Investment in Germany

kpmg.de

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© 2008 KPMG Deutsche Treuhand-Gesellschaft Aktiengesellschaft Wirtschaftsprüfungsgesellschaft, a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss coopera-tive. All rights reserved.

Investment in

Germany

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Authors

Oliver DörflerDiplom-Kaufmann, Steuerberater KPMG, Frankfurt

Dr. Gerrit AdrianDiplom-Kaufmann, Steuerberater KPMG, Frankfurt

Christian BirkerRechtsanwalt, Wirtschaftsprüfer, Steuerberater KPMG, Frankfurt

Dirk FleckensteinRechtsanwalt KPMG, Frankfurt

Oliver FranzDiplom-Wirtschaftsjurist (Univ.), LLM KPMG, Frankfurt

Eva HandwerkerDiplom-Wirtschaftsjuristin (Univ.) KPMG, Frankfurt

Michael HundebeckDiplom-Finanzwirt KPMG, Frankfurt

Dr. Martin RibbrockRechtsanwalt KPMG, Frankfurt

Christian SchenkRechtsanwalt KPMG, Frankfurt

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Preface

Investment in Germany is one of a series of booklets pre-pared by KPMG to provide information on subjects of importance to investors and entrepreneurs contemplating investments or business operations abroad.

The economic environment in Germany has undoubtedly become much more complex, thus giving rise to a growing need for reliable pathfinders to guide investors through the maze of new rules and regulations.

Numerous legislative changes were enacted in 2007, further altering Germany’s tax and economic landscape. Particularly noteworthy are the 2008 Business Tax Reform Act (Unternehmensteuerreformgesetz 2008), the Real Estate Investment Trust Act – REIT Act (REIT-Gesetz), and the 2008 Tax Act (Jahressteuergesetz 2008).

This booklet is intended to provide general background information and initial guid-ance in your preliminary planning efforts. We recommend that you obtain comprehen-sive advice before taking any action and would appreciate the opportunity to assist you in planning and executing your investment in Germany.

Our approach combines high-quality advice with a comprehensive focus on our cli-ents’ needs. We put ourselves in your shoes. We ask ourselves what demands are placed on you and your business and develop appropriate solutions with which you can effi-ciently meet these demands. This is the challenge we set for ourselves every day.

I would like to take this opportunity to thank our National Tax Department, headed by Dr. Martin Lenz, and each of this booklet’s authors: Oliver Dörfler, Dr. Gerrit Adrian, Christian Birker, Dirk Fleckenstein, Oliver Franz, Eva Handwerker, Michael Hunde-beck, Dr. Martin Ribbrock and Christian Schenk.

June 2008

Ernst Gröbl Member of the Board KPMG, Germany

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Contents

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Contents

Investment in Germany . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . I

Authors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . III

Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . V

1 Germany – an outline . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

1.1 Geography and climate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11.2 History and political system . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11.3 Population and language . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21.4 European influence on the economy and currency . . . . . . . . . . . . . . 3

1.4.1 General European background . . . . . . . . . . . . . . . . . . . . . . . 31.4.2 The economy and currency . . . . . . . . . . . . . . . . . . . . . . . . . . 4

1.5 Monetary policy in the European Union . . . . . . . . . . . . . . . . . . . . . . 51.6 Working conditions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

1.6.1 Residence and work permits . . . . . . . . . . . . . . . . . . . . . . . . . 61.6.1.1 Residence permits . . . . . . . . . . . . . . . . . . . . . . . . . 61.6.1.2 Work permits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

1.6.2 Business hours . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71.6.3 Cost of living and housing . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

1.7 Foreign direct investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81.7.1 Foreign direct investment in Germany . . . . . . . . . . . . . . . . . 81.7.2 German direct investment in foreign countries . . . . . . . . . . . 9

1.8 Attitudes towards foreign investment . . . . . . . . . . . . . . . . . . . . . . . . 91.8.1 Exchange controls . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91.8.2 Business regulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

1.8.2.1 Notification requirements . . . . . . . . . . . . . . . . . . . . 101.8.2.2 Regulated industries . . . . . . . . . . . . . . . . . . . . . . . . 101.8.2.3 Special business permits . . . . . . . . . . . . . . . . . . . . 10

1.9 German banking system, regulations and sources of finance for commerce and industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101.9.1 The German Central Bank and the European Central Bank 11

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1.9.2 German banking institutions . . . . . . . . . . . . . . . . . . . . . . . . . 111.10 Banking regulations and the impact of the EU . . . . . . . . . . . . . . . . . 131.11 Stock exchanges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

