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Tax Planning: Structuring Foreign Investments In Germany. Prof. Dr. Ulrich Prinz, WP/StB August 8, 2007. AGENDA. Business Taxation in Germany – Overview Cross-Border Business Tax Consolidation Thin Capitalisation – Interest Cap.
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Tax Planning:Structuring Foreign Investments In Germany Prof. Dr. Ulrich Prinz, WP/StB August 8, 2007
AGENDA • Business Taxation in Germany – Overview • Cross-Border Business • Tax Consolidation • Thin Capitalisation – Interest Cap
Business Taxation in Germany – Overview of German Business Entities • Aktiengesellschaft: Public limited company • Fixed share capital (at least EUR 50,000) divided into shares • Legal entity • Dividend payments (half income system/new flat tax planned, starting 01.01.2009) • Gesellschaft mit beschränkter Haftung: Private limited company • Fixed share capital (at least EUR 25,000) • Legal entity • Dividend payments (half income system/new flat tax planned, starting 01.01.2009)
Business Taxation in Germany – Overview of German Business Entities • Offene Handelsgesellschaft: General partnership • At least two partners • No share capital required • Partners are jointly and severally liable for the firm’s liabilities • Partners earn profits (transparency principle) • Kommanditgesellschaft: Limited partnership • One or more general partners with unlimited liability and • At least one limited partner whose liability is limited • Partners earn profits (transparency principle) Dual structured taxation of business activities
Business Taxation in Germany – Overview of German Business Entities • GmbH & Co. KG: Limited partnership with a private limited company as general partner • For tax purposes treated as limited partnership • Very common structure for medium sized entity types
1. Business Taxation in Germany – Overview of German Business Entities • Overall tax burden for an entity ≤ 40 per cent; transparent partnership with natural person or co entrepreneur up to 45 per cent income tax • Corporation tax (tax rate 25 per cent, 15 per cent planned from 01.01.2008) + solidarity surcharge 5.5 per cent = 15.8 per cent • Trade tax (= municipal tax, levy rate for trade tax purposes = 300 – 490 per cent, depending on municipality) • Value-added tax – VAT (19 per cent standard rate, 7 per cent for specifically defined goods) • Real estate transfer tax (3.5 per cent of real estate value, 95 per cent transfer of a company (shares) or a partnership may trigger real estate transfer tax if the company owns real estate)
1. Business Taxation in Germany – Overview of German Business Entities • Every calendar year • Tax base of the Corporation Tax Act (KStG) • KStG refers to the Income Tax Act (EStG) • All income categorised as income from trade and business • Worldwide income (but DTC to avoid double taxation) • Principle of congruency (Maßgeblichkeitsprinzip) CCCTB-Project (= Common Consolidated Corporate Tax Base) • Taxable profit/loss shown in the Steuerbilanz (balance sheet prepared for tax purposes) is the basis for taxable income
2. Cross-Border Business: Basic Considerations A Inc., a corporation resident in the US, plans to start up business in Germany. The corporation renders computer management services to German customers. The Chief Executive Officer has to decide whether to: • found a permanent establishment, • form a corporation under German law or acquire a shareholding in a German joint venture company, • participate in a German partnership. What do you think the differences are from a tax point of view?
2. Cross-Border Business: Permanent Establishment United States
2. Cross-Border Business: Permanent Establishment • Dependent part of the enterprise • Criteria in German tax law: Sec. 12 of the General Tax Code (AO) • Criteria in double tax conventions (Art. 5 OECD-MC) • Modified dealing at arm’s length principle (Art. 7 OECD-MC) • Subject to taxation as a non-resident (source taxation) • Business expenses only deductible for income determination purposes if commercially related to Germany • Deduction of losses is unrestricted if losses are commercially related to German income and can be demonstrated • Tax rate 25 per cent; no withholding tax
2. Cross-Border Business: Subsidiary United States
2. Cross-Border Business: Joint Venture Structure United States
2. Cross-Border Business: Subsidiary/Joint Venture Which function will be assigned to the German subsidiary/joint venture? • Fully-fledged • Commission model or • Agent model
2. Cross-Border Business: Subsidiary/Joint Venture • Independent corporation under German law • Acting in its own name and on its own account • Function in Germany • Stripped buy-and-sell • Subject to German taxation as resident • Business expenses deductible • Deduction of losses possible • Tax rate 25 per cent on taxable income • Subject to trade tax • Source taxation of profits withholding tax on dividend payments to the shareholder, DTT
2. Cross-Border Business: Partnership • Independent partnership under German law • Acting in its own name and on its own account • Subject to trade tax but not to corporation tax or income tax • Transparency principle tax rate at least 25 per cent for non-resident taxpayer • Business expenses deductible • Deduction of losses possible • (Liability risk)
3. Tax Consolidation: Overview P AG, resident in Germany, has several subsidiaries (different legal forms, different economic situations). Every company itself, P AG and its subsidiaries, pays taxes in Germany on its own (corporation tax, trade tax, VAT), Logistics GmbH makes losses and therefore pays no taxes; Thames Ltd pays taxes in England. The Finance Director wants to know whether German tax law allows group treatment. In commercial law, P AG and its subsidiaries are treated as a group (P AG World Net). What would you suppose?
