Reform of corporate tax code: Good intentions shouldn’t be thwarted

by Finanzplatz München Initiative

Munich, October 23, 2006 The members of Munich Financial Center Initiative (fpmi) are in favor of a corporate tax reform of lasting impact. The reduction in nominal tax rates is an encouraging step. This reduction will however only achieve its goal of making Germany’s tax code an inducement for doing business in the country should it lead to a substantially-large cut in the amount of taxation paid by corporations. This goal could be foiled by an accompanying and comprehensively-large broadening of the base of tax assessment.

The latter could be accomplished by the limitation in the tax deductibility of interest and other financing-caused expenditures now being discussed by members of Germany’s ruling coalition. The implementation of such measures would cause corporations to experience new encumbrances and would curb their willingness to invest. fpmi also maintains that the incorporation of interest on debt would impair the credit dealings undertaken with corporations, with all of the corresponding negative effects on Germany’s financial community as a whole. The proposed move would also contravene the objective of simplifying and not complicating Germany’s tax system.

fpmi hopes, for this reason, that the ruling coalition will have the courage to formulate a reform of Germany’s corporate tax code that leads to a real reduction in the corporations’ tax burden, and that it does not cause the arising of new hindrances. Accomplishing such would benefit the German public sector as a whole, as the creating of a system of taxation of international-level comprehensibility and viability would have a positive effect on the tax revenues reaped by the state.

Below are the in-depth statements released by fpmi’s members on the reform of Germany’s corporate tax code:

Association of Bavaria’s banks: avoid changes in tax codes harming business

International-level comparisons reveal that Germany’s level of corporate taxation is one of the highest in Europe and in the world. Urgently needed to foster growth, employment and international viability is a reform of the country’s corporate tax code which produces a reduction in both nominal and effective levels of taxation. The promulgation of such a reform would enhance Germany’s appeal among domestically and internationally-based investors.

The proposals made by Germany’s government would reduce, as of January 1, 2008, corporations’ nominal level of taxation from some 39% to some 29%. Corresponding tax-cutting measures are to be introduced for partnerships. Although neither constitutes a major revamping of the corporate tax code, both are positive steps. Notwithstanding this, Germany’s business community is pushing for a ceiling on total corporation taxation of 25%.

These cost-reducing measures will only produce their desired effects – of increasing the German business community’s potential for growth – should they not be accompanied by so-called and contravening ‘offsetting financing’. Such financing could take the form of making the outside capital secured by companies subject to major and all-encompassing taxation. Such changes would do great harm to Germany’s business community. They would make it more difficult for investments to secure requisite financing, and would thus curb growth and employment. These changes are, for those reasons, to be strictly rejected.

The reduction in the nominal level of taxation has to yield a decline in the net amount of taxation paid by companies. This move would take into account the companies’ having been in the recent past subject to changes yielding on balance a greater increase in net taxation than that experienced by private households.

Germany urgently needs an improvement of its tax codes, one that will enhance the viability of domestically-based companies competing on the international level. The country’s legislative bodies are called upon to make all due haste in enacting the measures putting the country on a course for high growth and low taxes.

BayernLB: requisite is the reduction of nominal tax rates

1. Key points of corporate tax code reform:
On May 12, 2006, the German government reached an agreement on the key points to be contained in the reform of the corporate tax code, as detailed in a press release issued by Germany’s federal ministry of finance:
  1. Today’s corporate income and trading taxes are to be replaced by federal and local-level corporate taxes, each of which is to be calculated using the same base of assessment.

  2. The nominal level of total corporate taxation is to be reduced from 38.65% to just under 30%. Both corporations and partnerships subject to paying income taxes are to profit from the reform. It is to be ascertained which method would produce the optimal results: through the constituting of reserves for investments, or through according preferential treatment to all profits retained by corporations.

  3. Also to be examined for their efficaciousness are measures designed to staunch losses of tax base deriving from the use of outside capital, and ones shoring up municipal finances.

