Meteorologists see global warming as a threat. Tax practitioners in Germany see it as beneficial, certainly in the light of its effects on the tax climate. Traditionally, Germany has been ranked as a country with high direct, but relatively low indirect, taxation. That changed, however, in 2008 with a cut in the corporation tax rate from 25 percent to 15 percent following a VAT hike from 16 percent to 19 percent a year earlier. These and the other accompanying changes were part of the then government's policy of reducing direct taxes as far as necessary to be seen to be taking international pressure from, in particular, financial investors and major MNCs seriously, whilst remaining true to its overriding aim of achieving budget equilibrium in 2011. The extra VAT revenue was absorbed into the state budget easily enough; the corporation tax drop called for compensation from within the overall sphere of business taxation.
Businesses in Germany are faced with two taxes on profits – corporation (or income) tax and trade tax. The corporation tax rate change was accompanied by a change in the method of calculating the trade tax due which meant – seen nominally – an overall reduction of the total burden from some 38-41 percent to a theoretical, but highly publicised, finance ministry claim of “below 30 percent”. However, this claim depended on a business location in an outlying country district where local trade tax rates tend to be lower; a more reasonable estimate for a location near a business centre with easily accessible communications by road, rail and air would lie in the range of 32-33 percent.
When pointing to these rates other compensatory changes to the system have to be taken into account. Partly, these relate to simple disallowance of expenditure and partly they serve to increase the trade tax base over that for corporation tax. It is becoming increasingly unrealistic to talk of a composite burden from two taxes with differing bases of assessment, especially when both bases are moving ever farther from accounting income. A measure of the problem can be gleaned from a simple statistic: the corporation tax rate cut of 10 percentage points was to cost – net of compensating items – no more than EUR 5bn within a total federal budget of EUR 280bn. It will be appreciated that few of the compensating items were immaterial to those affected. It is, though, true that the burden was not evenly spread. SMEs in local ownership were spared most of the ill effects of the limitation on the deduction of related-party interest to 30 percent of EBITDA with a generous threshold of EUR 1m interest cost below which the limitation does not apply. Provisions in the Income Tax Act largely offset the trade tax of small businesses with a combination of a credit for the amount paid and a reduced top rate for trading income. The loss forfeiture provisions on change of shareholder do not affect unincorporated entities. International businesses feel the pinch, though, especially as they are also the butt of a toughened foreign tax credit policy aimed at curbing “white” income (income taxable in neither country by reasons of differing legal definition) and treaty-shopping (shifting income by source and location to maximise treaty benefits).
In point of fact, not all of the compensating items are apparent from the legislation. There is a growing tendency for tax auditors to take a hard line in the interests of cash collection. Often this takes the form of an over-emphasis on formality, enabling the tax auditors to move income and expenditure within the audit period (typically five years at one stint) or to disallow tax groups. The resulting recalculation of the tax base can lead to significant shifts in the payment pattern (such as from the accumulation of expense in a loss period) giving the tax authorities, at the least, the opportunity to levy large interest charges and to bring tax payments forward.
Less significant from the point of view of the revenue raised than tougher tax audits, though of far greater publicity value, has been the campaign against the misuse of tax havens. The finance ministry has taken an aggressive stance on “uncooperative tax havens” and has succeeded in negotiating information exchange agreements with most European financial centres with low-tax regimes. The ministry has sternly announced that it intends to keep a watchful eye on its treaty partners and to take a firm line with any failure to honour commitments. There is a distinct contrast in tone here with the idiom of the OECD which proudly reported at the end of September that all major financial centres had now committed to observe OECD standards of transparency and information exchange and that only a few countries had failed to meet their long term commitments. On the other hand, the official German list of uncooperative havens – a register of countries, transactions with which come in for special scrutiny – remains blank.
The economic crisis hit Germany, though not in all sectors of the economy, in early 2008. Initially, the hope was to fend off the worst with massive cash support for the banking system and from then on to muddle through until the crisis solved itself. The aim of a balanced budget in 2011 was dropped, but otherwise there was little apparent change in policy. Certainly, tax audits have not become any more lenient and there have only been one or two minor concessions in tax law to help companies in trouble to overcome their problems. It is now clear to all that something more is needed.
The general election held on September 27, 2009 yielded a clear parliamentary majority for a conservative/liberal coalition government between the CDU/CSU and the FDP. The combination is the wish of both sides and talks on the coalition agreement setting policy for the next four years went smoothly. All three parties involved have committed themselves in their election campaigns to reduce taxes, and all three are now realising that there is no scope for doing so before economic recovery is on a solid footing. On the other hand, something must be done, if the new government is not to be the first in the history of the Federal Republic to take office without changing the tax acts.
The new cabinet adopted a “Growth Acceleration Bill” on November 9, 2009 with the aim of enacting tax improvements by the end of the year. They would then take effect for 2010. The measures include: indefinite extensions of the previous government's EUR 3m interest limitation threshold, and of its suspension of the loss of carry-forward curtailment provisions on change of shareholders within the context of a rescue operation. The bill suggests complete exemption for group reorganisations from the loss curtailment provisions and hidden reserve protection of a loss-carry-forward despite shareholder changes. Also included on the bill is: relaxation of the interest limitation, exemption of property ownership changes on merger or spin-off from real estate transfer tax, reduction of the trade tax add-back for property rentals and, for the tourist trade, a reduced VAT rate for hotel accommodation.
More innovatively, and of greater long term benefit, a tax credit for R&D expenditure is under consideration. This would be in addition to the standard deduction for the expense as incurred and would therefore be in the nature of a subsidy. Clearance from the European Commission would be necessary. The idea was launched in the academic world, but has now been taken up by the new government. Discussions with potential beneficiaries and other interested parties have not yet started and legislation is certainly a long way off. However, there is a strong body of support for an idea, which seems essential to maintain Germany's position among the world's technology leaders.
The initiative now lies with the new government. Expectations are that it will seek to generate a business-friendly climate, not least by making minor corrections to some of the wilder measures of its predecessor. At the moment, there is no money for major initiatives, but this is accepted by all key players. This will change when the crisis is over, but until then progress in the tax field is likely to be gradual, rather than spectacular. An easing up on tax audit intensity with a return to a more amenable but justified approach would seem a reasonable hope. A similar let up on foreign tax policy may also be in the offing.
The new government finds German tax at a cross-roads. The reforms are in place, but their impact has been dampened with restrictive conditions and compensatory measures. If these are eased, Germany will no longer be perceived as a country with an unfavourable tax climate. Of course, a country of the size and structure of Germany will never compete with low tax countries, though it may attract investors by offering a sophisticated, welcoming environment. All signs are positive.
Prof Dr Dieter Endres is the Senior Tax Partner of PricewaterhouseCoopers, Germany