Moving to Germany Forums

Germany Information · Joined: 21 Oct 2006 Posts: 27 Home Country: germany

DOING BUSINESS IN GERMANY

TYPES OF BUSINESS ORGANISATION

Principal forms of doing business

Companies operating in Germany must be entered in a Commercial Register (Handelsregister). Registration requirements are complicated, however, so companies are advised to seek legal advice beforehand. The registration of a stock corporation or limited-liability company is of vital importance for foreign firms establishing a subsidiary in Germany, because under German law any pre-incorporation agreement remains the liability of the parent enterprise alone.

The most common form of incorporation is the joint-stock corporation (Aktiengesellschaft—AG), which is regulated by the Joint-Stock Corporation Act (Aktiengesetz). The second most common form is the limited-liability company (Gesellschaft mit beschränkter Haftung—GmbH), which is governed by the Limited-Liability Company Act (GmbH-Gesetz).

Requirements of an Aktiengesellschaft (AG)
Capital. Minimum capital is €50,000. At least 25% of capital cash contributions must be paid in when the company is formed, and all capital must be subscribed. Other capital contributions may be in the form of factories, machinery, patents, know-how, etc. Capital contributions in kind must be 100% paid in and are subject to rigid examination of value by court-appointed auditors. Shares not fully paid up must be registered. An amount equal to 5% of annual profits after taxes must go into a legal reserve account until the reserve has reached 10% of equity capital. If shares are issued exceeding nominal value, the amount of the premium also must be transferred to the legal reserve.

Founders, shareholders. One person alone can establish an AG. There are no restrictions on nationality or residence.

Board of directors. The supervisory board (Aufsichtsrat) must have at least three members or a multiple thereof up to a maximum of 21. Individuals may not be members of more than ten boards. Representatives of parent companies may hold up to five additional board seats in subsidiaries, for a total of 15. There are no limits on nationality or residence of directors. The shareholders’ meeting (Hauptversammlung) elects the shareholders’ representatives on the board for a maximum of five years, and the employees or their delegates elect staff representatives for the same period. Re-election is possible.

Management. The supervisory board appoints the management board (Vorstand) for up to five years. Each member may be re-appointed for additional terms. Managers need not be shareholders and there are no restrictions on their nationality or residence. Although the minimum number of board members is one, AGs with a capital exceeding €3m must have at least two members on their management boards.

Employees must establish a works council (Betriebsrat). It must have a voice in certain social and personnel decisions. Labour has 50% representation on the supervisory board of companies with a workforce of more than 2,000; in companies with a payroll of 500-2,000, labour representatives must hold one-third of the seats.

Disclosure. The shareholders must elect an independent certified accountant (Wirtschaftsprüfer) every year to audit the company’s financial statements. The board or the shareholders must approve the financial statements. All AGs must file their balance sheets at least once a year with the trade registry closest to their registered office location. Large firms (those that exceed two of the following three categories: annual sales of €27.5m, assets of €13.75m and a workforce of 250) must compile their annual balance sheets within three months of the end of the business year and have it assessed by an independent accountant. This period is extended to six months for medium-sized firms (exceeding annual sales of €6.875m, assets of €3.438m and a workforce of 50).

All companies must publicise their financial statements together with a management report, a proposal on the allocation of profits and the report by an independent accountant within 12 months of the end of the business year by depositing them with the Commercial Register and publishing a note in the federal gazette (Bundesanzeiger). All financial statements must contain comparative data and include details of the company’s minority and majority holdings in other corporations and disclose valuation and depreciation of fixed assets.

Companies in Germany must set up a depreciation plan and announce details in the business report at least once every three years. Changes in property-valuation and depreciation methods must be announced. In addition, some companies voluntarily make other disclosures in “social accounts”. Disclosure is obligatory each time a shareholder obtains voting shares in an AG surpassing thresholds of 5%, 10%, 25%, 50% or 75%.

Taxes and fees. There are no taxes on incorporation or capital increases. Costs of entering a company in the trade register and of notarising the articles of association depend on the company’s capital stock and on whether a lawyer is used to formulate the articles. Costs range from roughly €100 to more than €1,000. Mandatory announcement in the Bundesanzeiger and at least one daily newspaper costs €100-250, depending on the volume of the information to be announced. Where shares are issued at a premium, the premium is not considered taxable income.

Types of shares. Minimum par value of shares is €1. An AG must issue common (ordinary) shares but may also issue preferred shares (which usually carry no vote) up to the full amount of common shares. Multiple-vote shares are generally not permitted; non-voting shares are permitted. Bearer shares (Inhaberaktien) are often used, though registered shares (Namensaktien) are permitted. There has been a trend since the late 1990s to change to registered shares, which are more common internationally. In November 2000 the German parliament passed an amendment to the securities law, adapting it to the international practice of issuing registered shares. Namensaktien now have the same legal rights, specifically in computer trading, as the traditionally used Inhaberaktien.

Control. A simple majority is sufficient to approve most actions; a majority of more than 75% is required for major decisions. A minority of 5% of equity capital or €500,000 in shares, whichever is lower, may do the following: call an extraordinary shareholders’ meeting or put topics on the agenda of the shareholders’ meeting; object to a decision of the shareholders’ meeting for the formation of reserves, if this decision is shown to be “economically unreasonable”; and request a special audit when the business report seems incomplete or assets are believed to be undervalued. A minority of 10% or €1m, whichever is lower, may force a vote about a nominated board member and demand a special audit of the annual balance sheets and business report, even if the report seems to be complete. The board of management and the shareholders’ meeting may each decide on the use of one-half of the profit.

Requirements of a Gesellschaft mit beschränkter Haftung (GmbH)
Capital. Minimum capital is €25,000, but only €12,500, including deposits in kind, must be paid in. The registry court must value assets in kind paid in by the group or person establishing the GmbH. No legal reserve is required.

Founders, shareholders. There is a minimum of one founding member. Founders may also be companies or private partnerships. The acronym “GmbH” must appear in the firm’s official name.

Board of directors. A supervisory board (Aufsichtsrat) is required if the payroll exceeds 500. The board then controls management, and no person may serve as director and manager simultaneously. The board must comprise at least three members.