  4. A final withholding tax on capital gains is to be introduced.

  5. Germany’s inheritance tax code is to undergo modifications easing the inter-generation transferring of corporate ownership, with this to be accomplished by according tax privileges to the setting forth of family ownership of companies.

  6. Measures to secure offsetting sources of financing have yet to be resolved. A range of models is currently undergoing examination. One option would be to recapture interest or interest components; another to limit the deductibility of expenditure for outside capital. It appears that a limit on interest-deductibles is currently being favored. It would set ceilings on the amount of interest and other costs of financing which companies could immediately declare to be operating expenditure. These ceilings would take the form of a certain maximum percentage of expenditures or of profits. Those costs which were not capable of being deducted in the current financial year could be carried forward into the next one.

  7. With this to include the offsetting effects of the final withholding tax, the reform of the corporate tax code is expected to reduce tax revenues by €5 billion. Germany’s finance minister had originally foreseen the final withholding tax’s having a 30% rate at its time of introduction in 2008. This was then to be reduced to 25% in 2009. Recent deliberations foresee the introduction of the tax in 2009 and at a rate of 25%. A final decision on this matter has yet to be made.

2. Position taken:

Forming part of the reform of the corporate tax code, the introduction of a final withholding tax on capital gains is well worthy of being welcomed. This tax is expected to yield a simplification of the tax code. This, however, will only be accomplished should the final withholding tax have a moderate rate. Germany’s banking associations are advocating a maximum rate of 20%. This tax is supposed to be introduced in 2008. This still seems like an excellent idea. Achieving this means resolutely sticking to the schedule of formulation and promulgation, which foresees the legislative process as having been completed by mid-2007. To enhance the viability of Germany’s financial community by strengthening the trust accorded by investors to it, clarity has to be promptly forthcoming as to the tax’s provisions and applications. An early-stage finalization of these will facilitate their subsequent technical implementation.

The competition for investment prevailing among the world’s countries necessitates the reduction of the nominal rates of corporate income and other taxes. The measures designed to offset the costs of this reduction – involving the recapturing of interest payments on outside capital or of interest components, or the placing of limits on the deducting of expenditures for financing – are to be rejected, as they both blunt the effects of the nominal reduction of tax rates, and as they more strongly and negatively affect the country’s SMEs than they do corporations which enjoy easy access to capital markets and have efficacious ways of securing equity. Should legislators ignore these considerations and opt for these measures, the allowances for exemptions should be generous in size, so as to prevent the disproportionate increasing for SMEs of the costs of securing outside capital. The structure of banks’ financing will make it necessary to enact regulations especially applying to them (along the lines of the provisions made in trading taxes for so-called ‘interest on permanent debt’).

Bavarian ministry for economic affairs, infrastructure, transport and technology: tax reform has to substantially reduce corporate burdens

Economic considerations dictate that companies should pay taxation amounting to some 25% of their sales. This rate should by no means break the 30% mark. Within this mix, corporate income taxes (rather than trading taxes) have to remain the main kind of taxation. Should Germany succeed in reducing its rate of taxation to less than 30%, it would approach Europe-wide averages.

The total amount of tax reduction should be at least €5 billion. All of this is to accrue to the country’s business community, as doing such will foster its ability to achieve, and will decisively enhance the attractiveness of Germany as an object of investment. Corporate tax revenues are currently on the rise. This increase provides the government with the resources requisite to carry out this bold move. The costs arising from the introduction of final withholding tax, which is designed to staunch the outflow of private capital, are not to be intermingled with those of reducing corporate tax burdens.

An objective informing the implementation of the corporate tax code reform is the quelling of operations configured to profit from international-level variations in taxations, at thus the expense of Germany and its tax revenues. The pursuing of this objective is to be closed linked to avoid abuses of the system. The recapturing or non-deductibility of interest on debts, or of leasing and rental payments, or of licensing fees should not lead to companies showing low rates of equity’s experiencing rises in tax burdens.

