Germany is one of Europe’s leading European economies, having invested more than €200bn in both cash and guarantees in the European and international markets. It is not surprising, therefore, that the European debt crisis has for some time been top of both the economic and political agenda in Germany.
One of the most controversial talking points is the plan to establish a common European economic government with the power to coordinate economic and fiscal policies. One of the main powers of this proposed government would be the authority to impose a Financial Transaction Tax against speculative transactions, which would effectively force the German banking sector to commit to playing an active role in helping reduce the effects of the crisis.
However, despite the crisis, the German economy remains robust and is enjoying an increase in trade coupled with a decreasing rate of unemployment. In addition, Germany’s fiscal revenue in 2011 will be much higher than estimated.
Reorganising the tax law: a long-awaited decree
After a wait of almost five years, the guidance to the 2006 Reorganisation Tax Act has now been published. The main focus of the 2006 reform was to expand the act’s scope to include cross-border EU transactions. Several issues which had been common practice have now been regulated in a more restrictive way:
• The transfer of assets upon reorganisation of a business may be made tax-neutral at book value, even if the assets have been stepped up to fair market values in the German statutory statements;
• There is now also an option to step up the assets transferred to a value between book and fair market value. While it was common practice until now to step up in the first place all balance sheet assets before self-developed intangibles and goodwill, it is now law that there has to be a uniform pro-rata step-up of all assets, including also intangibles and goodwill so far not capitalised.
In such cases, going forward, there will be a need to value any self-developed intangibles and goodwill for tax purposes, which will significantly increase the costs of the reorganisation. This new rule will be applied to reorganisations where the respective shareholder resolution or contribution agreement, respectively, are made after the publication of the decree in the Federal Tax Gazette (Bundessteuerblatt).
• Spinoffs may now be made at book-value only if the assets transferred have the quality of an entire business or at least a stand-alone branch of activity. This differs from the previous rules in that it is now required that the branch of activity already exists at the effective date of the reorganisation for tax purposes.
• Where a corporation is being merged into a corporate subsidiary, being part of a German tax group (Organschaft) there are now additional requirements for a tax-neutral book-value transfer if the head of the Organschaft is an individual or a partnership held by individuals. In such cases, a tax-free transfer of reserves to the individuals could be possible if the assets transferred were stepped up to fair market value for German GAAP purposes. The decree now states that a book value transfer of the assets is possible only if the parties involved agree to tax any difference between a higher German GAAP value and book value of the assets upon reorganisation as a deemed dividend to the ultimate individual owner.
Common French-German corporate tax system targeted
It came as a surprise at a bilateral euro-crisis meeting in August 2011 that France and Germany unveiled plans to harmonise the corporate tax regimes in both countries as part of a range of measures for closer eurozone integration. The French and German finance ministers had been asked to prepare proposals aimed at having a common corporate tax base and rate in Germany and France from 2013. This first step towards a common corporate tax system is a revolution within the EU.
Even the proposal for a directive on a Common Consolidated Corporate Tax Base launched by the European Council in March 2011 has so far been considered to have no chance of political approval. The development of a common French-German corporate tax should provide new thrust to this project and could be a starting point for other EU countries to follow.
Withholding tax on outbound dividends violates EU law
According to current German tax law, dividends paid by a German corporation to corporate shareholders are subject to a 26.375 percent withholding tax (WHT). On the one hand resident corporate shareholders benefit from a participation exemption and a full WHT credit/refund. However, non-resident corporate shareholders can only reduce WHT to 15.825 percent according to German tax law or an applicable double tax treaty, provided the EU Parent-Subsidiary Directive does not apply. The remaining WHT can only be credited against domestic corporate income tax on the level of the shareholder.
The ECJ decided in October that this different treatment of domestic and foreign shareholders is not in line with the free movement of capital. EU shareholders of German corporations that do not benefit from the EU Parent-Subsidiary Directive should apply for a refund of German dividend WHT already paid based on the ECJ decision. However, the applicable statute of limitations for a refund has to be considered.
However, the Finance Ministry estimates that a budgetary impact of potential tax refunds for EU cases could reach approximately €600m. As a result, it might well be that the German participation exemption regime could be abolished with respect to non-qualifying portfolio shareholdings in the near future, to achieve an equal tax treatment of domestic and foreign shareholders. This would not eliminate the violation against EU law if the Parent-Subsidiary Directive does not apply for other reasons than falling below the minimum shareholding quota of 10 percent – for example, not meeting the minimum holding period of one year. Hence, these cases may still benefit from a WHT refund.