Management. One or several managers are permitted. Members of a company may specify management procedures in the company’s byelaws. Managers need not be shareholders. When a GmbH has a board of directors, the rules governing representation of labour are the same as for an AG.

Disclosure. Like AGs, GmbHs must file their balance sheet at least once a year with the trade registry. The financial statements must be approved by the shareholders. Otherwise, the same rules apply as for AGs.

Taxes and fees. There are no taxes on incorporation or capital increases. Incorporation costs start at €250 and rise with increasing capital. Including notarisation and the use of a lawyer, the costs for registering a GmbH with a capital of €25,000 add up to roughly €1,000; without a lawyer, the cost is about €320. Announcement costs are the same as for an AG. Where shares are issued at a premium, the premium does not constitute taxable income.

Types of shares. Minimum par value for a single share is €100. The value of shares held by partners may differ but must be divisible by 50. Shares are transferred or assigned by notarisation.

Control. To change the articles of incorporation, more than 75% of the votes represented in a shareholders’ meeting are needed. Such decisions must be notarised. Transfer of shares usually also depends on the consent of a qualified majority. Other decisions require a simple majority. To call for a shareholder meeting, 10% of the votes are sufficient.

Shareholders often have the right to decide whether profits will be paid out or reinvested. The minority enjoys a statutory right to introduce motions. German courts arbitrate cases of misuse of majority power for objectives counter to the GmbH’s purpose.

Establishing a branch

A foreign company does not need a permit to establish a branch in Germany. A branch (unlike a subsidiary) is not a separate legal entity and has no rights or obligations other than those of the parent company. A branch is categorised either as a dependent entity lacking its own business profile (like a representative office) or as an independent trading entity. Only independent branches need be entered in the Commercial Register (Handelsregister). The tax treatment, however, is the same for both types of branches.

Corporate income tax is assessed on both branch and subsidiary income at a flat rate of 25% (temporarily raised to 26.5% for 2003) regardless of whether branch profits are retained in Germany or repatriated to a foreign head office. The remittance of branch profits is not subject to withholding tax, but remitted subsidiary profits face a 20% withholding tax (except profits remitted to EU parent companies). Double-taxation treaties may specify lower rates.

A branch is not subject to the same disclosure requirements as a subsidiary. In a start-up situation, a branch has the advantage of letting the foreign investor offset German-sourced start-up losses against home-country taxable income. But a subsequent conversion of the branch into a German corporation typically results in gain recognition, particularly for goodwill; different rules apply to EU companies. The liability of a branch extends to the foreign parent, whereas a subsidiary does not expose the foreign parent to potential liabilities.

A foreign firm may set up an independent branch by registering it in the local Commercial Register. The registration has to be made at the local court where the branch will be located in the presence of a notary public. If the parent is a corporation, the entire management board has to make the application. If the parent is another form of company, the executive chairman alone may make the application. The state government grants (usually readily) permission for the creation of a branch. Branch managers may be foreign nationals and are not subject to residence limitations.

Foreign corporations must include a certified copy of the articles of incorporation (including a German translation) and certified signatures of the management board members with the application. They must also include detailed information about both the parent company and the branch, such as business objectives, amount of equity and composition of the board. Finally, the applicants must provide evidence of the existence of the parent company, preferably an extract of the entry in the company register of the company’s home country.

Setting up a company

Some companies are incorporated as a commercial partnership limited by shares (Kommanditgesellschaft auf Aktien—KGaA). The most common forms of unincorporated firms are the limited commercial partnership (Kommanditgesellschaft—KG) and the general commercial partnership (Offene Handelsgesellschaft—OHG), in which the liability of the partners is unlimited. Sometimes limited-liability companies are founded for the purpose of being a partner in a KG (GmbH & Co. KG). These combine the advantages of a GmbH with those of a KG: it is a partnership in which none of the partners is liable without limit. For property-development purposes and very small companies, civil partnerships (Gesellschaft bürgerlichen Rechts—GbR) are popular.

Procedures for forming a joint-stock corporation (AG) are complicated. Although no permit is needed to form a joint-stock corporation or to issue shares, the founders must draw up articles of association (Satzung). These must state the following: the name of the company, the location of its registered office in Germany, its objectives, the amount of its share capital, the denominations and type of its shares, and the members of its board of management. A notary public (Notar) must certify the articles. The founders appoint the supervisory board (Aufsichtsrat), whose members in turn appoint the board of management (Vorstand). The members of both boards supervise the company’s formation. Sometimes, such as for contributions in kind, an additional examination by court-appointed auditors might be required.

The company pursuing the AG form must then file its registration application with the commercial, provincial or district court where it is based. At the same time, it must file a deed that certifies the articles of association. It must also file the following: any agreements concerning contributions and acceptances in kind, a computation of the costs to be borne by the company for formation, all documents on the appointment of the boards, the founders’ report on the formation of the company and proof of payment of the founders’ shares. The joint-stock corporation comes into existence when the articles of association are entered in the Commercial Register and after the total share capital is subscribed (only 25% must be paid in).

Procedures for forming a limited-liability company (GmbH) are similar but simpler. The GmbH has less-detailed requirements for stating the firm’s major business purpose in the articles of association, lower minimum-capital requirements, simpler formalities, and more flexibility in legal and business transactions. But its shares may not be traded on a stock exchange.

Like the AG, the GmbH comes into existence after application information is recorded in the Commercial Register. Before registration, persons who act on behalf of a GmbH are personally liable. Incorporators must agree on the firm’s name, place of incorporation (which must be in Germany), intended purpose, amount of capital (including the amounts contributed by each partner) and fiscal year. The minimum capital is €25,000. This information must be notarised and entered into the Commercial Register.

Usually the local chamber of commerce (IHK) compiles an expert opinion on the availability of the capital and the purpose of the firm on which the relevant court bases its final decision. The acronym “GmbH” must appear in the firm’s official name. The registration takes effect only after one-quarter of the capital has been paid in (at least €12,500 must be paid in at registration). Partners may be foreign nationals, and they need not have a residence or work permit as long as they retain their residence in their home country. The managing director may be a foreign national but must have a residence permit (for which non-German EU nationals are automatically eligible); a work permit is not necessary where the managing director is not regarded as a regular employee. There are special agreements with countries like Canada, Switzerland and the United States. Detailed information can be obtained from the local chamber of commerce.