Deutsche Bundesbank: Tax code could be made even more complex

The Deutsche Bundesbank detailed its position on the reform of the corporate tax code on page 59 of the August, 2006 edition of its monthly report. In the article, the Bundesbank calls for the strict observance of such fundamental principles of taxation as the showing of no bias towards any particular kind of financing, and the same-year taking into account of losses. The Bundesbank also expressed its wariness about the special rules set for introduction or expansion. These, it maintains, could make the tax code even more complex. The position paper (in German) is available here.

Bavaria’s association of cooperative banks and credit unions: new key provisions are a step in the right direction

According to the information available, a working group comprised of members of parties forming the governmental coalition has reformulated the key provisions of the reform of the corporate tax code. The information indicates that the regulations regarded by companies as causing especially great problems and bureaucracy, with these pertaining to the recapturing of interest and the elimination of interest deductibles, have been removed.

Reformulation of key provision of reform of corporate tax code

On October 27, 2006, the working group comprised of representatives from the coalition parties will convene to consider the provisions of the reform of the corporate tax code resolved upon on September 27, 2006. The information currently available indicates that the rates of corporate income tax and trading tax will be reduced to 15% and 3.3 % respectively. These cuts would reduce corporations’ tax burden from some 38% to some 29%. Provisions on the constituting of retained earnings reserves will assure partnerships (with these including providers of services not requiring prior certification of suitability) of receiving the same tax treatment as corporations.

Not to be retained are the proposals to use the recapturing of expenditures for outside capital (interest, rents and leasing payments) and for the introduction of a limit on interest deductibles (which foresees spreading the deductibility of operating expenditures over several years) as source of offsetting revenues. These sources are to be replaced by a beefing up of the regulations applying to outside capital supplied by a partner. This is regulated in § 8 of Germany’s Corporate Tax Code. Trading tax is no longer to be deductible as an operating expenditure. Providers of services not requiring certificate of suitability are to become trading tax liable. Also planned are the re-elimination of the declining balance method of calculating depreciation, and the near doubling of the amount of real property tax levied on corporations.

The introduction of the final withholding tax on January 1, 2009 remains a matter of dispute. The Association has come out for this new tax, as it constitutes the only way of inducing a substantially-sized inflow of capital originally ‘exported’ abroad. This should be accompanied by a reintroduction of “bank non-disclosure” provisions. The elimination of the costly inspections and monitoring and obligations to secure certification (with these including the procedure of securing bank account statements and the obligation to submit certification of annual payment of taxes) currently in use and the setting of a moderate rate of final withholding tax will join to make a reduction in tax revenues improbable. We’re calling upon legislators to introduce the final withholding tax in 2008, as we believe that a longer term between resolution and promulgation will harm the German economy as a whole, by causing an ‘emigration’ of capital – with all its attendant negative effects.

We expressly hail the elimination of non-earnings components (interest payments on permanent debt) of trading tax from the base of assessment used in calculating corporate income taxes. We do however regret the failure to take the next logical step towards achieving a unified system of income tax calculation. The optimal result of the reform process would have been the complete elimination of the trading tax.

Delay in reform of Germany’s inheritance tax

The reform of the inheritance tax is expected to be postponed. This postponement constitutes an opportunity to improve the act’s provisions.

Inheritance tax reform: the German government won’t take action until the country’s Federal Constitutional Court has issued its ruling. Information available to us indicates that the German cabinet will issue a decree in mid-October enabling the first and second readings of the Reform Act in the Bundestag (Germany’s parliament) by the end of 2006. The rest of the legislative process – and thus a final determination of the Act’s contents – is, however, to be postponed until the Federal Constitutional Court has determined the constitutionality of the bias shown towards operating assets. This postponement would constitute an opportunity to reconsider the regulations foreseen for the Act. These set up a system of valuation distinguishing between productive and non-productive assets, and between requisite and non-requisite corporate assets. These regulations would cause a great deal of bureaucracy, and show little understanding of the matter at hand. A prime concern of SMEs is the handling of changes in ownership. This concern mandates that the regulations applying to this be highly practicable and flexible.

