fpmi: Revisions required in corporate tax reform
by Finanzplatz München Initiative
Munich, December 27, 2007 – Taking effect on January 1, 2008, Germany’s corporate tax code contains several key provisions requiring revision, maintains Munich Financial Center Initiative (fpmi). According to mfci, the tax code does contain several highly welcome reforms, as well as items needing correction. Prime among these is the code’s underlying and much too optimistic assessment of the financial situations of Germany’s companies. This assessment manifests itself in the ceiling on interest-derived deductibles contained in the code.
Another point worthy of mention is that the code’s bias towards well-capitalized and large-sized companies, which benefit strongly from it. For the country’s SMEs (small and medium-sized enterprises), the code causes encumbrances. Leasing and project financing companies are especially strong and negatively affected by the codes, which will have a huge and detrimental influence upon their operating environments.
A final area of criticism is the code’s requiring of banks that they collect and transfer both the recently-introduced final withholding tax and the longstanding confessional tax revenues to the appropriate taxation authorities. This provision will take effect in 2011, and will give rise to further and greater expenditures and risk exposure on the part of banks, which will be liable for the amount of tax revenues supposed to be relayed to the authorities. The in-depth positions taken by participants in Munich Financial Center Initiative on the reform of Germany’s corporate tax code are listed below.
Allianz SE: “measures providing offsetting financing often go too far”Taking effect in 2008, Germany’s reform of its corporate tax code will have major and positive repercussions. The reform will enhance the viability and attractiveness of its business community. It took courage to cut the rate of corporate income tax from 25 % to 15 %, and we hail this move, which, unfortunately, was accompanied by a retention of the local trading tax. All told, German companies have to pay taxes amounting to some 30 % of their earnings. That rate is still in the mid-to-upper reaches of the EU.
The cut in the rate of corporate income tax will cause a drop in revenues. This is to be offset by so-called “counter-financing measures”. These include placing a limit on interest-deductibles, enacting follow-up regulations on the sale of corporate shells, the revision of the laws applying to so-called “operation relocation”, and the extension of the base of assessment applied to determining trading tax. Several of these measures go too far. They have the potential to cause double or even multiple taxation. They also could imperil the adherence to such fundamental principles as taxation being levied according to ability to pay. Germany’s legislative has recognized these imperfections and perils. For that reason, the legislative has committed itself to undertaking an audit of the code’s effects in 2009.
The urgently-needed revisions of the code are found in the following areas:
To increase the accountability and comprehensibility (with this also applying to those trying to understand it from abroad) of Germany’s system of corporate taxes, the trading tax should be incorporated into the country’s taxes on personal or corporate income. This highly necessary step has, unfortunately, not yet been taken. The extension of the recapturing of expenditures (interest, rents and the like) has given rise to taxation on asset stock. Both this and the multiple taxation of such payments on the intra-group level (through, for instance, landlord and tenant relationships) urgently require amendment.
2. Corporations’ net loss carryover (§ 8 c of Germany’s corporate tax code)
Rather than preventing misuse of the so-called ‘purchase of corporate shells’ – something achieved by the law it has replaced, the revision constitutes a wide-ranging and far-reaching prohibition on the exploitation of losses. It is of the greatest necessity that the revision’s maximum values be reduced, so as to avoid such incongruous situations as the reassigning of a subsidiary to another corporate parent within a group’s giving rise to the lapsing of losses, although no change of ultimate ownership has taken place. Also needed are amendments effectively regulating private equity and PPP (public private partnerships) arrangements. Should these not be enacted, urgently required investments will not be made.
3. Limits on interest-deductibles
The limits on interest deductibles have to be made easier to apply in real business life. We understand why Germany’s politicians strove to enact a local version of the USA’s "earnings stripping rule". Its formulation should, however, have adequately taken business realities into account. In its current form, the limit on interest deductibles will cause problems for companies showing the low equity ratios characteristic of their sectors or of the country’s business community as a whole. In its current form, the escape clause has no practical impact.
4. Relocation of operations
The levying of taxation on transnational transactions requires prior and international-level consultation. The foreseen alteration in § 1 of Germany’s Foreign Taxes Code has not been produced by such consultations. For that reason, it could well give rise to multiple taxation. Another point of fundamental concern is the levying of taxes on imputed future earnings, as this constitutes a contravention of the principles of realization and of taxation according to ability to pay.
Bavaria’s economics ministry: a good comprise between the needs of business and of the budget
Two thousand eight’s reform of Germany’s corporate tax code is pro-growth. The fundamental changes it will unleash will impart further momentum to the upswing gripping the country’s economy, and will thus increase the international-level viability of Germany’s business community on a sustained and sustainable basis.
The code reduces the total taxes levied on corporate retained earnings to below 30%. Joined by the introduction of preferential treatment for the retained earnings recorded by partnerships, this move, undertaken by Germany’s government, gives the world’s business community the unequivocal message that this country is an attractive place in which to do business. The introduction of tax rates which are competitively low by international standards will foster the making and retaining of investments in Germany, and will thus promote a rise in net employment in the country. Rather than radically rewriting the country’s system of corporate taxation, the reform contains those changes which are of practical use to Germany’s business community: reducing their total overhead and the nominal rates of taxation.
