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1. General political situation

The national elections held on 27 September 1998 turned out the coalition of Christian Democrats and Liberals under Chancellor Kohl which had been in office for the past 16 years. The Social Democrats (SPD) took 298 seats in the new Federal Parliament (Bundestag) and the Greens won 47, giving them a surprisingly solid majority of 21 seats over all other parties combined. The SPD and Greens have since wasted little time in forming a new "red-green" coalition government, which elected Gerhard Schroeder as its chancellor on 27 October 1998.

Major tax reform proposals were announced via the press in mid-October and are a part of the coalition agreement signed on 20 October 1998. The reaction to these proposals has been largely negative. Industry has complained vociferously that the planned tax changes would result in significant net tax increases for businesses, particularly for small and medium sized businesses. Even in circles inclined to think well of the new government, the reform plans have been criticised as timid and inadequate. In response to the barrage of criticism, vague statements have recently been made by Chancellor Schroeder and other lead ing members of the new government suggesting that they are reconsidering some aspects.

This article was prepared largely on the basis of newspaper reports through 3 November 1998. The government formally introduced a draft tax bill on 10 November 1998 after this article had been largely finalised. This draft bill does not contain the additional changes the government has indicated it may make. A separate draft bill for the first phase of the "ecological tax reform" (see below) was introduced in mid-November. While cursory review of this draft legislation revealed no significant discrepancies between the text of the draft and the account given in this article, readers are nevertheless cautioned that our article may be inaccurate, misleading, and/or incomplete in certain respects. Case-specific professional advice is indispensable in deciding how to respond to the pending tax legislation.

The confusion may be reminiscent of that which accompanied the 1997 tax reform efforts of the previous government. A decisive difference nevertheless exists between the clouds which surrounded the former government's tax reform plans and those still obscuring the precise contours of the red-green tax reform package: The outgoing government lacked the majority in the Federal Council (Bundesrat) necessary to enact into law the tax measures voted by the Federal Parliament (Bundestag). The new government, or rather the parties which compose it, command such a majority. This means that, when they make up their minds, whatever they decide will this time become law.

2. General contours of the red-green proposals

The proposals announced so far bear considerable resemblance to the counterproposals developed by the SPD in the summer of 1997 in response to the tax reform drive of Chancellor Kohl's government (see article no. 70). The proposals are intended to be largely revenue-neutral and involve no substantial tax rate reductions. Considerable controversy surrounds the revenue impact of the new proposals. While the red-green coalition appears to believe that businesses will benefit at least slightly on the bottom line from moderate reductions in certain tax rates, industry has complained that the counterfinancing measures, which affect primarily businesses, will lead to net higher taxes. Much of the extra tax revenue generated by the counterfinancing measures appears to go to families with children and individuals with low to moderate incomes. As a matter of economic policy, the hope apparently exists that the extra purchasing power conferred on these taxpayers will lead to additional consumer spending on a virtual 1-to-1 basis and so stimulate the economy.

The bulk of the revenue-raising measures target businesses or individuals with some degree of personal wealth. Critics argue that a tax reform of this nature is unlikely to provide incentive for greater personal performance or increased investment.

The proposals are intended to take effect in three phases: 1999, 2000, and 2002, with many of the most important tax reduction measures postponed until phases 2 or 3. According to the draft legislation released on 10 November 1998, the impact of the reform on revenue cash flow through 2002 is as follows (revenue reductions negative, revenue increases positive):


DM millions

1999 2000 2001 2002

Decreases -10,065 -24,648 -26,015 -56,905

Increases +10,122 +22,319 +27,603 +41,622

Net impact +57 -2,329 +1,588 -15,283


Most of the revenue-generating measures are scheduled to take effect in 1999 (see sec. 4 below). The above figures to not include the ecological tax reform (see sec. 5 below).