3. Tax Consolidation: Overview German tax law allows tax consolidation (group treatment but without consolidated accounts) for the purposes of • Corporation tax • Trade tax • VAT (special criteria: economic and organisational integration) if a subordinate corporation (consolidated subsidiary) is integrated into the enterprise of the controlling parent corporation. same criteria
3. Tax Consolidation: Overview P AG World Net Group
3. Tax Consolidation • Financial integration • Majority of voting rights (qualified majority) • Indirect shareholding via subsidiary possible • Profit transfer agreement (profit-and-loss absorption agreement) • At least five years • Recorded in the register of companies • Only resident legal entities can be part of tax consolidation; that means: the Asset Management GmbH & Co. KG can not be part of the organic unit.
3. Tax Consolidation: Consequences • Losses of the consolidated subsidiary can be offset against the profits of the parent or vice versa; P-AG is liable for all risks in the group • No withholding tax on dividends distributed by the consolidated subsidiary to the parent • No denial of refinancing expenses at parent level directly in connection with the shareholding in the consolidated subsidiary pursuant to Sec. 3c EStG • Structure with minority shareholder guaranteed dividend payments
4. Thin Capitalisation Rules Rich Industrial Inc., resident in the US, is the only shareholder of Rich Industrial Machines GmbH. In order to expand business in Germany, the company requires 15.0 million euros (alternative 20.0 million euros). Rich Industrial Inc. is considering whether to finance this project either by equity or debt. Therefore the CFO is not sure if Rich Industrial Inc. as well as the bank should give debt to its subsidiary. Moreover he is interested in avoiding possible disadvantages from a tax point of view. What would you advise him to do?
Rich Industrial Inc. Rich Industrial Machines GmbH 4. Thin Capitalisation Rules • Fixed interest loan sec. 8a (1) no. 2 KStG • Hybrid loan sec. 8a (1) no. 1 KStG • Safe haven • Double taxation problems • Interest & • Amortisation 15.0 million euros • Interest rate: 6.0 % • Result: interest treated partly as deemed dividends, if arm’s length test was not successful!
4. Thin Capitalisation Rules Deutsche Bank AG Guarantee? Rich Industrial Inc. • Interest & • Amortisation • Interest rate: 6.0 % 15.0 million euros Rich Industrial Machines GmbH
4. Thin Capitalisation Rules Rich Industrial Inc. Equity Financing From a tax point of view: the most inefficient way to finance, due to the leverage effect. 15.0 million euros Rich Industrial Machines GmbH
4. Thin Capitalisation Rules: Sec. 8a KStG Conditions: • Interest paid to shareholders holding at least 25 per cent • Interest (remuneration) more than 250,000 euros • Save haven of 1.5 debt to 1 equity • Not applicable if the corporation could have obtained the loan from a third party under the same circumstances (arm’s-length arrangement) • Third party test • Deemed dividend distribution • Not deductible
Inbound • Domestic • Outbound M Ltd. M Ltd Interest Interest M AG T GmbH T GmbH Interest T GmbH 4. Thin Capitalisation Rules: Application of Sec. 8a KStG Thin capitalisation rules? Abroad Germany • Constructive dividends? • Waiver of interest? Tax-exempt income? Sec. 8b (1) sentence 2 KStG Applicable for non resident taxpayer
LT BV 100 % DM 3 million 4,5 % LH BV 100 % LH GmbH 4. Thin Capitalisation Rules: European Union law • Judgement of the European Court of Justice in 2002 • Lankhorst-Hohorst decision LT BV = shareholder/ person related to shareholder? • Tax authorities: “hidden dividends” • Hoge Raad judgement 24.05.2002 • Double taxation NL D Save haven is not applicable
4. Business Tax Reform 2008: General Interest Cap • New rules will replace the current thin capitalisation rules • They will place an annual cap on all interest deductions (related and unrelated parties) • Sum of all interest income and all interest expenses exceeding an amount equal to 30 per cent of the taxable income before the interest income and interest expenses, depreciation and amortisation (EBITDA) • Smaller businesses excluded if • Net interest expense in excess of 1.0 million euros (threshold) per year • Does not belong to a group
4. Business Tax Reform 2008: General Interest Cap The German X partnership shows a profit/loss for the period of 0 euros on its profit and loss account. For same period the company had interest expenses of 10.0 million euros, interest income of 1.0 million euros and depreciation of 2.0 million euros.
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