To further the interests of Germany’s large number of SMEs (small and medium-sized enterprises), this tax reduction is being accompanied by a reconfiguring of the revaluation reserves into a total amount of investment deductibles. This change constitutes a highly-effective incentive to invest, one which will particularly benefit SMEs. Applied to the calculation of trading tax base of assessment, the new allowance of €100,000 nicely reinforces the impact of this change.
All told, Germany’s business community will experience an annual reduction in net total tax expenditure of €5 billion. This is less than the optimal amount, from the economic policy-makers’ point of view. Facilitated by support from Bavaria’s state government, it was possible to introduce improvements of benefit to the country’s companies into the code prior to its being approved. Viewed as a whole, and taking into consideration the current political situation and the state of public sector finances, the reform represents a good compromise between the wishes of the business community and the needs of the budget.
This reform does have a number of initial flaws. These now have to be taken care of:
- The sale of shell companies and the relocation of operations have not been properly addressed from the economic policymakers’ point of view.
- The newly-enacted limit on interest-deductibles is the only one of its kind in the world. Its impact has to be closely monitored, to see if revisions are required.
- The regulations governing the recapturing in trading
tax levies of income from rental or leased property are too strict.
Sixty-five percent of rent and leasing-caused interest payments are
treated as trading tax-liable “financing component”. For that reason,
they are subject to the same 25 % rate of income recapturing applied to
loan-derived interest in the calculation of trading tax base. This
percentage is too high.
Association of Bavaria’s cooperative banks and credit unions: back-to-back regulation is not acceptableThe reform of Germany’s corporate tax code enacted in 2008 creates a final withholding tax. Many of the code’s provisions are expressly worthy of being welcomed. Viewed as a whole, the code will serve to strengthen the country’s business community. With a number of exceptions (for instance: the limit on interest-deductibles), the code has met with approval by the country’s SMEs. Especially worthy of praise is the introduction of the final withholding tax. This move enhances the attractiveness of and ease of operation in Germany’s financial community. It will thus serve to counter the outflow of capital from the country.
Chamber of Industry and Commerce for Munich and Upper Bavaria: a range of further encumbrances
On July 6, 2007, Germany’s Federal Council approved the reform of the country’s corporate tax code, which will therefore take effect on January 1, 2008 (the component governing corporate taxation) and on January 1, 2009 (final withholding tax).
These moves represent Germany’s way of giving the business world a very clear message: that the country now has a system of corporate taxation which is attractive by international standards. The system now features a 15% rate of corporate income tax and a total tax burden of some 30%. Joined with the creation of a 25% final withholding tax on capital gains, these tax reductions will foster the making of investments and the increasing of returns. The reform’s net impact upon Germany’s business community will be a reduction of tax-related expenditure of €5 billion.
One aspect has to be taken into account. These advantages do not equally and equitably accrue to Germany’s companies. Flourishing companies – those with high equity ratios, low indebtedness and high profitability – will benefit most from the tax cut, as will large-sized, sustainedly profitable partnerships. These will be able to exploit the retained earnings provisions.
Other kind of companies, such as retailers operating chains of outlets, restaurants and hotels, are threatened with increases in expenditures, as are any other firms operating on rented premises, or using leasing facilities or fleets. All of these are facing increases in trading taxes thanks to the recapturing provision.
A large number of partnerships will not be able to fully offset the detrimental effects of the elimination of the declining-balance tax depreciation method by availing themselves of the investment deduction allowance/special-purpose writedowns permitted by § 7g of Germany’s Income Tax Act, or of the retained reserves constituted according to § 34a of the Income Tax Act. This change will result in an estimated 200,000 SMEs’ not profiting from the reform.
In the final analysis, the introduction of regulations establishing a limit on interest-deductibles, governing the relocations of operations, and altering the reporting of negligible-worth business supplies, and the applying of recapturing provisions to trading taxes have made Germany’s tax codes even more complex. This, in turn, will hamper the formulation of corporate plans.
For these reasons, the Chamber and the organization of which it forms part are going to continue to push for changes in these taxation policies. Our objectives are to reduce red tape and to get a single, earnings-derived base of calculation for personal and corporate income taxes and trading taxes. A further objective is to have the pension reserves compiled for working partners in partnerships be tax deductible.
For further information, please visit www.ihk-muenchen.de (in German)
KGAL: Corporate tax reform gives rise to undesirable side effects
raised by Germany’s Association of Leasing Companies as well as the incontrovertible proof of the far-reaching disadvantages facing SMEs, project developers, leasing companies and PPP projects, Germany promulgated its reform of its corporate tax code. To preclude both individual companies and Germany’s business community as a whole from feeling the reform’s negative effects – which could include, in a worst case scenario, a wave of insolvencies and a blocking of investments – a rethinking of several of the act’s provisions has to be carried out. The fruits of this are to be implemented by the passing of enabling legislation.
