2008 Corporate Tax Reform: Corrected Plans of the German Federal Government Relieve Companies – However, Further Reform Steps Still Need to Be Taken

The draft of the 2008 corporate tax reform produced by the working group “Reform der Unternehmenssteuer in Deutschland” (Reform of the German Corporate Tax) headed by Roland Koch (CDU) and Peer Steinbrück (SPD) promises relief, but falls short of the coalition agreement’s targets. The fiscal attractiveness of German locations will improve. On the other hand, the sub-goals of an improved tenure and financing neutrality of taxation will not be achieved. These are the findings of a current survey conducted by the Centre for European Economic Research (ZEW) and the University of Mannheim.

On 2 November 2006, the coalition partners agreed on a draft concerning the corporate tax reform planned for 2008, which now is to be turned into law. The main goal is to enhance the attractiveness and competitiveness of Germany as a business location by reducing the corporate tax burden to nominally less than 30 per cent in order to create the necessary conditions for growth and employment.

According to the Federal Ministry of Finance, the planned reform is designed to lighten the corporate tax burden on companies by 30 billion euros. To strain tax revenue with a maximum of 5 billion euros only, the tax base is to be broadened in return.

It is well known that, from a fiscal point of view, Germany is hardly competitive, as the negotiated and effective encumbrances of company profits are among the highest in Europe. This incites the firms to move earnings and production to low-tax areas abroad.

The ZEW carried out calculations on the basis of a medium-sized capital company using the European Tax Analyzer. In the view of the planned fiscal measures, the results suggest that the effective corporate tax burden will substantially decrease by 24.82 per cent to 1,381,410 euros over a period of 10 years. This is particularly due to the fact that reductions in tariffs greatly influence companies of this size, whereas key elements of the scheduled counterfinancing measures are ineffective since the allowance of trade-tax addition regulations for outside capital payments, as well as the exemption limit for the planned interest barrier would take effect. Due to the low depreciation coefficient of 20 per cent, the planned abolition of the decliningbalance method does not entail any additional burdens worth mentioning. In international comparison with twelve states, Germany would thus climb four positions reaching the seventh rank. An examination of further economic sectors illustrates that Germany was able to catch up in terms of international tax ranking and advanced to the lower-middle range. However, bigger companies are less likely to significantly profit from these reliefs on account of the exceeding of the exemption limit/tax allowance. In this context, it should be noted that the introduction of an interest barrier involves the abolition of deduction restrictions for interest from shareholder loans (§ 8a KStG).

The planned withholding tax on private investment income facilitates tax collection and may close taxation gaps. Due to its poor coordination with corporate taxation, however, the withholding tax is very inconsistent with the intended improvement of the financing neutrality of taxation since the encumbrances of company profits exceed the planned final withholding tax rate of 25 per cent on interest income. The result would be the discrimination of equity capital financing, which might influence the attractiveness of investing in Germany as a business location. Besides, the withholding tax does not necessarily relieve distributed profits since in return the so-called half-income system ceases to apply. ZEW calculations also involving shareholders suggest that on an aggregate level, which is particularly relevant for medium-sized enterprises, burdens would reduce by merely 9.81 per cent to 2,302,746 euros.

Including further property tax elements into the tax base of the corporate tax, Germany also missed the fiscally convincing opportunity to simplify taxation for trade tax purposes by adopting the corporate income tax base. Instead, both tax bases increasingly diverge on account of the extensive addition of interest rates (also short-term interest rates) as well as financing quotas to rental and lease expenses, leasing rates and licenses regarding the trade tax. Compared to the plans made by the Federal Government in July 2006, which intended to extend the corporate income tax base by property tax elements, the current regulation seems to be the lesser evil.

The sub-goal of an improved tenure neutrality of taxation cannot be achieved either. The planned accumulation reserve for partnerships, which is designed to limit the income tax burden on retained profits to 28.25 per cent plus solidarity surcharge, offers no way out of the dilemma. It probably also causes an immense administrative workload. Administrative services need to keep records of all members of a partnership drawing on this option. These records have to indicate who withdraws which part of the accumulated profits at which time and thus are to be taxed subsequently. This implies a very complex assessment procedure resembling the structure of the available equity capital of the former corporation tax credit system. In the view of a withholding tax amounting to 25 per cent one might question if an accumulation rate of 28.25 per cent plus solidarity surcharge give any incentives at all to keep funds in a partnership.

The intended taxing of corporate transfers will probably be a very complicated project, which, according to the working group, has a considerable potential for reciprocal financing. On the one hand, this is attributed to the expanded reporting duties and collaboration obligations of the taxpayers. Existing and developing intangible assets, for instance, always have to be recorded in a comprehensible way and be submitted upon request. On the other hand, the required evaluation of the profit potential transferred in connection with corporate transfers and the resulting need for correction due to differences in the actual profits involve great difficulties. It is furthermore essential to be aware of the signs indicating that the plans for the taxation of corporate transactions may fail because they lack conformity with EU law.

It is to be noted that a reduction in tariffs for capital companies to less than 30 per cent improves the fiscal attractiveness of Germany. Medium-sized companies benefit the most as they are barely affected by the planned counterfinancing measures on corporate level. Multinational enterprises will have to wait for concrete rules regarding the interest barrier and the prevention of corporate transfers. The sub-goals of an improved tenure and financing neutrality of taxation will not be achieved. The accumulation reserve for partnerships needs to be reconsidered and the realisation of a withholding tax requires a better coordination with corporate taxation.

Contact

Prof. Dr. Christoph Spengel (University of Mannheim), Phone +49/621/181-1705, E-mail: spengel@uni-mannheim.de

Dr. Timo Reister, E-mail: reister@zew.de