sec. 4.1.4 and 4.1.5), we reported on provisions in the draft legislation which would eliminate tax recognition for writedowns of fixed and current assets to going concern value for fiscal years ending after 31 December 1998.
It is not clear whether assets written down to going concern value prior to the effective date of the new law must be written back up to their historic cost (adjusted for scheduled depreciation) in the 1999 fiscal year even if they have not recovered in value. Contrary to the comments in our previous article, this reading of the law appears permissible, however. In other words, writeups of assets previously written down may occur whether the asset has recovered in value or not. Writeups can at least be spread over five years. On the other hand, there are also unconfirmed reports that going concern value is intended to represent the upper limit of any reversals of previous writedowns.
In the same connection, it is noted that the proposed changes in the law leave open the possibility of unscheduled depreciation for extraordinary technical or economic wear (sec. 7 (1) sent. 5 EStG). At least certain writedowns previously taken by reason of a decline in going concern value should be permissible on the grounds of extraordinary technical or economic wear as well.
2.2 Passive activity losses of corporations and partnerships
Sec. 4.2.4 of our previous article discussed the planned restrictions on the utilisation of passive activity losses. The proposed changes were treated in more depth in sec. 1.4.2 of article no. 148. Here it was noted that the amendments in their present form would affect corporations and partnerships as well as individuals because certain income derived by such entities would be "passive" income under the proposed rules.
It is not clear whether the drafters of the legislation foresaw or desired this effect, which has since been the subject of public discussion. Changes in the law appear possible at least with respect to corporations.
3. Matters not covered or briefly covered in our prior article
3.1 Reorganisation provisions
3.1.1 Trade tax reorganisation losses (sec. 18 (2) UmwStG)
Sec. 18 (2) UmwStG has been revised to prevent trade tax consideration of any loss sustained by the receiving partnership when a corporation is merged or converted into a partnership. This revision is intended to provide statutory confirmation of a position taken by the tax authorities in their directive on the Tax Reorganisation Act. Failure to count the reorganisation loss for trade tax purposes means that no step-up in basis occurs for trade tax purposes. Consequently, a special calculation of profits for trade tax purposes will be required in the future in addition to the calculations according to company law and income tax law. Since, in the opinion of the tax authorities, the amended statute only clarifies what has been the law all along, no transition provisions are included.
3.1.2 Trade tax loss carryforward on merger and divisive reorganisations (sec. 19 (2) UmwStG)
Sec. 19 (2) UmwStG has been amended with effect from the 1999 assessment period so that a trade tax loss can only pass to the receiving corporation in corporate mergers or divisive reorganisations if the corporation which receives the business or sub-business which caused the loss continues to operate such business or sub-business (Betrieb or Betriebsteil) on a comparable scale for five years following the reorganisation. Under previous law, it was sufficient that the business (Geschäftsbetrieb) of the transferring corporation not have been discontinued at the time of the reorganisation.
3.1.3 Blocking amount under sec. 50c EStG in merger situations (sec. 13 (4) UmwStG)
An upstream merger of a corporation whose shares are encumbered by a blocking amount within the meaning of sec. 50c EStG will cause the blocking amount to attach to the shares of the receiving corporation instead of vanishing along with the shares in the disappearing corporation. In the opinion of the tax authorities, this provision likewise merely "clarifies" the existing law. It can have major tax consequences for mergers which have already occurred or take place in the future.
3.1.4 Partition of assets of a commercial partnership (sec. 16 (3) sent. 1 EStG
From 1 January 1999 onwards, partition of a commercial partnership will only be possible for tax purposes if the partition involves transfer of branches of activity (Teilbetriebe) or interests in commercial partnerships to another business operation (Betriebsvermögen). If the former partners receive individual assets or if the assets received do not become part of another business operation, the partition will be treated as a taxable liquidation of an interest in a commercial partnership. This puts an end to the previous option of transferring individual assets from one business operation to another at book value. The relevant provisions of the Co-Entrepreneur Directive are no longer applicable. Tax-free transfers of appreciated assets will in the future only be possible under the provisions of the Tax Reorganisation Act and sec. 6b EStG.
