By King & Wood Mallesons
The national tax system
As most western countries, Germany has a rather complex and detailed tax system, with a wide range of legislation as well as decrees from fiscal authorities and jurisdictions of the fiscal courts.
Individuals are subject to income tax at a progressive rate, with a maximum tax rate of 45% for their global income if resident in Germany. Otherwise, only specific German-sourced income will be taxed. A solidarity surcharge of 5.5% of due income tax is also applicable. Where the individual runs a business, trade tax will be levied, which depends on the community the business is located in given that every community has a right to determine a municipal factor. Currently, the rates range from 7% up to approximately 19%.
Corporations are liable for corporate income tax at a flat rate of 15% for their worldwide income if they are resident in Germany or for specific German-sourced income. The solidarity surcharge and trade tax apply as well. Given this, the overall effective tax rate for a corporation usually lies somewhere between 27-30% but might actually deviate significantly from this range.
Partnerships are transparent except for trade tax purposes, i.e. any partner will tax his profit share individually in accordance with his own tax regime but the partnership itself will pay trade tax if
Subject to tax will be the net income, i.e. profit as a difference between income and expenses. For this, the financial statements under German GAAP can act as a starting point. Several exceptions apply in terms of the tax balance sheet. In addition, some expenses are not deductible; the most important ones being expenses in breach of the arms’ length principle and certain interest expenses.
Germany no longer has any net asset tax except for the property tax on German real estate.
As in most countries nowadays and especially within the EU, deliveries of services and goods might be subject to value added tax (VAT). The normal German rate stands at 19% and is usually added on to the net sum. The tax will normally apply at every phase of a delivery and might also occur in the case of imported goods and services rendered by a foreign provider. However, value added tax paid by an entrepreneur to a supplier might be credited against his own VAT payment.
Finally, Germany levies real estate transfer tax (often referred to as “RETT”) for the transfer of German property or for qualified transfers of companies owning German real estate. The latter regulations, in particular, require careful attention as these do not only apply to the direct acquisition of such a company, but also for indirect transfers including those within a group. The tax rate depends on the federal state the property is located in, as any given state has a right to assess its own tax rate. Currently, the rates range from 3.5% up to 6.5%.
Foreign investors might be subject to income taxation for specific German-sourced income, especially arising from a permanent establishment or the rental of German property.
Additionally, withholding taxes will be assessed. Whereas, under domestic law, interest is normally not subject to withholding tax, dividends and licence fees might trigger withholding taxes of 25% plus a solidarity surcharge of 5.5%, leading to an effective tax rate of 26.375%.
However, Germany has concluded double tax treaties with almost 100 countries which usually reduce such withholding taxes significantly. For instance, the Sino-German double tax treaty only allows for a withholding tax for licence fees of 10% (or 6% in certain scenarios) and for dividends of 5% for a qualified shareholder or 10% for almost any other shareholder. (Please note, that companies in Hong Kong or Macau are not within the scope of and as such are not protected by the double tax treaty).
Moreover, EU directives might lead to any withholding taxes being reduced to zero. In this context it should be noted that Germany has very detailed anti-abuse legislation, which can make accessing those benefits sometimes rather difficult.
Germany does not levy a branch profit tax.
Agenda to avoid tax issues
There is no way back from any tax leakage, once the documentation has been signed or a transaction has been implemented, and the facts have thus been established. Therefore, it is of utmost importance to check the tax consequences of any action in advance.
Given this, most of the following items should usually be on the agenda to be reviewed and discussed properly, and the structuring should be done accordingly:
- subject matter of an acquisition (share deal or asset deal; from a tax perspective, the acquisition of a partnership is equal to an asset deal);
- analysis of the German business to be operated or of German companies already owned;
- financing of an acquisition or a group (equity, shareholder loans, bank debt) considering tax deductions but also legal restrictions and balance sheet effects;
- minimisation of transfer taxes, e.g. avoidance of real estate transfer tax;
- reorganisations (post-closing or for existing groups) to streamline organisational needs without triggering adverse tax effects and to improve the tax position (e.g. for interest deduction);
- optimised repatriation of payments (dividends, licence fees, interest);
- effects on financial statements; and
- cash flow considerations.
As a cross-border investment also effects at least one other tax jurisdiction, it is essential to incorporate these effects into tax advice.
Subsidies and grants
In Germany, investment incentives are usually provided by the German federal government, the German federal states and/or the European Union. Whether cash incentives, interest-reduced loans, public guarantees, labour-related incentives and/or R&D incentives: in general, these grants are available to all companies and investors, including enterprises acquired or held by Chinese investors, provided that the investment is beneficial to the German economy.
These subsidies are often administered by the nationally operating German development bank (KfW) or German or EU authorities. In a number of deals, our understanding of the mechanisms behind the subsidies and grants have proven to be vital for the success of the transactions.
Tax breaks or tax free zones are usually not available.