Those who hoped for significant tax net tax reductions or at least a "level playing field" for taxpayers and fiscal authorities from a significant lowering of tax rates accompanied by thorough elimination of special tax regimes and benefits are disappointed by the red-green proposals. Indeed, if the fears voiced by industry representatives prove well-founded, the red-green proposals may make the playing field even more uneven than it used to be by making numerous revenue generating changes without providing sufficient relief through lower tax rates.

The majority of the proposed measures broadening the tax base are not new in themselves, but were included in the failed tax reform bill of the preceding government as well. However, the red-green proposals do not contain the tax rate reductions provided for in the package advocated by Chancellor Kohl's government, which would have resulted in immediate net tax reduction on the order of DM 30 billion (see articles nos. 60 and 70).

Surprisingly, the new proposals do not contain definite plans to introduce a new 35 % "enterprise income tax" for corporations and partnerships alike. This was a central feature of the SPD's 1997 tax plans (see article no. 70). Instead, a commission is to be convened to study this proposal. According to the coalition agreement, it remains on the agenda and is to be introduced by the year 2000 "if possible" (see below sec. 3.3). The impact of this measure could be far-reaching and has not been factored into the revenue impact predictions so far released by the new government.

A commission is also to be appointed to study the question of reintroduction of a net worth tax on personal wealth.

Also planned is at least a tame variant of the "ecological energy taxation" which the Greens in particular are known to favour (see below sec. 5). The proceeds of these taxes appear to be earmarked for reducing social contributions.

Lastly, we note that the global economic climate may have suggested the need for caution to the red-green strategists.

3. Proposed tax reductions

3.1 Businesses

The corporation tax rate for retained earnings is to be reduced from 45 % to 40 %. The change is to take effect in 1999, that is, for assessment periods from 1999 on. No change is planned in the corporation tax rate for distributed earnings (currently 30 %).

The corporation tax rate applicable to German branches of foreign corporations is also reduced from 42 % to 40 % with effect from 1999 on.

Except for the "enterprise income tax" (see sec. 3.3 ), no other proposed measures would lower business taxes as such. However, the proposed reduction in the personal tax rate for commercial business income (see sec. 3.2 ) is a related measure. The tax reductions from both measures (corporation tax rate and individual rate for commercial business income) were estimated by the new government at DM 5 billion.

3.2 Individuals

Currently, the top income tax rate is 53 %. The new proposals would lower this rate only slightly to 51 % in 2000 and 48.5 % in 2002. No reduction in the top marginal rate is planned for 1999. No changes at all are planned in the income levels at which the highest marginal tax rate is reached (DM 120,000 / 240,000).

These income levels, like the maximum tax rate of 53 %, have been unchanged for 40 years, which perhaps makes Germany the world's champion in using bracket creep to increase tax on middle income taxpayers.

The zero bracket amounts are to be increased from DM 12,360 to DM 13,020 in 1999, DM 13,500 in 2000, and DM 14,000 in 2002.

The lowest marginal tax rate is to be reduced from currently 25.9 % to 23.9 % in 1999, 22.9 % in 2000, and 19.9 % in 2002.

Government child support contributions for the first and second child are to be increased from currently DM 220 per month to DM 250 in 1999 and DM 260 in 2002.

Social insurance contributions are borne 50 % each by employers and dependent employees and currently amount to 42.3 % of employee income, up to certain income limits. These are to be reduced by 0.8 percentage points in 1999. Further as yet unspecified reductions are planned in later years to bring the total percentage under 40 %. The new "ecological" energy taxes (sec. 5 below) are to provide the required funds.

Since 1994, the German income tax code has contained a provision (sec. 32c EStG) limiting the marginal tax rate applicable to commercial business income to 47 % (6 percentage points under the highest marginal rate) to the extent such income exceeds DM 100,224 and is subject in fact to trade tax. This reduced tax rate is to be lowered to 45 % in 1999 and 43 % in 2000.

