DOING BUSINESS IN GERMANY Overview on Taxation March 2015 1. Introduction 2.3. The taxable income includes the corporation’s current profits or losses as well as any capital gains. In general, the entire 1.1. Generally, taxes are administered and enforced by the profit is fully taxable. However, there are some exemptions. competent local tax office. These local tax offices administer For example, the German Corporate Tax Act provides for a in particular the income tax to be paid by individuals, 95% tax exemption of dividends received, as well as capital Corporate Income Tax (CIT) to be paid by corporations as well gains from the sale of shares in other German or foreign as Value Added Tax (VAT) and Real Estate Transfer Tax (RETT), corporations, unless certain restrictions apply. However, this where applicable. Trade tax is based on the assessment of tax exemption may not be available if the selling corporation corporate taxes but is enforced and assessed by the local is a bank or other financial institution or, under certain municipalities conditions, is a holding company that holds the shares as 1.2. The Federal Central Tax OfficeBundeszentralamt ( für Steuern) trading assets. Further, to qualify for the exemption relating is, among other things, responsible for foreign taxpayers, e.g. to dividends, the parent company must hold at least 10% for the exemption and tax refund of withholding tax according of shares in the subsidiary. The tax exemption applies to double tax treaties and EU directives, advanced transfer irrespective of a minimum holding period. In return, any pricing agreements as well as the issuance of tax rulings for losses arising from the ownership of shares, as for example foreign investors and for several measures in connection with from the disposal or liquidation, are not tax deductible on the VAT on cross-border supplies and services. level of the corporation. 2.4. The CIT rate is 15%. In addition, the solidarity surcharge 2. Companies of 5.5% is levied on the amount of CIT due, resulting in an aggregate tax rate of 15.825%. The local tax office where 2.1. Corporations, such as the German Limited Liability Company the central management of the corporation is located is the (GmbH) or Stock Corporation (AG) that are tax-resident in competent office for assessing the CIT. Germany are subject to CIT on their worldwide income, unless 2.5. Corporations are also subject to municipal trade tax. relieved by double tax treaties. Corporations are resident Foreign businesses which do not have their registered office in Germany if their effective place of management or their or place of management in Germany but receive income registered officeSitz ( ) is located in Germany. The place which is allocated to a German permanent establishment are of management is the centre of the top management of a also subject to trade tax. The basic trade tax rate is 3.5% corporation. It is located where the commercial matters of which is supplemented by the application of a multiplier some importance for the corporation are effectively decided, fixed by the competent municipality and that varies from a usually at the directors’ office. The registered office of a minimum rate of 200% up to around 500%. Thus, the effective corporation is determined by the articles of association of the trade tax rate ranges from 7% to around 17.5%. As a result, corporation. Foreign corporations that have neither its place corporations are subject to CIT (including solidarity surcharge) of management nor its registered office in Germany are only and trade tax at a combined rate between 22.825% and subject to CIT on their German-source income. 33.325%. For trade tax purposes, the above mentioned 95% 2.2. The calculation of the taxable income is based on tax exemption of dividends received from other corporations the annual financial statements Handelsbilanz( ) drawn up requires a minimum shareholding of 15% as of the beginning pursuant to German generally accepted accounting principles of the respective fiscal year. which must then be modified under specific provisions of tax 2.6. Both CIT and trade tax are assessed on an annual basis. law. These notably include regulations on the treatment of However, the determination of the taxable income may hidden profit distributions and restrictions on the deductibility refer to a 12-month period deviating from the calendar year. of business expenses, in particular with respect to debt Additionally, corporations are obligated to make quarterly financing expenditures. prepayments of CIT and trade tax which are based on an estimate of the current year’s tax amount due. 2.7. For CIT and trade tax purposes, a general limitation to the 2.10. Dividends: In general, corporations have to withhold taxes deduction of interest payments applies, relating to both for all dividends and other profit distributions, irrespective third party loans and shareholder loans. Under the interest of whether the recipient or shareholder is a German or deduction