The GmbH is the preferred corporate form for foreign investors who want to limit the risk of their activities to the amount of capital they invest in Germany, and who do not anticipate raising funds in the capital market (which requires the AG legal form).

EU directives harmonise company reporting and accounting requirements. The basic rules, codified in the Commercial Code (Handelsgesetzbuch—HGB), affect most firms (AGs, GmbHs and KGaAs), though the major requirements apply only to large and medium-sized firms. The rules equally apply to German subsidiaries of foreign corporations.

The EU adopted a resolution in September 2002 making International Financial Reporting Standards (IFRS; hitherto known as International Accounting Standards—IAS) binding for all European corporations that are either traded on a stockmarket or issue bonds. The new rules will enter into effect for the financial year beginning on or after January 1st 2005. For tax filing purposes, however, German companies will still need to present balances according to the old rules governed by the HGB.

Corporate governance in Germany was reformed in the Third Financial Markets Promotion Act (Drittes Finanzmarktförderungsgesetz) of April 1998. This law determines that the supervisory board (not the management board as before) assigns and approves the annual balance-sheet audit. The supervisory board must meet at least four times a year, and members’ pay is fully taxed (it was previously 50% tax free). It also became easier to sue management—especially supervisory-board members—for serious negligence.

A transparency and publication law was passed in July 2002, with immediate effect. Its primary aim is to improve corporate governance and strengthen the role of supervisory boards. All corporations must compile a catalogue of transactions that management may not conduct without board approval. Individual board members can demand written reports and call meetings. The management must inform the board about the businesses of subsidiaries and when targets have been missed. At the same time, breach of confidentiality by board members is severely punishable. Other provisions allow for annual shareholder meetings to be web-cast and for dividends to be paid in the form of shares or even goods. Another key element of the law is its incorporation of a code of conduct for managers and board members.

A commission under Gerhard Cromme, advisory-board chairman of Thyssen-Krupp (a steel company), drew up a code in 2002 that sets rules to avoid conflicts of interest. Compliance with the code is voluntary, but the transparency and publication law forces corporations to publicise whether or not they adhere to the code.

BUSINESS TAXATION

Overview

The German parliament passed a tax-reform plan in July 2000 that applies for 2001-05. The reform, which eases both corporate and individual tax rates, was effective from January 1st 2001. The third step of the tax reform, which the government decided in June 2003 to bring forward by one year to January 2004, concerns only individual income taxes, not corporate taxes. But many small and medium-sized companies are organised as partnerships and, therefore, profits are taxed at the level of the partners at individual rates; hence they will benefit from lower taxes. The government estimates that the annual tax relief for such companies will total €10bn.

Before 2001 German corporate income tax (Koerperschaftsteuer) was calculated according to a split system: 40% on retained profits and 30% on distributed profits. It also employed an imputation system, under which domestic shareholders were entitled to credit the full amount of corporate tax against their income-tax liability. Foreign corporations with income from German operations were subject to a tax of 40% whether or not the income was distributed. Beginning with the 2001 tax year, a single tax rate of 25% and the “half-income” system replaced this method.

However, the tax reform contributed to a greater-than-expected fall in federal tax revenues in 2001 and 2002—the government had evidently underestimated the ability of companies to use loopholes in the law to reduce their tax bills. It closed a major loophole on the reimbursement of tax credits in May 2003.

Germany has a preliminary budget deficit of €38.6bn in 2003, €4.8bn less than expected. Now, the government wants to finance the next step of the tax reform, beginning in 2004, mainly by increasing borrowing, and only to a smaller extent by reducing subsidies and by selling more of its shares in Deutsche Post, the postal service, and Deutsche Telekom, the former telephone monopoly.

In order to rein in the soaring deficit, the government in November 2002 proposed a host of measures to cut back tax reductions and exemptions. Both houses of parliament passed a trimmed-down version of the Tax Benefits Reduction Act in May 2003. It will bring in additional annual tax revenue of €4.4bn, instead of the original €16bn that the government had desired. Measures that were dropped in the final legislation would have affected private investors (such as taxes on capital gains from the sale of shares and bonds) and would have established a minimum corporate tax and stricter depreciation rules. Measures included in the final law, effective with the financial year 2003, are as follows:

* A three-year moratorium (until end-2005) on the reimbursement of corporate tax credits, after which any reimbursements will be limited to one-sixth of annually distributed profits;

* The abolition of multiple parent consolidated tax groups (Mehrmüetterorganschaft);

* Limits on loss deductions for silent partners, so that companies that are silent partners in another company can offset losses only against income from the same company;

* Extended documentation requirements about transfer pricing for both domestic and international companies; and

* Elimination of double-tax treaty protection for income from subsidiaries in tax havens under the controlled foreign corporations (CFC) rule (Hinzurechnungsbesteuerung).

Further measures, which are effective with the financial year 2004, are as follows:

* Investment-related deductions. The existing regulation (Sec. 8b Subs. 5 German Corporate Income Tax Act), according to which 5% of the dividends received from foreign subsidiaries at the level of a corporation are treated as deemed non-deductible business expenses, shall be extended to dividends received from domestic subsidiaries and to capital gains realised upon the sale of foreign or domestic subsidiaries. In turn, actual business expenses of the parent company (eg financing costs in the limitation of the thin-capitalisation rule) related to the tax-exempt income can be fully deducted. The new regulation is applicable from the fiscal year 2004.

* Change of Sec. 8a CITA (thin capitalisation).

The German corporate tax system is complex. It is essential to retain the services of a German tax accountant (Steuerberater) who has been certified by the association of tax accountants (Steuerberaterkammer). The German tax collector is the Federal Ministry of Finance (Bundesfinanzministerium).

Shareholder financing
Thin capitalisation. Because of major changes in German tax legislation, the thin-capitalisation rules have been amended for fiscal year 2004 (fiscal year 2005 for companies with a business year deviating from the calendar year).

The German thin-capitalisation regulation is now principally extended to loans not granted on a short-term basis from domestic shareholders or related parties. Furthermore, it also applies to foreign corporations subject to restricted tax liability in Germany to the extent of their domestic activity, eg through a permanent establishment or a partnership interest.