The preferential taxation of commercial business income is controversial even in its present form. The current spread between the top rate for commercial business income and the normal top marginal rate is, roughly speaking, intended to neutralise the burden of the trade tax on earnings, which also falls on commercial business income. The proposed changes would widen the rate gap to 8 percentage points from 1999 through 2001. The new government favours this measure apparently because it sees a correlation between the types of activity which generate commercial business income (a term of art in the German tax system) and job creation or preservation.

At least at present, dividends received from a corporation by an individual do not constitute commercial business income (unless the stock is a business asset). However, the distributive share of earnings from a commercial partnership is commercial business income.

3.3 Enterprise income tax of 35 %

There is a conspicuous dearth of detail on this important point. We speculate that the basic plan is to lower the corporation tax rate for retained earnings to 35 % and then to grant commercial partnerships the option of electing taxation as corporations. The purpose is to encourage the reinvestment of business earnings. Possibly, sole proprietors engaged in commercial business activity would have the same option as partnerships. It is also conceivable that there will be no option, hence that partnerships would cease to be taxed as transparent entities altogether. The intention appears to be to retain the present corporation tax distribution tax rate of 30 %. Hence, the proposal would not benefit foreign shareholders of German corporations.

It is unclear whether the distributions of German corporations and partnerships would be taxed at preferential rates as commercial business income (see sec. 3.2 above) in the hands of individual shareholders and partners or would be subject to the full marginal rate. It is also unclear whether the trade tax on earnings will continue in force unchanged, although this appears to be the case.

The coalition agreement contains the following passage on this measure:

"Immediately after taking office, the new federal government will convene a state and federal government commission with participation by tax experts and industry groups to fundamentally reform the taxation of commercial enterprises. The goal is a commercial enterprise tax law which taxes all commercial enterprise income at not more then 35 % and takes effect in the year 2000 if possible."

4. Major revenue-generating measures

Having covered all the "good news" contained in the new proposals, we now turn to the "bad news". Only proposals likely to have significant effect are included. Proposals are classified into the following three groups based on the area in which a measure is likely to have its predominant impact. The impact need not be exclusively in this area. The percentages are rough estimates of the share of total new tax revenue coming from each group.


Businesses (56 %)

Individuals with some degree of personal wealth (27 %)

Average individuals (13 %)


About 4 % of the extra tax revenue comes from other groups, in particular from farmers. From this breakdown, it is obvious that few sacrifices are being required of average wage-earners. The vast majority of the tax increases required to fund the tax reform fall on businesses and individuals of some wealth. Even the changes in our "average individual" category apply to taxpayers at the high end of this group.

The changes referred to below may take effect in the current fiscal year for companies with a fiscal year which differs from the calendar year. Such companies should consider changing their fiscal year to end on 31 December 1998.

It is, however, not clear in all cases exactly when a measure is intended to take effect. It appears, however, that all changes except repeal of the personal interest deduction (sec. 4.3.4 below) and the changes in the splitting rates for married couples (sec. 4.2.15 below) are to go into effect in 1999.

Most changes affect taxes on income (trade tax on earnings, corporation income tax, personal income tax). A few relate to the value added tax (sec. 4.1.18).

4.1 Businesses

1. Loss carryback and carryforward: sec. 10d EStG

Under present law, losses can be carried backwards up to two years (subject to a DM 10 million limit) and forwards indefinitely. The loss carryback is to be eliminated entirely from the year 2001 onwards. For the years 1999 and 2000, losses can be carried back only one year, subject to a new limit of DM 2 million. However, plans appear to have been abandoned to introduce severe restrictions on the use of losses carried forward (similar to those discussed in sec. 3 of article no. 70).

2. Deduction of losses from foreign branches located in tax treaty countries: sec. 2a (3) and (4) EstG

Contrary to initial expectations based on earlier draft legislation introduced by the outgoing government in the summer of 1998, the tax benefits for foreign branch losses contained in sec. 2a (3) and (4) EStG are to be eliminated entirely. The former government's draft bill would have imposed a five year limit on loss utilisation and enacted more severe recapture provisions.