The Association proposes that the consideration of business necessities take the form of the establishment of generously-sized exemption allowances. These would ensure a large number of small-sized companies of realizing a reduction in tax burden. Our proposal is for an allowance amounting to €400,000 and available to all. The parties forming the ruling coalition have advanced the idea of setting up an allowance of €100,000. This is a step in the right direction, and would benefit both a large number of taxpayers and the tax authorities by substantially reducing the amount of their declaring and work. The drop in tax revenues would be minor in comparison to the dimensions of the benefits.

The Association is calling upon the country’s legislators to take the brave step of abolishing the inheritance tax within ten years’ time for those family members who inherit a company and then continue to manage it. The determination of eligibility is to be done without imposing hindrances, excess paperwork and provisions of proof.

Bavarian congress of chambers of industry and commerce: plans show lack of resolution

According to a study conducted by Bavaria’s chambers of commerce and industry (BCCI), the state’s business community is highly optimistic about its prospects. For many years, sales abroad constituted the engine of economic growth in the state. This growth is now also revving up those sectors serving domestic demand. The study finds that companies do, however, expect the upswing to slacken in 2007.

Now required is a strengthening of the engines of domestic growth. Instead of this being accomplished, tax increases have been placed on the agenda. Many companies have recently sharply and downwardly revised their business expectations. These oft frightening drops are partially attributable to a loss of confidence in the CDU-CSU/SPD coalition’s willingness and ability to undertake reforms. This is especially pronounced in the area of corporate tax code reform. Instead of resoluteness, the coalition is showing irresolution. Should the act and its key provisions be passed in its current form, the country’s SMEs would bear its negative brunt. The strong increase in the tax revenues accruing to the government eloquently details the fact that economic growth is the only way to secure a greater amount of tax income. The country’s politicians therefore have to rely on a tax cut’s self-financing effects when planning measures offsetting losses of tax revenues. The BCCI call for the considering of the increase in corporate tax revenues as being the up-front financing of the reform of the corporate tax code, and for a refraining from plans to increase bases of tax assessment, with this to be carried out by the incorporation of interest paid on outside capital.

The BCCI point out that the increase in corporate tax revenues will amount to some €7 billion this year, with the total coming to more than €23 billion. The trading tax is expected to increase by some €4 billion to €36 billion in 2006. All told, the total increase in corporate tax payments is forecast to come to much more than €10 billion, with this including the above-average rises shown in the taxes paid by partnerships and single-person companies. With these increases, the companies could well provide the financing required for the reform of the corporate tax code. Politicians have to allow themselves to be influenced by the strong growth in corporate tax revenues, and have to modify their plans to set up offsetting financing.

KG Allgemeine Leasing: offsetting financing plans imperil investment propensity

“The reanimating of investment is the key to generating economic growth.” Contract of coalition, November 11, 2005

“The ruling coalition is going to enact a reform of the corporate tax code which will substantially enhance the appeal of Germany to international businesses, and will dramatically improve the conditions under which companies based in Germany compete for business.” Credo of reform of corporate tax code, July 2, 2006


These fundamental principles were supposed to inform the programs undertaken by the ruling coalition. They are completely contravened by the proposals being considered by the coalition to “offset” the costs of the reform of the corporate tax code. The taxation planned for financing costs – be it in the form of a recapturing, or be it in the form of a limitation of deduction – represents a direct intervention in the highly-sensitive area of investments. There are currently a variety of proposals being considered. They would make investments more expensive, or would hinder them, or would even completely prevent them. The key to increasing the amount of investment in Germany is the cutting – with this referring to the effective and not nominal rate – of taxation. The reduction of rates of taxation will have no net effect, should it be accompanied by a broadening of the base of tax assessment which is achieved by adding to it investment costs. The proposals for reform have triggered responses by companies based in Germany and by those non-German ones considering investing in the country which are diametrically opposed to the ones foreseen by the new act. Many of them are highly unsettled by and deeply worried about an act which was actually originally proposed to provide them with more productive operating conditions.