The regulations provide that remunerations for liabilities, which a corporation being subject to unlimited taxation in Germany pays to a shareholder with a qualifying investment, are constructive dividends (formerly are qualified as constructive dividends), if the German corporation exceeds a certain debt to equity ratio (so-called safe haven) and if it cannot be proven that a third party would have granted the financing under the same conditions. The same holds true if the financing has been granted by a shareholder’s related party or if the financing has been granted by a third party that can take recourse to the shareholder or the related party.

A shareholder with a qualifying investment is a person who directly or indirectly holds an interest of more than 25% of the nominal capital (share capital) in the corporation.

For fixed-interest-bearing liabilities, all corporations dispose of a safe haven of 1.5:1. (Formerly, qualifying holding companies had a safe haven of 3:1; in case of a deviating fiscal year, the year 2003/04 is the last one in which this expanded safe haven is valid.) For the calculation of the safe haven, the statutory balance sheet of the end of the previous fiscal year of the corporation to which the loan is granted is decisive. However, it has to be underlined that in case of a qualifying holding company, the lower-tier companies do/did not dispose of a safe haven of their own in order to avoid a multiplication of the safe haven. In this case, all respective liabilities should be lead through the holding company.

A corporation is qualified as a holding company if:

* Its main activity is the holding and financing of corporations; or
* More than 75% of its total assets consist of investments in other corporations.

The relevant equity is determined based on the statutory equity of the company. In case of partnership investments, the partnership’s assets will be allocated to the corporate partner. Book values of shares in corporations have to be deducted from the equity unless the company qualifies as a holding company for thin-capitalisation purposes.

If the pro-rata equity is negative at the end of the fiscal year, the safe haven for the business year is “0”. Accordingly, all remunerations for liabilities paid from a German company to its shareholder/related party company are constructive dividends. The remunerations will, however, still be deductible if the third-party test can successfully be met.

However, the loss of a fiscal year does not reduce the equity, if it is compensated until the end of the third fiscal year following the year in which the loss has been incurred (temporary loss). Profit reserves or capital contributions must restore the original equity. This provision shall avoid that the safe haven is simply exceeded by a current loss. Thus the prerequisite for not considering the loss for the calculation of the relevant equity is that the loss is only temporary and not permanent.

The new regulations include a base allowance, which means if the interest on harmful debt does not exceed €250,000 in a fiscal year, the thin-capitalisation regulations do not apply.

Furthermore, the thin-capitalisation regulations have been extended on related party loans granted to partnerships in which corporations or related parties of corporations hold interest of more than 25%. The (proportional) liabilities of the partnership are deemed to be liabilities of the corporate partner for thin-capitalisation purposes.

Deviating from the former draft tax reform bill, leasing fees for tangible and intangible assets have not become subject to the thin-capitalisation rules.

Interest expenses on loans granted from shareholders or related parties of the shareholders that have been used to acquire corporations from the shareholder or related parties of the shareholder are generally not deductible for tax purposes. This regulation seems also to apply to reorganisation measures effected before 2004.

Furthermore, from 2004, the thin-capitalisation rules apply for trade tax purposes as well.

The thin-capitalisation regulations are still applicable to loans granted from third parties (eg banks) if the third parties may take recourse to the shareholder or a related party of the shareholder.

For corporations with a business year deviating from the calendar year, the new law applies for fiscal year 2005 for the first time. Equity for purposes of the safe-haven test will be calculated based on the statutory equity at the end of the preceding business year. An increase of the “safe haven” for thin-capitalisation purposes from 2005 will have to be finalised at the end of the preceding business year in 2004 at the latest (if necessary) by equity measures (eg contributions in cash or in kind, waiver of shareholder loans). A third party test may still be provided for fixed-interest-bearing loans to avoid the application of the thin-capitalisation rules.

Loss relief
Corporate income tax. Losses that cannot be offset against gains in any given year may be carried forward indefinitely and carried back for one year. From January 2001 only losses up to €511,500 may be carried back into the previous year.

Trade tax. Losses that cannot be offset against gains in any given year may be carried forward indefinitely.

Loss deduction/minimum taxation. A minimum taxation rule has been implemented for income tax, corporate tax and trade tax purposes according to which losses may only be offset against positive taxable income, to €1m without limitation per year. A positive taxable income exceeding €1m in a year may only be offset against existing tax-loss carryforwards in the amount of 60%.

The new regulation applies from fiscal year 2004 onwards. Thus for companies with a fiscal year deviating from the calendar year, the rule is already applicable.

There are two special regulations regarding loss relief in case of restructuring measures.

Consolidation
A tax group always consists of one controlling company (Organtraeger) and at least one controlled company (Organgesellschaft). The prerequisites to establish a tax consolidation differ for the various taxes (corporate income and trade tax vs value-added tax).

Tax consolidation for corporate income and trade tax purposes. In order to achieve tax consolidation for corporate and trade tax purposes, the so-called financial integration and a profit-and-loss transfer agreement are required.

Financial integration. The parent company/controlling company must directly or indirectly and without interruption hold the majority of voting rights in the subsidiary from the beginning of the latter’s business year. An indirect interest is sufficient only if each indirect interest itself grants a majority of voting rights.

Profit-and-loss transfer agreement. A profit-and-loss transfer agreement (so-called Ergebnisabführungsvertrag) must be concluded between the subsidiary and the parent. Under this agreement, the subsidiary is obliged to transfer its entire annual profit to the parent, but at the same time the parent commits itself to compensate the losses of the subsidiary.

The agreement must run for at least five years, and must be concluded until the end of the first year in which it shall take effect. The Organschaft shall then become effective for the first time only for the year in which the agreement is registered with the Commercial Register of the parent company and the subsidiary. The agreement must be notarised by a notary public.

If the profit-and-loss transfer agreement is not effectively carried out in any one of the first five years (ie the subsidiaries fail to surrender their entire profit, or the parent defaults on its obligation to take over the losses), the agreement is for tax purposes only retroactively treated as if it had never been concluded and the companies involved are reassessed for tax purposes. As a result, the profits previously surrendered or the losses previously suffered would be re-qualified as deemed dividends or deemed contributions. A profit-and-loss transfer agreement, however, may be cancelled because of important reasons, eg sale of the subsidiary, merger or contribution.