3. Denial of expense deduction in connection with certain tax exemptions: sec. 3c EStG and sec. 8b KStG

The possibilities which presently exist to deduct expenses (in particular interest expense) in connection with shareholdings yielding exempt dividends under tax treaty law will be eliminated from 1999 onwards. Furthermore, losses sustained by corporations on the sale of shares in foreign corporations will no longer be deductible if a gain on the sale would have escaped taxation under sec. 8b KStG. The same applies to losses on liquidation and reductions in capital of such foreign corporations.

4. Mandatory reversal of writedown:

Sec.6 (1) no. sent. 4 EstG, sec. 6 (1) no. 2 sent. 3 EstG

The election to reverse a prior writedown to going concern value is to be eliminated and replaced by a mandatory writeup. This may apply even if the asset does not recover in value. Under general principles, historic cost constitutes the upper limit of the writeup. This will put the business taxpayer in the position he would have occupied if the writedown being reversed had never taken place. An option is created to spread the writeup over five years.

5. Elimination of writedowns to going concern value for fiscal years ending after 31 December 1998: sec. 6 (1) no. 1 and no. 2 EStG

The intention exists to prohibit writedowns to going concern value with effect for fiscal years ending after 31 December 1998. A writedown to going concern value taken in 1998 would still lead to a tax deferral even considering the planned requirement to reverse such writedowns in later years.

6. Restrictions on general bad debt accruals: sec. 6 (1) no. 2 EStG

Plans to abolish general accruals for doubtful receivables appear to have been abandoned.

7. Valuation of liabilities at going concern value at the balance sheet date: sec. 6 (1) no. 3 EStG

Under prior law, a liability or accrual could be carried at its previous higher value even if the amount of the liability had decreased in the interim (for instance, because of falling prices with regard to a delivery obligation). In the future, the liability must be shown at its lower going concern value. This change represents a marked departure from the commercial accounting principles of conservatism (Vorsichtsprinzip) and unequal treatment of revenues and liabilities (Imparitaetsprinzip). It is expected to affect insurance companies above all by reducing the amounts of their accruals for future insurance payments.

8. Creation of a requirement to discount accruals to present value: sec. 6 (1) no. 3 EStG

A requirement to discount accruals to present value is planned.

9. Deduction of revenue in valuing accruals: sec. 6 (1) no. 3 EStG

To date, accruals have been valued without any offset for revenue from other sources for lack of a direct connection to the expense. From 1999 on, account is to be taken of revenue related to the discharge of a liability (example: dumping fees charged while performing an obligation to refill a quarry site).

As regards executory contracts, this legislative change had been presaged by court decisions (see article no. 108).

10. Valuation of accruals on a direct cost basis: sec. 6 (1) no. 3 EstG

In the future, only direct costs and variable overhead costs may be included in valuing accruals.

11. Changes affecting primarily nuclear power plants: sec. 5 (4b) and (4c) EStG

The period for building up (phasing in) accruals for closing and disposing of old nuclear power plant facilities is to be lengthened from 19 years to 25 years. Furthermore, a prohibition on accruals for the cost of purchasing or manufacturing a new asset is to be introduced into the tax law. This is expected to affect primarily nuclear power plants which have hitherto set up accruals for the cost of reconditioning and reprocessing used nuclear materials to make new nuclear fuel.

12. Limitations on rollover of gain on asset sale: sec. 6b (1) - (7), 6c EStG

The benefits of sec. 6b EStG (deferring gain realised on sale of certain assets provided replacement assets are purchased) will be limited to sales of real property. It may be advisable to apply gain on the sale of qualifying assets, whether from the current year or rolled over from previous years, against the purchase of replacement assets by the end of 1998 in order to avoid immediate taxation of these gains under the new law (assuming that there will be no transition provision for "old" rollover gain, which might be unconstitutional).