A limitation of the deduction of interest will cause, in many cases, companies which have broken even or which have even registered losses’ having to pay taxes. This implies that the institution of a limit on tax deductibles will also not suffice to eliminate the problems of taxation upon property and the hindering of the founding of companies. A further point of criticism is that this limit will defame all payments of interest, rents, license fees and lease installments as “tax-caused configurations”. This will include those payments which represent recompense for services flowing between completely unrelated parties. Affected by this change would be annual investments of €50 billion in the leasing sector alone. This is equivalent to one fifth of all investments in capital goods made each year in Germany. All of the investments undertaken by domestically-based leasing companies are made in Germany, and virtually all of them are provided for the utilization of companies which do not form part of affiliated groups. The shifting of profits abroad which the act wishes to prevent is thus innately impossible in such corporate situations.

Viewed in general terms, the treatment of leasing as a form of outside financing is not justified. Leasing is, rather, a complex service entailing the provision of business assets for utilization, of a wide range of service components, and of a variety of risk management modules and options. The educing of an “interest component” out of leasing, which is, after all, a service, seems highly arbitrary, as does the use of this component as an addition to the base of tax assessment, especially since other services showing a comparable intensity of deployment of capital goods have been exempted from this arrangement. By way of an example: a company using a fleet of leased vehicles – and ones whose management is undertaken by the lessor in a full-service arrangement – will have to include the ‘leasing component’ when calculating its taxes. A competitor commissioning a freight forwarder with the transport of its goods is not called upon to do this, even though the transport fees also comprise the forwarder’s payment of interest upon the real capital it has employed.

Hence our urgent appeal to the ruling coalition: dispense with the recapturing of interest and with the limitation of the deductibility of expenditures for financing, as they will encumber the propensity for investment shown in Germany. This, in turn, will sap the positive effects foreseen to accrue from the improvement of the conditions of taxation experienced by companies investing in Germany. Rather than doing the above, the offsetting of the costs of the reform could be much more efficaciously and investment-compatibly carried out by, for instance, by the increasing of the taxes on real property.

Munich Re: offsetting finance worsens reinsurers’ operating conditions

We view the reduction to below 30% in the nominal corporate burden foreseen by 2008’s reform of the corporate tax code as being an important step towards assuring the international-level viability of Germany’s business community. The municipality of Munich uses a relatively high percentage of the basic rate in calculating its trading tax. This implies that the tax burden would only be reduced to less than 33% for companies based in the city, a level which is still far too high by international standards. The German government plans on setting up a single, unified base of tax assessment. This would greatly streamline the administrative procedures undertaken by companies and tax authorities.

The positive signals emanating from the tax cut are being countervailed by the measures being considered to offset the cut’s costs and to shore up municipalities’ finances. The measures are designed to limit the deductibility of expenditures for financing. Fundamental principles lead us to reject a percentage-based recapturing of interest and interest components, and a limitation on the deductibility of expenditures for financing, with this to take the form of a ‘minimum tax’. A recapturing of components which are not derived from earnings would lead to a taxation of basic worth, and this would flout the principle of taxation being levied according to achievement. It would also meet with incomprehension on the international level. The institution of such regulations would make Germany even more unattractive to reinsurers, as the measures would cause a rise in the costs of procuring capital, and would also intensify the minimum taxation levied on losses carried forward which so disadvantages reinsurers, which have to contend with volatile tax-liable results.

