Germany: 175. Tax Reform Update

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Article no. 165 described the so-called Brühl business tax reform recommendations and other developments relevant to future tax reform in Germany.

On 23 June 1999, the Federal Cabinet adopted a draft budget for the year 2000 and announced a budget consolidation programme for the period through 2003 . In this context, the Government also stated its basic intentions with respect to further tax reforms, including the Phase II ecological tax reforms.

The Government's declared intention is to enact the sort of tax reform outlined in the Brühl recommendations, but not until the year 2001. Effective in January 2001, the present split rate corporation tax system will be abandoned in favour of a unitary corporation tax rate of 25 %. Inter-corporate dividends will be exempt from taxation. Individuals will pay tax on only half of dividends distributed to them. These rules will replace the present imputational system of corporate taxation. Partnerships and sole proprietorships will also at least have the option of being taxed at the corporate tax rate on their retained earnings. The means by which this particularly difficult part of the reform will be accomplished remain unclear.

The announced plans have the same level of specificity as do the Brühl recommendations, in which they are contained as sub-options of the main proposals. We therefore refer to our previous article for further details.

A number of tax-increasing measures were also announced. The most important of these is the reduction of declining balance depreciation from 30 % in the initial year to only 20 %. The Government also said that it would repeal the tax exemption for interest built up inside long-term whole life insurance policies taken out after 22 June 1999. At present, such interest is exempt from income taxation not only while it accumulates inside the policy, but upon disbursement at maturity as well. A similar tax exemption would also be eliminated for annuity life insurance policies with optional capital payout. Plans to eliminate the deductibility of all business food and drink expenses for third parties were shelved, at least for the time being.

The Government also plans to eliminate the special capped personal income tax rates for commercial business income (§ 32c EStG). The constitutionality of this preference is doubtful anyway after a recent decision of the Federal Tax Court (reported on in article no. 165).

Finally, the special depreciation and anticipated depreciation allowed by § 7g EStG for small and medium sized businesses is also apparently slated for repeal.

The Government has not announced any intention to change the German thin capitalisation rules (§ 8a KStG). A tightening of these rules is still expected, at the latest in connection with the coming business tax reform.

The Government's figures put the annual net tax reduction from the business tax reform at DM 8 billion.

The Government also announced new energy tax increases for each of the coming four years. The annual planned increase on fuels is DM 0.06 per litre and that on electric current is DM 0.005 per kwh.

It is not entirely clear from press reports or the statement on the internet site of the Federal Ministry of Finance whether the tax increase is to apply to all fuels covered by the mineral oil tax or only to certain fuels. The government's announcement has been popularly received as an increased tax on petrol (gasoline), but the mineral oil tax also applies to a variety of other mineral oils and to natural gas. Assuming the tax increase applies to natural gas, the unit of reference will be one kilowatt hour.

As was the case for Phase I, the funds raised by Phase II of the ecological tax reforms will also be used to reduce the statutory social security contribution (pension and disability contribution), which is borne half each by employees and employers. A reduction of one percentage point in the contribution rate is anticipated over the four year period covered by the energy tax increases. This would lower the contribution rate to 18.5 % of wages (up to a limit amount which is adjusted annually and currently stands at DM 102,000).

Phase I of ecological tax reform is described at length in article no. 168.

Article no. 173 reported on a decision by the Federal Constitutional Court indicating that the German taxation of families with children is presently unconstitutional. In an initial reaction to this decision, the Government has announced plans to increase government child support payments by an additional DM 20 per month for the first and second child effective in January 2000. Furthermore, a new flat rate child care deduction of DM 3,024 per year for children up to age 16 will also be enacted. Like the present flat rate deduction for dependent children, the new child care deduction will be alternative to child support payments, not in addition to them. The present child care deduction will be eliminated. The present flat rate deduction for single parents with children is to be phased out over several years.

Additional unspecified family relief measures were announced for the year 2002.

While a lot can still happen between now and the start of the second year in the next millennium, the Government has committed itself to a rough plan and a schedule for business tax reform. Such reform will come in the middle of the present Government's term in office and bring only limited net tax reduction. Indeed: an overall net tax increase may result for many businesses from the coming business tax reform in conjunction with the tax "relief" acts enacted in 1999. The opposition parties and independent experts continue to call for a reduction of income tax rates across the board, but it is unlikely that the Government will adopt such a strategy.

The Government's announcements in late June 1999 have also clarified the – modest – dimensions of Phase II of the Government's experiment with "ecological" energy taxation.

Families probably have the most reason to be pleased, as the Government indeed seems determined to comply with the recent Federal Constitutional Court ruling and significantly reduce the economic burden of raising children.

For further information, please send a fax stating your inquiry to KPMG Frankfurt, attn. Christian Looks +49-(0)69-9587-2262 or an e-mail using the button appearing below. Please state your name and organisation in all inquiries.

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