Germany Least Attractive Location for Taxing Digital Business Models

While the US tax reform under President Donald Trump is intensifying global tax competition and many European countries are increasingly promoting investment in innovative business models, Germany is falling behind on the global stage due to its unchanged high effective tax burden. As a result, Germany has come in last in an international ranking comparing the tax attractiveness of countries for investments in digital business models. This is the key finding of the study “Digital Tax Index 2018: Locational Tax Attractiveness for Digital Business Models”, carried out by the Centre for European Economic Research (ZEW), Mannheim, together with the University of Mannheim and the auditing and consulting firm PricewaterhouseCoopers (PwC).

The results of the study, which has been conducted for the second year now, are somewhat sobering for Germany. Of the 33 countries considered, Germany shows the highest effective average tax rate for digital companies (22.2 per cent), exceeding even the USA (22 per cent). By contrast, the effective average tax rate for all countries considered is around 8.8 per cent. Italy (minus 33.2 per cent), Ireland (minus 3.4 per cent), Hungary (minus 0.5 per cent), Lithuania (minus 0.05 per cent) and Latvia (0.1 per cent) occupy the top five spots in the ranking.

“Germany has come under massive pressure to avoid further tax obstacles to investments in digital business models. This is primarily important for the creation of new jobs,” says ZEW Research Associate Professor Christoph Spengel, Chair of Business Administration and Taxation II at the University of Mannheim and co-author of the study.

The Digital Tax Index 2018 analyses tax location factors relevant for investments in digital business models and compares data from the EU-28 as well as Canada (rank 23), the USA (rank 32), Japan (rank 31), Norway (rank 13) and Switzerland (rank 26). For their analysis, the authors of the study calculated the cost of capital and effective average tax rates on investments, taking, among others, tax rates, depreciation rules for software and hardware, tax incentives for research and development (R&D) as well as preferential tax regimes for promoting income from R&D activities into account. Among the countries analysed as part of the study, the effective average tax rate ranges from minus 33.2 per cent in Italy to plus 22.2 per cent in Germany.

Compared to last year, this year’s overall ranking clearly shows that, on average, both the cost of capital and the effective average tax rates continue to fall internationally. This development is driven by the increase of tax incentives for R&D activities, for example in the Netherlands (rank 15), as well as the introduction of write-offs of 250 per cent for investments in IT infrastructure and reductions in corporate tax rates, as in Italy.

Germany still lacks tax incentives for R&D activities

“Germany has become the least attractive location in terms of effective tax burden as well as for digital business models. Not least due to the massive reduction in the burden of corporation tax and the preferential taxation of foreign profits, the USA has improved its position in the battle to attract digital companies, pulling ahead of Germany,” explains Christoph Spengel.

The study further shows that, particularly in the European context, tax incentives for R&D activities are increasingly being used to stimulate investment in innovation. “In Germany, this form of research funding does not yet exist in practice, which may put the country at a disadvantage in international comparison,” explains Spengel. This is because digital business models only benefit from tax incentives for R&D if the regulatory framework is broad enough to cover more than just usual laboratory activities or patentable economic goods. For example, measures such as tax credits in Belgium (rank 21) or additional tax deduction in Croatia (rank 6) promote not only the development and use of software but also the development and optimisation of digital processes.

Platform-based digital business models in particular benefit from special tax regimes, as they strongly focus on software development. “These business models are highly flexible as they are not determined by physical location factors, making it possible for them to take advantage of the existing differences in tax burden between countries,” says Spengel. Finally, the US tax reform at the beginning of 2018 provided great tax relief for investments made in the Unites States in digital business models. This has placed local companies at a competitive advantage and has intensified global competition for future investments.

“It can be observed that companies that are embracing digital innovation have become legion. This development has long become brick and mortar, and in a few years all companies will more or less go down that path. If questions arise about where to settle down in business, tax consultants must draw attention to the massive international differences that exist in the taxation of digital business models,” says Dr. Frank Schmidt, tax partner at PwC in Frankfurt.