Advancing sales scheduled for later years to 1998 may also make sense, though perhaps only if a replacement asset can be purchased in the same year.

13. Exchange opinion and other reorganisation measures: sec. 6 (4) and (5) EStG

Application of the so-called "exchange opinion" (relating to tax free like-kind exchanges - see article no. 135) is to be discontinued. Furthermore, possibilities previously available under the Co-Entrepreneur Directive for transferring individual assets will be restricted.

14. Repeal of the valuation discount for certain imported goods purchased: sec. 80 EStDV

Repeal of this valuation discount is planned. Previously, newly purchased imported raw materials considered to have strategic importance could be valued at 10 % below cost, which amounted to an immediate deduction.

15. Limitation of treatment of passive asset management as commercial activity to "old" partnerships: sec. 15 (3) no. 2 EStG

Partnerships with only corporate general partners (e.g. GmbH & Co. KG) formed after 1984 can qualify as commercial business partnerships even though engaging solely in passive asset management. Plans to close off this possibility from the year 1999 onwards appear to have been abandoned.

16. Prohibition on passing flat rate wage tax along to the employee

Under present law, the contract of employment may require the employee to reimburse the employer for flat rate wage tax paid. This will no longer be permitted under the new proposals.

17. Elimination of special depreciation and anticipated special depreciation for small and medium sized businesses: sec. 7g (1) and (2) EStG, sec. 7g (3) and (7) EStG

Special depreciation and anticipated special depreciation are subsidies for small and medium sized businesses. Both subsidies will be limited to newly founded businesses from the year 2001 onwards in the case of special depreciation and from 2000 onwards for anticipated depreciation.

18. Value added tax

A variety of changes are planned in this area:


sec. 10 (4) UStG: End of determination of taxable value of benefits provided to employees with reference to standard values prescribed by administrative ordinance.

sec. 15 UStG: Reduction to 50 % of input tax deduction on passenger car expenses.

sec. 36 - 38 UStDV: Elimination of input tax deduction on extra meal expenses.

sec. 36, 39 UStDV: Elimination of employer's input tax deduction on employee travel and moving costs.


19. Prohibition on deduction of bribes paid in Germany or abroad: sec. 4 (5) no. 10 EStG

The new law extends the scope of the existing prohibition to include foreign bribes and makes it considerably easier for the tax authorities to deny deductions on these grounds by eliminating the requirement for a criminal conviction.

20. Limitations on changes in the tax balance sheet: sec. 4 (2) EStG

Under present law, the tax authorities can permit changes in the tax balance sheet which the taxpayer cannot make as a matter of right. This discretion is eliminated from 1999 onwards.

4.2 Individuals with some degree of personal wealth

1. Elimination of the preferential tax rate for "extraordinary income"; instead, spreading of such income over 5 years: sec. 34 (1) and (3) EstG

Under current law, "extraordinary income" (up to certain limits) is subject to taxation at only half of the otherwise applicable average tax rate. Examples of "extraordinary income" are capital gains on sales of businesses or material shareholdings in corporations. Settlement payments upon employer-initiated termination of an employment relationship can also qualify (cf. sec. 4.3.1 below). The intention is to delete this provision entirely. Planned instead is a provision spreading such income over a 5 year period. It may therefore be advisable to realise such income before the end of 1998. Income received in a single year for work performed over a multiple year period can currently be spread over three tax years. It would be spread over 5 years under the proposed amendment.

2. Taxation of capital gain on sale of former business assets: sec. 6 (1) no. 4, sec. 23 EStG, sec. 21 (2) no. 1 UmwStG

When an asset previously used in a business is moved into the private sphere (e.g. by a sole proprietor), the withdrawn asset is revalued at its going concern value (leading to gain or loss for the business). If the asset is later sold by the taxpayer, any gain is tax free under the general principles applying to sale of non-business property by individuals. A proposed change would make the gain taxable under sec. 23 EStG unless the asset was held for at least 5 years after its withdrawal. If the intention exists to sell assets withdrawn from a business in recent years, it may be advisable to do so by the end of 1998.