Tax consolidation for value-added tax purposes
The requirements for a tax consolidation solely for VAT purposes are not identical with the requirements for the tax consolidation for corporate income and trade tax purposes. Next to the financial integration as mentioned above, a profit-and-loss transfer agreement is not required but there are two other prerequisites that have to be met. These additional prerequisites are:

Organisational integration. The organisational integration presupposes a degree of management control exercised by the parent, such that the subsidiary cannot be said to have a will of its own, at least as far as significant issues are concerned. The law stipulates that an organisational integration will automatically be deemed to exist if:

* The subsidiary has surrendered its own management rights, powers and duties to the parent under a management-and-control agreement (domination contract/Beherrschungsvertrag) in accordance with the provisions of sec. 291 para. 1 of the Public Limited Companies Act Aktiengesetz); or

* The subsidiary is integrated in the controlling company in accordance with secs. 319?327 of the Public Limited Companies Act. However, this integration requires a participation in the controlled company of at least 95%.

Economic integration. An economic integration exists where the business activities of the subsidiary complement or support those of the parent as if the subsidiary were merely a department or business division of the parent.

Within the VAT group all intra-group invoices have to be issued without VAT. The parent company that is regarded as the entrepreneur according to VAT law has to file the VAT returns for the whole tax group.

Treatment of tax losses within a tax group
The results of the German tax group companies are consolidated on the level of the controlling company. Please note that tax loss carryforwards of subsidiaries resulting from business years prior to the companies’ integration in the tax group are not available for transfer to the parent company during their membership in the tax group. Furthermore, the tax consolidation generally freezes in the controlled company’s losses that have been accumulated prior to tax consolidation. Such losses may be carried forward until the tax consolidation ceases to exist on the level of the subsidiary and may then be offset against future profits.

Mergers
Especially when buying a business, it is necessary to understand the legal form in which it is presently conducted. Most business activities in Germany are carried out through one of the following forms:

* Sole proprietorship (Einzelunternehmen);
* General partnership (OHG);
* Limited partnership (KG);
* Limited partnership with corporate general partner (GmbH & Co. KG);
* Limited liability company (GmbH); and
* Stock corporation (AG).

German company and tax law distinguishes between trade and business activities and other activities. Generally, tax law will assume commercial activity where a trade, which is not related to self-employment or passive asset management, is undertaken in order to achieve profits. The Business and Tax Reorganisation laws deal with the reorganisation of commercial enterprises.

The way in which an acquisition is structured is often determined by tax or other commercial reasons. The buyer’s interest is to gain a step-up and a corresponding depreciation volume in the acquired assets to reduce the future tax rate. The vendor’s interest is, however, to minimise the tax on the capital gain or, in the best case, to secure a tax exemption. Accordingly, the tax structuring of an acquisition requires thorough examination.

For certain transactions, German tax law provides tax exemptions or at least tax relief. The most important are:

* Tax exemption for corporations for capital gains from the sale of shares in a corporation.

* Tax relief for individuals for capital gains from the sale of shares in corporations (half-income system; reduced income-tax rate under certain conditions).

* Tax relief for individuals for capital gains from the sale of partnership interests (tax allowance, reduced income tax rate under certain conditions).

* In principle mergers (Verschmelzungen) and spin-offs (Ab- und Aufspaltungen) of corporations and partnerships can be performed tax neutral (continuation of book values).

* In principle the contribution of shares in a corporation or stakes in a partnership into another corporation or partnership can be performed tax neutral.

* Some reorganisations that involve German and other EU corporations (eg German shares are contributed into another EU corporation) can be performed tax neutral if certain conditions are met.

For tax and statutory purposes, most reorganisations can be carried out with retroactive effect up to eight months. Usually, this regulation is used to have a transaction valid back to the last balance-sheet date, thereby offering sufficient time to prepare and to perform all steps required.

Further important tax issues with regard to reorganisations are:

* Thin-capitalisation rules; and
* Utilisation of losses.

Sec. 8 para. 4 CITA (“Mantelkauf”; shell company acquisition). The loss deduction of a corporation is regulated under Sec. 8 para. 4 CITA. According to this regulation, a corporation may only take a loss deduction if it is legally as well as economically identical to the corporation that sustained the loss. The economic identity does especially not exist, if:

* More than 50% of the corporation’s stock was transferred.

The same results arise when a shareholder change through the transfer of more than 50% of the stock occurs in the cases of:

* A capital increase, in which case the newly arrived partner fully or partly makes the contribution and has a capital interest of more than 50% after the capital increase.

* A merger with the loss company, if the new partner, who has until now not participated in the company that sustained the loss, has more than a 50% capital interest after the merger.

* The capital contribution of a business, business segment or partner interest if the newly added partner owns more than 50% interest after the capital contribution.

* The corporation continues or resumes its business operations with predominantly new business assets.

New business assets can also be allocated through the merger of another corporation into the corporation sustaining the losses.

A timely connection must exist between the transfer of shares and the allocation of new business assets. For this reason, the regulations only take into account new business assets that are allocated within five years after the detrimental share transfer.

Predominantly new business assets are allocated if the new business assets exceed the existing business assets at the time of the share transfer. The business assets in this sense are the assets (fixed and current) of the corporation; the comparison does consequently not refer to the net assets (equity) of the company. The going concern values of the existing and allocated assets are the valuation standard; possible intangible assets are also to be considered even if it is not possible to estimate their value through the determination of tax net income.

The allocation of new business assets is not detrimental if the assets alone service the recapitalisation (“Sanierung”) of the business operation that sustained the loss, and the corporation continues the business over the following five years to a comparable extent of the previous overall economic relationship.

Sec. 12 para. 3 sen. 2 Reorganisation Tax Law (CTC) [Loss transition through a merger]. Sec. 12 para. 3 sen. 2 CTC requires in the case of a transfer of loss deductions:

* That the acquiring corporation continues the business or business segment that produced the loss;
* To a comparable extent of the previous overall economic relationship.