2 Importing to Germany . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

2.1 Customs duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 182.1.1 German customs tariff . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 182.1.2 Customs value – transaction value . . . . . . . . . . . . . . . . . . . . 182.1.3 Origin of goods and preferences . . . . . . . . . . . . . . . . . . . . . . 192.1.4 Customs regimes to avoid, reduce, or defer duty payment . . 20

2.2 Anti-dumping and countervailing duties . . . . . . . . . . . . . . . . . . . . . . 212.3 Special import duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

2.3.1 Other excise duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 212.3.2 Import VAT tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

2.4 Starting business in Germany other than through branches or subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

3 Company law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

3.1 Limited liability companies and stock corporations . . . . . . . . . . . . . 233.1.1 Formation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 233.1.2 Registered share capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 263.1.3 Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 273.1.4 Supervisory board . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 283.1.5 Shareholders’ or general meetings. . . . . . . . . . . . . . . . . . . . . 293.1.6 Amendment of the GmbH Law . . . . . . . . . . . . . . . . . . . . . . . 30

3.1.6.1 Accelerated formation of GmbHs . . . . . . . . . . . . . 303.1.6.2 Increasing the attractiveness of the GmbH via

greater flexibility of the corporation . . . . . . . . . . . 313.1.6.3 Abuse deterrence . . . . . . . . . . . . . . . . . . . . . . . . . . 31

3.1.7 German Corporate Governance Code . . . . . . . . . . . . . . . . . . 323.1.8 Business register – Unternehmensregister . . . . . . . . . . . . . . . 333.1.9 Insolvency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 333.1.10 Liquidation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

3.2 Other forms of corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343.2.1 Societas Europaea – SE . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343.2.2 Limited partnership with share capital – KGaA . . . . . . . . . 34

3.3 Other business associations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 353.3.1 Partnerships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

Contents

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3.3.2 Silent partnerships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 363.3.3 Civil law associations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 373.3.4 Sole proprietorship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37

3.4 Branches . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 373.5 Companies organized under the law of a foreign jurisdiction . . . . . 38

4 Accounting and reporting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41

4.1 German accounting principles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 414.1.1 Financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 414.1.2 Consolidated financial statements . . . . . . . . . . . . . . . . . . . . 45

4.2 International Financial Reporting Standards (IFRS) . . . . . . . . . . . . 484.2.1 Consolidated financial statements . . . . . . . . . . . . . . . . . . . . 484.2.2 Financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48

4.3 Enforcement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49

5 Recent and proposed changes in fiscal policy . . . . . . . . . . . . . . 51

5.1 Current legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 515.1.1 2008 Business Tax Reform Act . . . . . . . . . . . . . . . . . . . . . . . 51

5.1.1.1 Tax relief for corporations . . . . . . . . . . . . . . . . . . . 515.1.1.2 Earnings stripping rules . . . . . . . . . . . . . . . . . . . . . 515.1.1.3 Trade tax addbacks . . . . . . . . . . . . . . . . . . . . . . . . . 525.1.1.4 New change-in-ownership-rules . . . . . . . . . . . . . . 525.1.1.5 Transfer pricing changes . . . . . . . . . . . . . . . . . . . . 525.1.1.6 Retained earnings of partnerships and

sole proprietorships . . . . . . . . . . . . . . . . . . . . . . . . 535.1.1.7 Flat tax for income from capital and capital gains 53

5.1.2 Real Estate Investment Trust Act – REIT Act . . . . . . . . . . . 535.1.3 2008 Tax Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54

5.1.3.1 Recapture taxation of carryover EK 02 . . . . . . . . . 545.1.3.2 Application of § 8b (3) KStG to shareholder loans 545.1.3.3 Redesign of general anti-abuse provision . . . . . . . 545.1.3.4 Changes in the Foreign Transactions Tax Law . . . 55

5.2 Pending Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 555.2.1 Act for the Modernization of the Legal Framework for

Equity Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 555.2.2 Draft Accounting Law Modernization Act . . . . . . . . . . . . . . 56

5.2.2.1 Improvement of information content . . . . . . . . . . . 565.2.2.2 Relief from certain requirements . . . . . . . . . . . . . 56

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5.2.3 Draft Inheritance Tax and Valuation Law Reform Act . . . . . 575.2.4 Draft 2009 Tax Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57

5.2.4.1 Losses with a foreign nexus . . . . . . . . . . . . . . . . . . 575.2.4.2 Taxation of non-resident taxpayers . . . . . . . . . . . . 585.2.4.3 Treaty and directive shopping . . . . . . . . . . . . . . . . 585.2.4.4 Bookkeeping in a foreign country . . . . . . . . . . . . . 58