3. Lowering the threshold for capital gains taxation on sale of material shareholdings in corporations from presently 25 % to 10 %: sec. 17 (1) EstG

Capital gain on sale of all or part of shares in a corporation is presently not taxable if the shares are held as non-business property and the total direct or indirect shareholding during the preceding five years was not "material", i.e. not more than 25 %. This limit is to be reduced to 10 %. It may therefore be advisable to sell shares which are not "material" under the present rules by the end of 1998.

4. Loss utilisation - minimum taxation: sec. 2 (1a) (3) EStG

The new government also intends to limit vertical loss offset (i.e. the ability to offset losses from one of the seven basic income categories against positive income from other categories). To this end, income is divided into the categories "passive" and "active". Passive losses can be set off against active income up to DM 100,000. Above this amount, passive loss offset is limited to half of the amount of the remaining active income. For example, a taxpayer with active income of DM 200,000 could offset passive losses of only DM 150,000 (DM 100,000 + half of remaining positive income = DM 50,000). Passive losses not offset can be carried forward (as normal or passive loss carryforward, depending on amount). Joint filers are treated as separate for these purposes, but benefit in that each may use the other's losses.

5. Extension of the holding period to avoid taxation of gains on sale of real property from 2 years to 10 years: sec. 23 (1) no. 1a EstG

Under present law, capital gain on the sale of real property is not taxable provided a 2 year holding period is observed and the sale is not part of a business activity. The holding period is now to be lengthened to 10 years. If sales of real property are contemplated, it may be advisable to make these by the end of 1998 provided the present 2 year holding period can be met.

6. Extension of the holding period to avoid taxation of gains on sale of securities from 6 months to 1 year: sec. 23 (1) no. 1b EStG

Under present law, capital gain on the sale of securities (especially stock) is not taxable provided a 6 month holding period is observed and the sale is not part of a business activity. The holding period is now to be lengthened to 1 year. If sales of securities are contemplated, it may be advisable to make these by the end of 1998 provided the present 6 month holding period can be met.

7. Taxation of income from operation of ships in international traffic (80 % of overall income) at full tax rate instead of half of normal rate: sec. 34c (4) EStG

Changes are planned in the current preferential taxation of income from the operation of ships in international traffic (usually through partnerships formed for this purpose).

8. Fine tuning of partnership at risk loss provisions: sec. 15a EStG

Limitations on use of distributive shares of losses were planned in certain areas. These plans now appear to have been abandoned, however.

9. Repeal of the DM 60,000 exemption for capital gains from sale or liquidation of businesses, branches of activity, or interests in commercial partnerships: sec. 16 (4) EStG

An exemption of up to DM 60,000 can apply to the taxable gain realised on sale or liquidation of businesses, branches of activity, or interests in commercial partnerships. This exemption is to be deleted completely. It may be advisable to realise such capital gains by the end of 1998.

10. Repeal of the DM 20,000 exemption for capital gains from sale of material shareholdings in corporations: sec. 17 (3) EStG

The DM 20,000 exemption for capital gains from sale of material shareholdings in corporations is to be deleted. Here as well, it may be advisable to make such sales by the end of 1998.

11. Deletion of the DM 60,000 exemption for capital gains from sale or liquidation of personal service businesses, their branches of activity, or interests in personal service partnerships: sec. 18 (3) EStG, sec. 16 (4) EStG

An exemption of up to DM 60,000 can apply to the taxable gain realised on sale or liquidation of personal service businesses, their branches of activity, or interests in personal service part nerships. This exemption is to be deleted completely. It may be advisable to realise such capital gains by the end of 1998.

12. Repeal of the option to distribute deductions for repair and maintenance expense in restoration areas, urban development areas, and for historic buildings over up to five years: sec. 4 (8) EStG

This loss deduction can at present be spread over up to five years (for instance, by a sole proprietor of a business). The intention is to repeal this option.