‘Serious doubt’ about validity of German minimum tax rule
Under the current German minimum taxation rule, taxable income up to a total amount of €1m can be fully offset by tax loss carried forwards. Any taxable income exceeding €1m can be offset up to 60 percent by tax loss carried forwards – i.e. 40 percent of the taxable income is subject to tax.
The minimum taxation rule is not considered unconstitutional as it merely defers the actual loss offset to a later period. However, combined with other tax rules or tax relevant events, such as loss forfeiture rules or a merger, the minimum taxation rule may trigger a final exclusion from loss offsetting.
In this respect the Supreme Tax Court confirmed a lower court’s suspension of execution based on serious doubt on the constitutional validity of the minimum taxation rule in August 2010. However, ‘serious doubts’ do not indicate that one point of view is more likely than the other: that is, a final decision would only be made in a full trial in the future.
The Finance Ministry finally decided in October 2011 to apply the aforementioned Supreme Tax Court order, but only with respect to the following cases of final loss forfeiture:
• Loss forfeiture rules according to Section 8c of the Corporate Income Tax Act, applicable until December 31 2009 (i.e. prior to the introduction of a group relief);
• Reorganisations under the Reorganisation Tax Act – liquidation of a corporation;
• Termination of the individual tax liability by death of the taxpayer.
In particular, the Finance Ministry does not grant a suspension of execution in cases of abuse of law or a departure of a partner. Taxpayers potentially affected by the order should be aware that it is currently unclear whether future loss forfeiture may have retroactive effect allowing an adjustment of tax assessment notices of former years. Therefore, it is crucial to apply for a preliminary assessment in this respect to benefit from a potential favourable court decision in the future.
Final report of the task force
According to the coalition agreement, the German government recently appointed a taskforce to evaluate alternatives with respect to the restructuring of the German loss offsetting rules and of the current tax group system based on the following considerations:
• The total amounts of tax loss carry forwards for corporate income tax as well as for trade tax have already exceeded €500bn in 2004. These figures are synonymous with an alarming future decrease in tax revenue of more than €150bn. Furthermore, the pending cases on the minimum taxation rule and the loss forfeiture rules gave rise to evaluate potential changes in the loss offsetting system;
• The Organschaft requires a majority shareholding and a five-year profit and loss pooling agreement. In particular the excessive formal requirements for the profit and loss pooling agreement based on tax and company law led to lively discussions with tax auditors resulting in countless court cases in the past.
Therefore, the task force was also asked to come up with ideas to simplify the group taxation system and to adapt it to international standards. The task force published its final report in November 2011. In a nutshell, it is business as usual. The German loss offsetting rules (including the loss forfeiture rules) as well as the Organschaft remain unchanged due to the budgetary impact of substantial changes. However, the task force announced the following preferred alternatives – assuming that revenue neutrality might become expendable as a decisive criteria in the future:
• The minimum taxation rule shall not apply in certain cases of final loss forfeiture;
• Termination of the minimum taxation rules over an eight-year period, i.e. decrease the amount that cannot be offset (currently 40 percent) by five percent a year;
• Time limitation for tax loss carry-forwards to a 10-year term.
The Organschaft system shall be replaced by a domestic group contribution system with the following key factors:
• Minimum shareholding of 95 percent;
• Minimum term of five years;
• Group contribution between all group members;
• Pre-existing loss carry forwards may not be employed within the tax group;
• The group’s consolidated trade tax income should be allocated to the group members to avoid arbitrage activity based on the different municipal multipliers.
However, it is unlikely that Germany may enact any of these recommendations on a stand-alone basis without considering the results of the German/French task force working on an adaption of their corporate income tax systems as well as considering the European Commission’s proposed Common Consolidated Corporate Tax Base directive that may enter into force in 2013.
Summary
As with the previous year, 2011 did not witness many groundbreaking changes in terms of German tax law, although there have been several significant court decisions and decrees. With the upcoming elections in 2013, the coming year is likely to be more interesting based on the outlook provided: a tax marketplace where the taxpayer needs to stay alert.