3.2 Loss utilisation provisions
3.2.1. Trade tax reorganisation losses
Trade tax loss carryforward on merger and divisive reorganisations
See sec. 3.1.1 and 3.1.2 above.
3.2.2 Losses on the sale of material shareholdings (sec. 17 (2) EStG)
Modifications have been made in the provisions respecting the utilisation of losses on sale of material shareholdings in corporations.
3.2.3 Losses from margin transactions (sec. 15 (4) EStG)
The intention is to prohibit carryback of commercial business losses from margin transactions (examples: options or commodities futures transactions). It will also no longer be possible to net such losses against other commercial business income or income of other types. Netting is to be limited exclusively to future profits from margin transactions.
3.3 Investment funds
3.3.1 Short-term capital gains for investment funds (sec. 39 (1) and (1a) KAGG)
Short-term capital gains (so-called "speculation gains") within the meaning of sec. 22, 23 EStG will constitute taxable income from capital or taxable business income in the hands of investment funds. These gains are also part of accrued profit (Zwischengewinn). The new rules are to apply to speculation gains received by a fund after 31 December 1998.
3.3.2 Speculation gains under the Foreign Investment Act
Corresponding changes are planned in the provisions of the Foreign Investment Act (Auslandinvestmentgesetz). Speculation gains (including margin transactions) will thus also be subject to taxation if realised by foreign investment funds. Furthermore, the definition of accrued profit is expanded to include such income just as for domestic investment funds.
3.3.3 Withholding tax on investment fund dividends (sec. 39 (2) KAGG)
Dividends received on German stock by a domestic investment fund are subject to 25 % withholding tax whether distributed or retained by the fund.
3.4 Withholding tax
3.4.1 Withholding tax on investment fund dividends
See sec. 3.3.3 above.
3.4.2 Non-resident tax liability for artistic and other activities (sec. 49 (1) no. 2d EStG)
The new rules extend the scope of withholding to include payments by a resident person to a non-resident for the exploitation (Verwertung) in Germany of performances and the like outside Germany (example: broadcast in Germany of concerts recorded abroad).
3.4.3 Non-resident withholding (sec. 50a (7) EStG)
The proposed legislation would introduce a new general 25 % withholding requirement for all payments to non-residents. The draft provision thus goes far beyond its original purpose, which was to ensure the taxation of foreign contractors who have so far been able to evade their tax liabilities because of the temporary nature of their domestic activities. It remains to be seen whether this provision will be enacted in its present form.
3.5 Consolidated tax groups (Organschaft)
3.5.1 Trade tax requirements (sec. 2 (2) sent. 2 GewStG)
The cross-reference to sec. 14 KStG is expanded to include sec. 14 no. 3 KStG. This means that the lead entity in a consolidated tax group for trade tax purposes must have both its principal place of management and its legal seat in Germany. Lead entities with senior managers residing abroad should pay particular attention to the requirement of a domestic principal place of management. When the lead entity is a partnership, certain special provisions apply and must be considered.
3.5.2 Trade tax add-back for writedowns of shareholdings to going concern value (sec. 8 no. 10 GewStG)
The previous version of sec. 8 no. 10 GewStG provided for an add-back to the extent profits had been reduced by writedowns of shares in corporations to going concern value by reason of dividend distributions which were eliminated from profits under sec. 9 GewStG. In accordance with prior court decisions and the position taken by the tax authorities, this provision is now extended to include writedowns to going concern value by reason of profit transferred by members of a tax consolidated group to the lead entity.
3.5.3 Progression clause for tax consolidation (sec. 32b EStG)
Tax free foreign income derived by individuals under a tax consolidation structure (Organschaft) will be subjected to the general progression clause.
3.6 Investment income
3.6.1 Earnings from margin transactions (sec. 23 (1) no. 5 EStG)
Under the new law, non-business earnings from margin transactions within the meaning of sec. 764 of the Civil Code will be subject to taxation. According to the official explanation of the measure, it is intended to apply to futures transactions in which a cash equalisation payment is contemplated instead of a delivery of goods.