According to Sec. 8 para. 4 CITC, the business includes the entire economic activities of a company. A business segment is conversely a limited economic activity to which certain personnel and pertinent resources can be assigned (eg a product line or the single interest of a holding company).

The loss deduction passes on to the acquiring corporation only if the original company that sustained the loss is continued. This provides, among other things, that the acquired corporation had not, when the transfer of property was recorded in the commercial register, stopped its business activities.

The five-year period begins with the tax transfer date.

It is not detrimental for the transfer of the loss deduction if the business or business segment is expanded in the following five years. It is sufficient if the company is continued at least to the required extent.

The continuance of the business or business segment through the acquiring corporation is necessary. A transfer by the corporation to the business or business segment in the form of singular succession (eg a sale, an investment of capital, a split) subsequently causes the loss transfer to fail.

VAT. Asset purchases of a business or a division thereof (branch or activity) are not subject to German VAT (Sec. 1 para 1a UStG). Purchases of shares in a corporation or interests are zero-rated under Sec. 4 para 8 (f) UStG.

Real estate transfer tax. The acquisition of real property (land and buildings) in an asset purchase is subject to a 3.5% real estate transfer tax on the purchase price allocated to the real property.

Real estate transfer tax, however, can also be due if no purchase has taken place but some change of ownership in real property is assumed. The most important cases the law provides are:

* A direct or indirect transfer of at least 95% of the shares in a corporation or stakes in a partnership owning real estate, which is located in Germany.

* Less than 95% of the shares or stakes are transferred, but after the transfer at least 95% in the entity is owned by one party.

* Real property is transferred to a new owner by way of a merger or spin-off.

As in these cases there usually is no purchase price, the real estate transfer tax rate of 3.5% is based on a special valuation of the real estate.

Taxable income and rates

Taxable income defined
Corporations with a registered or administrative office in Germany are subject to corporate income tax on their global income. From 2001 the corporate income tax rate is 25% (though temporarily raised, on an emergency basis, to 26.5% for tax year 2003). Foreign companies (whose registered or administrative offices are not in Germany) are considered non-resident for tax purposes and are subject to corporation tax on income from domestic sources only. The income of a non-resident company that is derived from the company’s permanent business establishment in Germany is subject to a corporate income tax rate of 25% (26.5% in 2003). A non-resident company’s other sources of income (such as from royalties) are taxed by way of withholding assessments that may be reduced under a tax treaty.

In general, a solidarity surcharge of 5.5% of the corporate tax levied is due.

Dividend distributions are subject to withholding at a statutory rate of 20% plus the solidarity surcharge of 5.5% of the withholding tax. The withholding tax is credited against the corporate income tax of resident shareholders. The tax is final, however, for non-resident shareholders. Under many of Germany’s bilateral tax treaties, the tax is 5% on distributions to non-resident corporate shareholders with at least a 10% stake in the firm.

Resident companies must declare foreign-sourced income, even when there is a tax treaty that prevents the tax from having to be paid twice.

Corporate taxes paid abroad are usually not deductible from the taxes due in Germany. Exceptions apply to German AGs or GmbHs that own a minimum stake of 10% in a foreign incorporated enterprise. The foreign corporate taxes can then sometimes be deducted from the German taxes.

Only half of the dividends paid out by a German or foreign corporation to resident individual shareholders is subject to income tax. In the rare instance when gains on the sale of shares are taxable, they are treated in the same manner (effective from 2002). For dividends paid by a foreign corporation, the provision is effective from 2001. The same holds true for the sale of shares in a foreign corporation.

For corporate shareholders, German or foreign corporate dividends and gains on the sale of shares in German and foreign corporations are tax free from 2002. For dividends paid by a foreign corporation, this provision is effective from 2001. The same holds true for the sale of shares in a foreign corporation. As regards the taxation of 5% of such gains and dividends received. Thus corporations may sell stakes in other companies (including their subsidiaries) paying little tax. This change cleared the way for major banks and insurance companies in particular to sell their extensive holdings in industrial companies.

Foreign withholding taxes can or cannot be offset against taxes paid in Germany, depending on the type of income and its tax treatment in Germany.

Losses incurred by an incorporated subsidiary abroad may not be offset against the German parent company’s earnings. But German partnerships whose unincorporated production plants abroad incur losses may, under many double-tax treaties, deduct those losses from their domestic tax base, so that the partners move into a lower tax bracket.

Under the EU’s parent-subsidiary directive, Germany provides relief for the double taxation of qualifying dividends received from a subsidiary in another EU state. Relief may be granted under the directive via a tax exemption or issuance of a tax credit to the parent. This relief is for any withholding tax levied in the subsidiary’s country on the dividends. The credit is also applied to the appropriate portion of any corporate income tax levied in the home country on the profits from which those dividends are paid. Under the half-income system in force from 2002, only half the distributed profits are included in the shareholder’s tax base.

The Foreign Tax Law (Außensteuergesetz) specifies the tax method for income from a German company’s foreign subsidiaries and “base companies” (companies in which untaxed or low-tax income is gathered) operating in recognised tax-haven countries. To take advantage of lower tax rates available in a tax haven, the subsidiary must be operating actively (for example, as a manufacturer) in the country concerned. The tax-haven income of a foreign subsidiary not actively operating there (for example, of an investment company) is taxable in Germany as though generated by the German parent company.

Municipal trade tax (Gewerbesteuer) is deductible from federal corporate income tax (Körperschaftsteuer). For partnerships, no trade tax is levied on annual earnings of less than €24,500. However, incorporated enterprises do not enjoy this allowance.

In July 2003 the German parliament passed the so-called small business act (Kleinunternehmerförderungsgesetz), which is designed to reduce administrative red tape. Companies with annual sales of less than €350,000 or business income less than €30,000 are exempt from detailed book-keeping rules under the provision that they do not have a commercial business with regard to Sec. 1 para 2 German Commercial Code. For VAT purposes the limitation with regard to small companies increased from €16,620 to a maximum annual turnover of €17,500.

A wide range of deductions for most business-related expenses and many forms of depreciation is available. Tax laws also permit the creation of tax-free reserves for certain liabilities or anticipated losses (such as surety obligations, warranties, damage claims, litigation expenses and future pension payments to employees). Firms may create an accrual to deal with infringement of third-party patents and similar rights if the rights owner claimed compensation for damages or if such a claim is expected. The claim must be filed within three years.