The Corporate Tax Reform Act of 2008 introduced the so-called “limit on interest-deductibles” (§ 4 h of the latest version of the Income Tax Act) to counter large-sized and other companies’ practice of using non-German subsidiaries in the securing of outside capital. This practice often led to a transfer of domestic tax base abroad and a concomitant reduction of the taxation paid in.
There is nothing basically misguided about this approach, which is, after all, one used by many countries in Europe and farther afield. The pertinent question is whether or not the new regulation is an ‘overachiever’. In achieving its objectives, it precludes the use of financing instruments which are completely above reproach and which aren’t even used outside Germany (which means that they can’t be used to transfer tax base abroad). A further point of criticism is that the reform is one-sided. Its negative consequences disproportionally impact upon the SMEs, which form the engine of economic growth in Germany. These companies, in turn, do not get to commensurately profit from the reduction in corporate taxation.
Financing for large-scale projects is nowadays routed via dedicated-purpose vehicles, for purposes of minimizing risks or satisfying balance sheet imperatives. Today, it is virtually impossible to realize a project without setting up such a company. This holds especially true for large-sized projects. Such companies are set up to serve as vehicles for the refinancing of the project. Their earnings stem from the project’s sale or long-term usufruct. This practice is becoming more and more widely used in PPPs (public private partnerships). By increasing overall operating efficiency and by producing notably-large savings, these increasingly prevalent arrangements (PPP) have a great positive benefit on the economy as a whole.
A project’s requisite equity ratio generally increases with the level of associated risk. Should however an adequate quantity and quality of collateral be provided, banks are in certain cases willing to provide all of the capital required for the project. In such arrangements, neither tax deferrals nor savings are either striven for or achieved.
The introduction of the limit on interest-deductibles removes up to 60 % of the immediate tax deductibility accorded to interest expenditure classified as operating expenses and necessitated by long-term assets. This change leads to project financing’s being overtaxed, as it precludes the interest carried forward’s being fully utilized in standard situations. The sale of the project, by way of an example, causes a portion of the interest carried forward to lapse unutilized. The result of these changes: Germany-based dedicated-purpose companies will no longer be able to realize projects of investment in the country. The limit on interest-deductibles applies only to companies with equity ratios of less than 50 % ratios above this mark are both seldom and economically unrealistic. This situation joins with the facts that the refinancing of capital commitments and the restructuring of long-term conditional loans are no longer possible in triggering a wave of bankruptcies. This of course was anything but an objective of the legislators promulgating the reform.
Especially hard hit by the changes are SMEs which use subsidiaries having the legal forms of partnerships to secure financing for their large-sized investments. For such companies, the enactment of the limit on interest-deductibles causes a rise in total trading and corporate income tax payments. These rises will, in some cases, have serious consequences. Affected in the same way are the dedicated-purpose companies so prevalent in the leasing sector, in which the use of such financing vehicles is standard operating practice. The raising of the limit from EBIT to EBITDA did partially remedy the problem – at least for those companies engaged in the standard leasing of movable property. It did, however, not completely and satisfactorily eliminate the problem, with this especially applying to companies leasing real estate and large-sized movable property, several detailed and expert petitions and position papers from BDL (Germany’s Association of Leasing Companies) notwithstanding.
The legislation formulation process was accompanied by a dialogue between Germany’s federal finance ministry and the country’s business community on how well executive orders would solve the problems posed for dedicated-purpose companies and providers of financing for projects. This discussion has been set forth in the post-promulgation period. Common ground was found in the concept of a dedicated-purpose company’s having a comparable nature of operation as that of a bank. Rather than securing its revenues from interest payments and principal repayments, a dedicated-purpose company receives them from rents and leasing installments. The latter, however, contain the charged-on costs of refinancing. Viewed from the dedicated-purpose company’s point of view, these are equivalent to imputed interest income. Viewed objectively, the bank’s revenues from interest and repayment do correspond to the rent revenues accruing to the dedicated-purpose company. As a consequence, a dedicated-purpose company has to be taxed in the same way as a bank. This entails the interest component contained in rents and leasing installments’ being able to be offset against refinancing interest in the limit on interest-deductibles. This offsetting is not to be dependent upon the lessee’s factoring this interest component into its calculation of trading tax base. An alternative solution is currently being considered. Its essential precondition is the establishment of a corresponding regulation. This solution would also lack practicability in rentals undertaken outside Germany.
Summary: Ex post facto revisions of several provisions of the reform would be highly welcome. These should incorporate the ideas advanced in the statements submitted by BDL, and would eliminate the negative side-effects (ones surely not striven for by legislators) of the limit on interest-deductibles, and would do so without causing this provision, which is in and of itself efficacious, not to have the desired effects. Financial authorities recently issued a statement pointing to the use of fairness-assuring measures in the warding off of insolvencies. Such measures do not sufficiently address either business needs or criminal liability concerns.