3.6.2 Bank disclosure obligation concerning withholding exemption requests (sec. 45d EStG)
Sec. 45d (1) no. 3 EStG is to be amended effective from 1999 onwards to require banks to report to the Federal Finance Office (Bundesamt für Finanzen) the actual income amount with respect to which no tax was withheld pursuant to an exemption request instead of the requested exemption limit.
3.7 Real estate transfer tax
3.7.1 Material change of ownership (sec. 1 (2a) GrEStG)
Sec. 1 (2a) GrEStG is amended to take account of indirect changes in the ownership structure of a partnership which owns real property. For example, a change in the sole shareholder of a corporation holding a 95% interest in such a partnership will be treated as a material change of ownership in the future. The revised version of sec. 1 (2a) GrEStG is applicable to acquisitions taking place subsequent to the day on which the law is promulgated.
3.7.2 Unification of interests and transfer of interests (sec. 1 (3) GrEStG)
Under prior law, no unification of interests occurs unless 100 % of the interests in a company holding real property are united, directly or indirectly, in the hands of an acquirer. In the future, real estate transfer tax will be triggered if 95 % or more of the interests are united in the hands of a single person. This applies analogously to transfers of shares. The new rules apply to acquisitions effected after 31 December 1999.
3.7.3 Incremental taxation (sec.1 (6) GrEStG)
Acquisitions under sec. 1 (2a) GrEStG (material change in ownership) will no longer be taken into account for purposes of the incremental taxation under sec. 1 (6) GrEStG. The new law applies to acquisitions effected subsequent to the date on which the law is promulgated.
3.7.4 Transfers to a partnership (sec. 5 GrEStG)
This provision applies to conveyances of real property by a partner to the partnership in which he holds an interest. It provides that real estate transfer tax is not levied to the extent of the contributing partner's interest in the partnership. In the future, this exemption will be subject to the condition that the contributing partner remain a member of the partnership for a period of five years after conveyance of the real estate. The exemption is also denied if the partner does not continue to share in appreciation as would an owner. The new rules first apply to acquisitions effected after 31 December 1999.
3.7.5 Tax base (sec. 8 GrEStG)
The standardised values under sec. 138 (2) or (3) BewG will in the future be used to determine the tax base for material changes in the ownership of a partnership as defined in sec. 1 (2a) GrEStG. The new rule applies to acquisitions effected subsequent to the date of promulgation of the law.
3.8 Other provisions
3.8.1 Reduction of the corporation tax rate (sec. 23 (1) KStG)
From 1999 onwards, both the corporation tax rate for retained earnings (currently 45 %) and the reduced corporation tax rate for non-resident corporations (currently 42 %) are being reduced to 40 %. The reduced rate also applies to other corporate entities, to property funds, and to associations.
The retained earnings tax rate remains 45 % for dividends (including creditable corporation tax with respect thereto) received by corporate entities entitled to the corporation tax credit from subsidiaries subject to the corporation tax credit system, to the extent the distribution comes out of the subsidiary's equity basket EK 45. This provision makes it impossible to convert EK 45 into EK 40 by paying div-idends to group companies.
3.8.2 Inheritance tax: trusts (sec. 3 (2) no. 1, sec. 7 (1) no. 8 and 9 ErbStG)
Transfers by gift or inheritance to trusts which lack legal capacity and have either their legal seat or their principal place of management in a foreign country will be subject to inheritance and gift tax in the future. Tax arises at the time of passage of the property. The new law will apply to transfers of property taking place after 31 December 1998. Dissolution of the trust and transfer of the property to the beneficiary will constitute a separate taxable event.
3.8.3 Tax Procedure Act: violation of reporting and presentation obligations (sec. 379a AO)
Failure to submit tax returns or produce documents within a deadline set by the tax authorities despite express demand on their part will constitute an administrative offence punishable by fine of up to DM 10,000. Third parties required to issue tax certifications under sec. 150 (4) sent. 2 AO can also commit such offences.
In article no. 151, we included a table showing the projected revenue impact of the draft legislation of 10 November 1998. Unfortunately, in certain versions of the article, the table largely used a decimal comma, as is standard in German, instead of the decimal point customary in English. The decimal point should replace the comma everywhere it appears in the table. the error was corrected in later releases of the article. We apologise for any confusion caused by our error.
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.