Reinsurance is the sole remaining segment of the international market for financial services in which Germany has been able to retain a position of leadership. The maintaining of this position will be decisively determined by the creation of a tax system imparting viable operating conditions. The proposed cut in tax rates represents a step towards achieving this goal. It can not, however, be accompanied by the establishment of contravening and tax-caused obstacles.

The Association of Bavaria’s Business Community (VBW): a corporate tax code reform producing growth and employment

The reform of the corporate tax code has to achieve four things:
  1. Corporations’ tax burden has to be reduced to a level which is viable and productive by international standards: some 25%.
  2. If not simpler, the reform has to produce a corporate tax code which is at least easier to understand. And the reform has to be in accordance with the laws of the land and of Europe.
  3. The amount and form of taxation levied has to be calculated and chosen to foster economic growth, while assuring the accrual of the requisite tax revenue.
  4. This is because the public sector – at the federal, state and local levels – needs money.
The proposals being considered by the ruling coalition and divulged prior to summer 2006 do not achieve any of these objectives. Quite the opposite. The proposals would seriously increase the tax burdens borne by a large number of companies. The key problem stems from the plan to tax interest.
Interest taxation: taxes causing a crisis
The reform will reduce the tax burden to 30% – but only in nominal terms. Proposed is to offset the cut by taxing the financing components of interest paid on outside capital. This is to be done in forms which could cause companies dependent upon securing outside capital to be burdened with tax obligations several times greater than their annual profits.

This kind of reform would tip weak companies over the edge and into bankruptcy, and would impair the operations of Germany’s financial sector as a whole, as credit would cease to be a source of corporate financing once interest would start being taxed in the proposed way. The latest available reports give reason to hope that the most damaging provisions on interest taxation are no longer being considered. They are, in any case, inimical to a body of regulations striving to assure adequate rates of earnings and growth.

Reform has limited impact
Along with the disentangling of corporate income and trading taxes, one key objective of the proposed reforms is to make our tax system easier to understand. This objective is timely and important. But this reform fails, however, to attempt to reinstate the oft-violated basic principles of corporate taxation, with these including the ideas of taxation being determined by ability to pay and by the netting of objective items. Quite the opposite. The tax laws currently being considered (SESTEG, which implements EU-level tax codes in Germany and the 2007-enacted tax code) give rise to a new warping of the tax system. The reforms currently under discussion have to be followed by the undertaking of the next necessary steps.

Growth incentive or punitive tax code?
The reasons given for the assaults on a tax system which features a cogency of internal structures, a durability of use, a pan-European legal validity, and an openness to the needs of companies competing for business on international levels are always the same: current regulations are being misused and the budget requires these changes. The seemingly logical and requisite actions to be undertaken: the regulations have to be beefed up, taxes have to be kept high. The opposite courses of action would in actual fact produce the desired results. Companies would pay greater amounts of taxes in Germany if its tax system had appealing structures and rates. The companies would make their investments in Germany once it had been shown to be a base for profitable operation.

A tax code designed to be punitive and to curtail tax flight is fundamentally incapable of achieving these objectives. But these have to be the objectives of the reform of the corporate tax code. Should it accomplish them, the reform will trigger investments, and these will increase tax revenues and social account payments.

The financing of the reform of the corporate tax code: the problems are smaller than indicated
Germany’s budget planners have decided that the “costs” of the reform of the corporate tax code are not to be more than €5 billion. Germany’s business community, on the other hand, has determined the amount required to generate substantial growth – not more and not less. We estimate this amount to be at least €9 billion. To put this amount in perspective, Germany’s companies paid some €100 billion in taxes in 2006 (vbw will gladly provide the calculations used in deriving this sum). As this comparison indicates the total tax cut which we view as being necessary amounts to no more than 9% of the tax revenues received this year. And these revenues have been strongly increasing over the past few years. A tax cut of this size will produce the desired results.

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