13. Valuation of contributions of non-business income-producing assets: sec. 6 (1) no. 5 EStG

When a partner or sole proprietor moves property formerly used to earn non-business income, such as rental income, into the business realm, the property may be valued on the books of the receiving business at its going concern value.

If the property has already been depreciated in connection with the non-business income which it produced, a step-up in depreciation base can be obtained at no cost, since the contribution will typically not trigger a capital gain. The intention exists to limit such possibilities. It may therefore be advisable to contribute property of the sort described by the end of 1998.

14. Taxation of profits from margin transactions: sec. 23 EStG

The intention exists to tax earnings from margin transactions and currency futures transactions. Such earnings are at present not taxable unless they rise to the level of commercial business transactions. It may therefore be advisable to realise such earnings by the end of 1998.

15. Splitting rate for married couples: sec. 32a (5a) EStG

Beginning with the year 20002, the tax saving from joint filing will be limited to DM 8,000. At present, married couples filing jointly pay double the tax owing on half of their joint incomes. The current theoretical maximum advantage from the splitting rate is DM 22,842 and is achieved by a married couple in which one spouse has taxable income of DM 240,000 or more and the other spouse has no income of his or her own.

16. Elimination of partial deductibility of school tuition for children: sec. 10 (1) no. 9 EStG

Under present law, 30 % of tuition paid by taxpayers to send their children to private schools can be deducted as a special personal deduction. This provision is to be eliminated. Timely payment of school tuition may therefore be advisable.

17. Elimination of deductibility of interest on back taxes, deferred taxes, and taxes as to which collection was temporarily stayed: sec. 10 (1) no. 5 EStG

Under present law, interest paid on back taxes, deferred taxes, and taxes as to which collection was temporarily stayed can be deducted as a special personal deduction. This is to be completely eliminated under the new law. If payments of this sort are pending, it may be advisable to make them before the end of the year.

18. Changes in the taxation of income from domestic and foreign investment funds: sec. 38b, 39 KAAG, sec. 17 AIG

Significant changes are planned in the taxation of income from domestic and foreign investment funds. These include the introduction of withholding tax for stock funds.

19. Transfers to trusts: sec. 3 (2), 7 (1) ErbStG

Changes are made to bring inter vivos transfers to trusts under the inheritance and gift tax.

4.3 Average individuals

1. 50 % reduction of exemption amounts for settlement payments upon employer-initiated termination of an employment relationship: sec. 3 no. 9 EStG

Substantial reductions are planned in the exemption amounts (currently DM 24,000 to DM 36,000 depending on the employee's age and length of employment) upon employer-initiated termination of an employment relationship. It may therefore be advisable to fulfil the requirements for such exemptions by the end of 1998.

2. Elimination of deduction of "advance costs" in connection with purchase of a dwelling which qualifies for a home ownership subsidy: sec. 10i EStG

Present law permits the deduction of a standard amount of DM 3,500 and repair and maintenance expenses of up to DM 22,500 as special personal deductions.

These provisions are to be deleted. It may thus be advisable to qualify for these deductions before the end of 1998.

3. Uniform standard deduction for cost of educating dependent children: sec. 33a (2) no. 2 EStG

Expenses for the education of children 18 years of age or older can be deducted (from adjusted combined net income) in an amount of DM 2,400 per child per year if the child lives at home and DM 4,200 per year if he or she lives away from home. A proposed amendment replacing the two deduction amounts by a single amount of DM 3,000 appears to have been abandoned.

4. Reduction of the interest income exemption from DM 6,000 to DM 3,000: sec. 20 (4) EStG

Personal interest income is presently taxable only to the extent it exceeds an exemption amount of DM 6,000 / 12,000 for single and joint filers respectively. The exemption amounts are to be cut in half from the year 2000 on.