5.3 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58

6 Business taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

6.1 Comparison of legal forms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 596.2 Taxation of corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

6.2.1 Corporate income tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 596.2.1.1 Companies subject to taxation . . . . . . . . . . . . . . . . 596.2.1.2 Basic principles . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

6.2.1.2.1 Resident corporations . . . . . . . . . . . . . 606.2.1.2.2 Non-resident corporations . . . . . . . . . . 63

6.2.1.3 Determination of taxable income . . . . . . . . . . . . . . 646.2.1.4 Earnings stripping rules . . . . . . . . . . . . . . . . . . . . . 67

De minimis threshold (Freigrenze) . . . . . . . . . . . . 68Non-group businesses (Konzernklausel) . . . . . . . . 68Escape clause . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68Interest carry forward . . . . . . . . . . . . . . . . . . . . . . 68Tax groups (Organschaft) . . . . . . . . . . . . . . . . . . . 69

6.2.1.5 Loss relief . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 696.2.1.6 Tax groups (Organschaft) . . . . . . . . . . . . . . . . . . . . 706.2.1.7 Double taxation and relief for foreign taxes . . . . . 71

6.2.1.7.1 Methods of relief . . . . . . . . . . . . . . . . . . 716.2.1.7.2 Tax treaties . . . . . . . . . . . . . . . . . . . . . . 716.2.1.7.3 Subject-to-tax clause . . . . . . . . . . . . . . 72

6.2.1.8 EU directives relating to direct taxation . . . . . . . . 736.2.1.8.1 EU Parent/Subsidiary Directive . . . . . 736.2.1.8.2 EU Merger Directive . . . . . . . . . . . . . . 746.2.1.8.3 Interest and Royalties Directive . . . . . . 75

6.2.1.9 Transfer pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . 756.2.1.10 Filing requirements and payment of tax . . . . . . . . 766.2.1.11 Taxation in the event of liquidation . . . . . . . . . . . . 776.2.1.12 Withholding taxes . . . . . . . . . . . . . . . . . . . . . . . . . 776.2.1.13 Solidarity surcharge . . . . . . . . . . . . . . . . . . . . . . . . 78

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6.2.1.14 Binding rulings (verbindliche Auskunft) . . . . . . . . 796.2.2 Trade tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79

6.2.2.1 Basic principles . . . . . . . . . . . . . . . . . . . . . . . . . . . 796.2.2.2 Determination of trade income . . . . . . . . . . . . . . . 806.2.2.3 Tax groups (Organschaft) . . . . . . . . . . . . . . . . . . . . 826.2.2.4 Sample tax calculation . . . . . . . . . . . . . . . . . . . . . . 82

6.2.3 Net worth tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 836.3 Taxation of partnerships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

6.3.1 Income tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 836.3.1.1 Determination of taxable income . . . . . . . . . . . . . . 83

Step 1: Determination of income at the level of the partnership . . . . . . . . . . . . . . . . . 84

Step 2: Special remuneration, special busi-ness income and expenses . . . . . . . . . . 85

6.3.1.2 Loss relief . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 866.3.1.3 Trade tax credit against income tax . . . . . . . . . . . . 866.3.1.4 Tax group (Organschaft) . . . . . . . . . . . . . . . . . . . . 866.3.1.5 Sale of an interest in a partnership . . . . . . . . . . . . . 86

6.3.2 Trade tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 876.3.2.1 Basic principles . . . . . . . . . . . . . . . . . . . . . . . . . . . 876.3.2.2 Loss relief . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 876.3.2.3 Sale of an interest in a partnership . . . . . . . . . . . . . 88

6.4 Taxation of permanent establishments . . . . . . . . . . . . . . . . . . . . . . . 886.4.1 Definition of permanent establishment . . . . . . . . . . . . . . . . . 886.4.2 Taxation of German-source income of a permanent

establishment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 896.4.2.1 Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 896.4.2.2 Trade tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89

6.4.3 Determination of taxable income . . . . . . . . . . . . . . . . . . . . . 89

7 Indirect Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91

7.1 Value added tax (VAT) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 917.1.1 Liability for VAT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 917.1.2 VAT registration. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 927.1.3 Taxable transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 937.1.4 Place of supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93

7.1.4.1 Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 937.1.4.2 Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

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7.1.4.3 Intra-EC movements of goods . . . . . . . . . . . . . . . . 947.1.4.4 Reverse charge procedure . . . . . . . . . . . . . . . . . . . 95

7.1.5 VAT rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 957.1.6 Collection, filing and payment of tax . . . . . . . . . . . . . . . . . . 96

7.1.6.1 Output tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 967.1.6.2 Input tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96

