Tax Planning: Structuring Foreign Investments In Germany

1
Tax PlanningStructuring Foreign Investments In
Germany

• Prof. Dr. Ulrich Prinz, WP/StB
• August 8, 2007

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AGENDA

• Business Taxation in Germany Overview
• Cross-Border Business
• Tax Consolidation
• Thin Capitalisation Interest Cap

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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)

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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
  firms 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

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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

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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)

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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

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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?

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2. Cross-Border Business Permanent Establishment
United States
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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 arms 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

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2. Cross-Border Business Subsidiary
United States
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2. Cross-Border Business Joint Venture Structure
United States
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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

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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

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2. Cross-Border Business Partnership
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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)

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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?

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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
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3. Tax Consolidation Overview
P AG World Net Group
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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.

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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

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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?

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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 arms length test was not
  successful!

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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
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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
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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 (arms-length arrangement)
• Third party test
• Deemed dividend distribution
• Not deductible

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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
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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
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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

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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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