Depreciation
Accepted methods of depreciating assets for tax purposes under German law include the straight-line method, the declining-balance method and the production method. For movable assets subject to wear-and-tear and for buildings, firms are permitted to use straight-line depreciation (in which the same percentage of the original value is deducted each year) or the declining-balance method (in which a certain percentage of the declining book value is deducted each year).

The income-tax regulations applicable for the years until December 2003 provided for a simplification rule regarding the depreciation of moveable assets in the year of acquisition or production. For moveable assets acquired or produced in the first half of a business year, the depreciation for the entire year was deductible as expense. For moveable assets acquired or produced in the second half of the business year, half of the annual depreciation was deductible as expense in the year of acquisition. According to the new law, this regulation has been abolished. Consequently depreciation for moveable assets may now only be deducted on a pro-rata monthly basis. This new regulation applies for acquisitions and productions effected after December 31st 2003.

Rapid depreciation is permitted for exceptional wear-and-tear resulting from technical or economic causes only if the straight-line method is used. It is possible to switch from the declining-balance method to the straight-line method, using the remaining book value as the basis. This change may be made at any time; it would usually occur when the amount of straight-line depreciation becomes greater. The reverse is never allowed. The maximum depreciation is 20%. Declining-balance percentage rates for movable assets acquired after December 31st 2000 may not exceed twice the straight-line rates or a maximum of 20%, whichever is less. Low-value assets, less than €410, may be deducted at once.

In 2001 the Ministry of Finance published tax depreciation rates for other assets, based on more realistic useful-life periods. Examples of depreciation rates on the straight-line basis under this list are as follows: plant and machinery, 6–10%; office equipment, 6–14%; motor vehicles, 16.6%; airplanes, 5%; and computers, 33.3%. (For the first three categories, the declining-balance method may be used alternatively.) For industrial buildings, the annual straight-line rate is 3% if the application with regard to the planning permission has been applied after March 31st 1985 and the building has not been completed or bought before January 1st 2001. If the building has been completed or bought before January 1st 2001, the formerly straight-line rate of 4% is applicable. Both regulations provide that the building is business property and is not used as a living area.

For buildings and parts of buildings that do not fulfil the above-mentioned preconditions, the annual straight-line rate is 2% if the building was completed after December 31st 1924 and 2.5% for buildings built before January 1st 1925.

The special depreciation of 50% for investments in eastern Germany ended in 2000.

For small and medium-sized companies, additional depreciation of 20% is available for acquiring new movable assets, but only if the company previously took advantage of an antedated depreciation (Ansparabschreibung). Companies may use this investment reserve to lower their taxable income for up to two years before a planned investment, by 40% of the cost of the acquisition up to a maximum of €154,000. Start-ups may take advantage of a deprecation of up to €307,000 in the year the business starts and five subsequent years. If the investment is not made as planned, the reserve fund must be liquidated within two years (five years for start-ups).

Current-value depreciation for shares in other corporations has not been possible since 2002. This is a consequence of the tax reform provision under which companies no longer need to pay capital gains taxes for proceeds from the sale of stakes in other companies. Since the gains from shares in other companies are no longer taxed, the losses may no longer be offset.

Profit repatriation
Since July 1st 1996, no withholding taxes arise on dividend distributions made by a German company to a parent company located in another EU country if the conditions for the use of the EU-Parent-Subsidiary-Directive are met.

The German law prescribes a withholding tax of 20% and solidarity surcharge of 5.5% (calculated on the withholding tax on dividends, if the creditor pays the tax). However, if the debtor bears the withholding tax, it amounts to 25% and solidarity surcharge of 5.5% on dividends. According to most German tax treaties, this rate is reduced to 10%, 5% or 0%. (In case of a treaty rate of 0%, the tax treaty dividends could be paid free of German withholding tax.) In order to make use of such a reduction in withholding taxes, prior permission of the German Federal Office of Finance is required.

Capital gains taxation

Since the beginning of the 2002 tax year, capital gains from the sale of shareholdings between corporations are tax-exempt in Germany.

Changes to the original tax-reform law passed in 2000 are codified in the law for further development of corporate taxation. Accordingly, for partnerships, sales of stakes in other companies are tax-free up to €500,000 if proceeds are reinvested within two years (four years for investment in buildings and real estate).

The expected wave of mergers and acquisitions (M&A) activity as a consequence of the tax reform had not taken place by August 2003, mainly because of difficult market conditions. Another reason for this tepid activity may be that some of the tax burden has been shifted to the buying company. In 2002 loopholes were closed that had allowed the buyer to write off the cost of buying shares in another company as normal investments.

Private shareholders may sell their stakes in other companies after a minimum holding period of one year without paying tax, unless they have a “substantial” interest. However, the threshold for what constitutes a substantial interest was reduced from 10% to 1% from January 2002. If the sale is subject to tax (that is, when shares are sold within the one-year holding period or represent a substantial interest), the half-income method applies.

Gains on the sale of all other business assets are generally taxed at normal income-tax rates. A rollover provision, which allows for the tax-free use of capital gains for reinvestments, applies for proceeds from the sale of certain assets like real estate and buildings. Re-investment must be within four years, or six years for new buildings if construction has started before the end of the fourth year.

Proceeds from the sale of land may be reinvested in other land; proceeds from the sale of land or buildings may be reinvested in other buildings. In effect, the gain is tax-deferred, not tax-exempt; the amount re-invested tax-free must be deducted from the value of the newly acquired assets, thus reducing the depreciable value. For amounts not reinvested, interest at 6% p.a. is imputed on the unused balance.

Gains from the sale of non-business assets are not taxable if the assets are held long enough for the gain to be considered non-speculative (for example, ten years for real estate and one year for securities). Losses from the sale of non-business assets can only be deducted from corresponding gains.