ceiling (Zinsschranke), interest expenses exceeding foreign entity. The withholding tax is 25% plus the additional interest income (net interest) will only be deductible up to solidarity surcharge of 5.5%, resulting in an aggregate 30% of the corporation´s EBITDA (earnings before interest, tax rate of 26.375%. The withholding tax is credible at taxes, depreciation and amortization). The interest deduction shareholder level against the overall CIT liability. In case ceiling will apply (a) if the overall net interest exceeds that a foreign corporation is subject to limited tax liability €3 million (threshold) and (b) in case that the corporation in Germany, the withholding tax can be reduced to 15.825% does not belong to a group of companies, if a “harmful (including solidarity surcharge) if certain substance criteria debt financing” is in place, which is a debt financing by are met. An exemption from withholding tax applies under shareholders with more than 25% shareholding, related the EU Parent-Subsidiary Directive for distributions to foreign parties or third parties (e.g. banks) with recourse to such EU corporations with a minimum shareholding of 10%. The shareholders or related party, and interest paid for such debt withholding tax can also be reduced to a lower rate or be exceeds 10% of the overall net interest; or (c) in case that avoided/reclaimed under a respective double tax treaty. the corporation belongs to a group of companies, if “harmful However, the reduction as well as limitation and exemptions debt financing” exists in any group company and the financing under the EU Parent-Subsidiary Directive or the double tax 25% shareholder, related party or third party with recourse treaties are subject to a German anti-treaty shopping rule to the shareholder or related party is not part of the group; or whereby the limitation or exemption is not available if the the equity ratio of the borrowing corporation is lower than the recipient is an interposed entity with insufficient “substance”. one of the consolidated group. Net interest expenses that are 2.11. German partnerships, as for example the General not deductible under these rules may be carried forward to Partnership (OHG) or Limited Partnership (KG), are not subject subsequent financial years and may only be deducted within to income tax or CIT. Instead, CIT or income tax is levied at the limits of the interest deduction ceiling. the level of the partners of the partnership (transparency 2.8. Transfer pricing: Under the arm’s length principle, the principle). The income is determined “uniformly and consideration of any intercompany transaction must conform separately” on the level of the partnership and attributed to the level that would have applied if the transaction to the partners in proportion to its equity interest in the would have taken place between unrelated third parties. In partnership. The income tax rate for partners is equivalent to cases where the arm’s lengths principle is not met, the tax the tax rate for individuals. Partnerships may obtain business authority may be entitled to adjust the tax base resulting in income or conduct private asset management. Partnerships an additional taxable income. The tax office may also charge which only conduct private asset management, as for penalties. Further, tax payers are required to maintain proper example generating dividends, interest or lease income, do transfer pricing documentation in cases of intercompany not gain business income. The partnership itself is subject to cross-border transactions with respect to the type and municipal trade tax in case its activities can be qualified as content of the business relationships with related parties a trade under the German Trade Tax Act. However, the trade including details on the calculation of transfer prices. In case tax can generally be offset to a large extent with the personal that no or insufficient documentation is available, the tax income tax liability of an individual partner in proportion to its authorities are entitled to estimate a higher tax base and, equity interest in the partnership. additionally, penalty payments may be assessed. 2.9. The German rules for groups of companies (Organschaft) 3. Individuals under the Corporate Income Tax Act require a more than 50% shareholding in a subsidiary and a profit and loss transfer 3.1. Tax liability: A person’s taxation status in Germany depends agreement (Ergebnisabführungsvertrag) according to German on its residence status. An individual is deemed to be a corporate law, which is concluded between the group parent resident in Germany if the individual has a domestic domicile company and the subsidiary and executed for a period of at or a domestic customary place of abode. Nationality is not least five years. As a result, the subsidiary’s net income is a relevant criterion for determining the residence status or attributed to the group parent company for CIT and trade tax tax liability of individuals under German tax law.