5. Repeal of the exemption for payments on employee and business anniversaries: sec. 3 no. 52 EStG and sec. 3 LStDV

Various payments to employees on the occasion of certain employee and business anniversaries are tax exempt under current law. These benefits are to be eliminated. It may therefore be advisable to make such payments on a timely basis.

5. "Ecological" energy tax reform

The two coalition parties have also reached agreement, at least in broad terms, on the introduction of "ecological" taxes on energy. The Greens are known to favour this measure more strongly than the SPD. In the coalition agreement, the purpose of this reform is explained as follows:

"With the ecological tax and duty reform we are establishing market incentives for the development of energy-saving environmentally lenient products and new production processes and for environmentally conscious behaviour on the part of consumers. The ecological tax and duty reform is a market economy instrument of modern technological and industrial policy. It promotes structural change and creates jobs."

A three phase program is contemplated. Although the coalition agreement recognises that long-term predictability over time periods long enough for industry to adjust to changing price conditions is "decisive for the economic and ecological success" of the new taxes, details have been announced only with regard to the first phase, which was to begin on 1 January 1999, but will now apparently be postponed until 1 April 1999. It consists principally of the following excise tax increases:


6 Pfennig per litre on petrol (gasoline)

4 Pfennig per litre on heating oil

2 Pfennig per kilowatt/hour for electricity

0.32 Pfennig per kilowatt/hour on natural gas


The above increases are modest compared with the total taxes currently imposed on energy, particularly petrol. Draft legislation containing the above tax increases was introduced in mid-November 1998 but could not be analysed in detail before publication of this article.

Fuels used to generate electricity will not be taxed in addition to the higher excise tax on electricity. Furthermore, "energy intensive" industries will be exempted from the increases on heating oil, electricity, and natural gas during phase 1 because of the lack of uniform EU taxation on energy. There are also reduced energy tax rates for manufacturing industries.

The proceeds of phase 1 are to be used to finance a reduction in social charges of 0.8 percentage points. A total reduction of over 2.3 percentage points in social charges (from currently 42.3 % of wages and salaries up to certain ceilings to under 40 %) is projected for all three phases. The intention is to return all proceeds of the energy taxes to consumers and businesses in this manner. Social charges are borne half each by employer and employee. The "total tax volume" of phases 1 to 3 has been estimated at DM 36 billion, which presumably refers to the revenue the tax is expected to generate per year in phase 3.

As stated, phases 2 and 3 remain completely in the dark at present. The intention is expressed to push for harmonisation of European Union energy taxation after Germany assumes the rotating presidency of the European Council on 1 January 1999. The coalition agreement demonstrates optimism concerning the pace of development in the EU when it states that details on phases 2 and 3 will be announced in mid-1999 "when the results of the German EU presidency are known". The intention is also expressed to use the EU presidency to seek international agreement on ending the tax exemption for fuel for aeroplanes (kerosene) and ships.

The final sentence of the coalition agreement in this area reads: "In deciding on the specific content taken by these phases [phases 2 and 3], the overall economic situation and energy market price trends must also be taken into account."

The future of ecological taxation in Germany is thus at present anything but clear.

6. Conclusion

The national elections in September 1998 and the tax reform plans of the new coalition of SPD and Greens have set a process in motion which will lead to important tax changes. So far, the reform appears largely devoid of supply-side economic incentives and instead manifests a certain Keynesian orientation with its tax breaks for the bottom half of the taxpayer population. Important aspects of the total package, such as the 35 % enterprise income tax and phases 2 and 3 of the ecological energy taxes, have so far not progressed beyond vague expressions of intention. Authoritative information on the proposals so far released could not be completely evaluated before this article was prepared. The report in this article must thus be regarded as provisional and tentative.

Finally, the negative response evoked by the announced proposals appears to be causing red-green policy makers to reconsider certain points. Drastic departures from the announced proposals would be surprising, but can not be ruled out.

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