As part of the tax reform act, when a German corporation or branch of a foreign corporation holds shares in a foreign subsidiary, capital gains from the sale of such shares are generally tax free and losses are no longer deductible. However, from fiscal year 2004 onward, 5% of a capital gain is deemed as non-deductible expense and therefore taxed. Since January 2001, the law provides for a participation exemption (comparable to a full dividend-received deduction) for all intra-corporate dividends, domestic or foreign. There is neither a minimum shareholding requirement nor a minimum-holding-period requirement for corporate income-tax purposes. The participation exemption is available even for dividends received from tax-haven entities, though the German CFC (controlled foreign corporation) rules may result in a current German taxation of the CFC’s income. The existing regulation according to which 5% of the dividends received from foreign subsidiaries at the level of a corporation are treated as non-deductible expenses has been extended to dividends received from domestic subsidiaries and to capital gains realised upon sale of foreign or domestic or foreign subsidiaries. Dividends received by a German corporation are, however, taxable for trade tax purposes if the participation is less than 10%.

This exemption is also available when the shares are held through a partnership. Special rules apply to banks and other financial services companies.

The rules on capital gains contain a special provision on shares issued in a tax-free restructuring under the German merger and restructuring tax law. A tax-free disposition of the shares is then possible only after the lapse of a seven-year holding period.

Foreign income and tax treaties

As of January 1st 2004 Germany maintains double-tax treaties for taxes on income and capital with 88 countries, including most nations that have sizeable German investments.

By January 2004 Germany had negotiated double-tax treaties with the Philippines, Syria, Thailand, the Netherlands and Venezuela. Germany has initialled a tax treaty with Ghana and Malaysia. In addition, Germany has signed but not yet ratified agreements with Poland, Tadschikistan and Hong Kong.

Existing treaties were being renegotiated with Australia, Belgium, the Czech Republic, France, Greece, Iceland, Malaysia, the Netherlands, Poland, Romania, Singapore, Slovakia, Slovenia, South Africa and Switzerland.

Transfer pricing

German fiscal auditors usually carefully scrutinise crossborder intercompany transactions during a tax audit. It is expected that this review will now increase even further given that Germany has put transfer-pricing documentation requirements and penalties for non-compliance in place. In principle, German related parties should follow arm’s-length principles and prudent business manager standards when engaging in crossborder transactions with affiliated enterprises.

The 1972 Foreign Tax Act (Außensteuergesetz), Corporation Tax Act and the Income Tax Act (Einkommensteuergesetz) govern international transactions. A set of administrative regulations subordinated to these acts contain a fairly comprehensive set of rules for determining transfer prices, interest rates for loans and service charges for intercompany services (including royalties), as well as for sharing the costs of research and administrative service centres. Under the Tax Benefits Reduction Act passed in May 2003, the tax authorities require extended documentation about transfer pricing.

Section 1 of the Foreign Tax Law provides that a German taxpayer’s income may be adjusted upward to an arm’s-length compensation where the company’s reported income was lower than it would have been had it conducted business with unrelated business partners rather than familiar ones. The resulting tax burden can be substantial, particularly given that German tax authorities can also levy significant penalties (up to 10% of the income adjustment) in situations of non-compliance with the new transfer-pricing law.

Turnover and other indirect taxes and duties

Germany levies value-added tax (Mehrwertsteuer—MWSt) or VAT at a general rate of 16%. A reduced rate of 7% applies to certain “necessary” goods and services, such as food, artwork, local public transport, books and newspapers.

VAT is paid each time goods change hands; each company acts as a collector, deducts the VAT it has paid from the amount collected and surrenders the net to the government. The VAT is due as soon as a good or a service is delivered. Only smaller companies with annual sales of less then €125,000 and self-employed individuals may defer VAT until after payment is received. Electronic records have been acceptable since January 2002 as invoices for VAT purposes.

The VAT listed separately on invoices or bills to a company may be deducted from the company’s tax base, thereby reducing the tax burden (Vorsteuerabzug). VAT must be declared every month (every three months for companies with a total annual tax of less than €6,136).

VAT is also charged on imports. Special provisions apply for transactions with other EU countries. The European Commission started a public consultation phase in May 2003 on harmonising VAT rates throughout the Union.

VAT-exempt transactions include the following: export of goods; granting of loans; assumption of liabilities, guarantees and similar securities; deposit or management of securities and similar banking transactions; transfers of securities, bonds and shares in closely held corporations and partnerships; transactions covered by the real estate transfer tax; medical services; societal welfare activities; cultural activities; and educational activities. There are no VAT charges on the sale of companies or their units if the purchaser is another company or enterprise.

If a foreign company is not subject to corporate taxes in Germany, the Federal Tax Office will reimburse any turnover taxes deducted in Germany upon application. The mechanics of a VAT refund depend on the law on value-added tax of other countries. The tax office has published a list of countries that do not participate in the VAT-refund procedure.

According to government figures, the German state has lost about €10m every year because companies claim back VAT that was never paid to other companies for goods or services. A new law to fight turnover-tax fraud Steuerverkürzungsbekämpfungsgesetz) gives tax authorities the power to inspect the books of suspect companies without prior announcement and sometimes even allows wiretapping.

Other taxes

Germany levies numerous excise and other taxes (including on tobacco, petrol, oil and heating oil, and alcohol), stamp duties and lottery taxes. The government decided in October 2001 to raise tobacco taxes to help finance the fight against terrorism. It agreed in May 2003 on another cigarette tax increase by a total of €1 per package, with the first of three annual steps scheduled to start in January 2004.

Germany’s ecological tax reform went into effect in 1999. The energy-tax scheme (Ökosteuer) raised taxes on oil and natural gas, and also introduced a new levy on electricity (Stromsteuer). The income from the tax is mainly used to lower employers’ contributions to the state-run social security system. In its fifth and final stage, which began January 2003, the electricity tax is set at €20.50/mwh. The total tax on petrol is €0.4704–0.6545 per litre, depending on its quality, of which €0.1533 is for the so-called eco-tax. However, industrial companies pay only 60% of the standard eco-tax rates for electricity, heating oil and gas (up from 20% since January 2003). Companies with especially high energy consumption that benefit less from lower social security contributions than they have to pay in eco-taxes can get a refund on some of their paid eco-taxes.


Regions South America North America Middle East Europe Eastern Europe Asia Pacific Africa Countries Spain Netherlands Ireland France England Others Contact Us Advertise with Us Policy Germany News Send This Page