7.1.6.2.1 Electronic invoice transmission . . . . . . 967.1.6.2.2 Amendment of the input tax deduction

within the scope of § 15a UStG . . . . . . 977.1.6.3 VAT returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 977.1.6.4 EC sales lists . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 977.1.6.5 Intrastat declarations . . . . . . . . . . . . . . . . . . . . . . . 98

7.1.7 Foreign entrepreneurs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 987.1.8 Enforcement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98

7.1.8.1 Tax audits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 987.1.8.2 Electronic audits . . . . . . . . . . . . . . . . . . . . . . . . . . . 997.1.8.3 Fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99

7.2 Taxes on consumption (excise duties) . . . . . . . . . . . . . . . . . . . . . . . . 997.2.1 General . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 997.2.2 Tax territory and commodity subject to tax . . . . . . . . . . . . . 1007.2.3 Time of tax liability and parties liable . . . . . . . . . . . . . . . . . 1007.2.4 Tax concessions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1007.2.5 EU directives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101

8 Other taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103

8.1 Ecological taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1038.1.1 Electricity tax. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1038.1.2 Energy tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1038.1.3 Rates of ecological tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104

8.2 Miscellaneous taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1048.2.1 Real estate transfer tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1048.2.2 Real estate tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105

9 Taxation of inbound investments . . . . . . . . . . . . . . . . . . . . . . . . . 107

9.1 Choice of legal form and location . . . . . . . . . . . . . . . . . . . . . . . . . . . 1079.1.1 Types of inbound investments . . . . . . . . . . . . . . . . . . . . . . . . 1079.1.2 Taxation of current income . . . . . . . . . . . . . . . . . . . . . . . . . . 1099.1.3 Exit taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111

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9.2 Financing of inbound investments . . . . . . . . . . . . . . . . . . . . . . . . . . . 1129.2.1 Permanent establishments and partnerships . . . . . . . . . . . . . 1129.2.2 Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113

9.3 German holding companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1159.4 Taxation of controlled foreign corporations (CFC rules) . . . . . . . . . 1179.5 Transfer pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121

9.5.1 Transfer pricing principles . . . . . . . . . . . . . . . . . . . . . . . . . . . 1219.5.2 Documentation requirements . . . . . . . . . . . . . . . . . . . . . . . . 1229.5.3 Transfer pricing principles for the secondment of staff . . . . 123

9.6 German REITs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125

10 Acquisition and restructuring of business entities . . . . . . . . . . 127

10.1 Legal aspects of acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12710.1.1 Sales of business entities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12710.1.2 Typical steps of a business entity acquisition . . . . . . . . . . . . 127

10.1.2.1 Initial contact . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12810.1.2.2 Confidentiality agreement . . . . . . . . . . . . . . . . . . . 12810.1.2.3 Letter of intent . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12810.1.2.4 Due diligence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129

10.1.2.4.1 Significance and purpose in Germany . 12910.1.2.4.2 Legal consequences . . . . . . . . . . . . . . . 129

10.1.2.5 Sale and purchase agreement . . . . . . . . . . . . . . . . . 12910.1.2.5.1 Contents of the purchase agreement . . 12910.1.2.5.2 Statutory warranties . . . . . . . . . . . . . . 13010.1.2.5.3 Contractual warranty clauses . . . . . . . 130

10.1.2.6 Completion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13110.1.3 Antitrust law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131

10.2 Tax considerations for acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . 13210.2.1 Asset deal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13210.2.2 Acquisition of shares in a corporation . . . . . . . . . . . . . . . . . . 13310.2.3 Acquisition of a partnership interest . . . . . . . . . . . . . . . . . . . 13410.2.4 Funding an acquisition. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134

10.2.4.1 Acquisition of a corporation . . . . . . . . . . . . . . . . . 13410.2.4.1.1 Acquisition by a corporation . . . . . . . . 13410.2.4.1.2 Acquisition by an individual . . . . . . . . 13510.2.4.1.3 Thin capitalization rules . . . . . . . . . . . 135

10.2.4.1.3.1 Through 2007 . . . . . . . . . . . 13510.2.4.1.3.2 From 2008 onwards . . . . . . 136

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10.2.4.2 Acquisition of a partnership . . . . . . . . . . . . . . . . . . 13710.2.5 Utilization of pre-acquisition tax losses . . . . . . . . . . . . . . . . 137

10.2.5.1 Acquisition of a partnership interest . . . . . . . . . . . 13810.2.5.2 Acquisition of corporations . . . . . . . . . . . . . . . . . . 138

10.3 Legal aspects of reorganizations . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13810.3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13810.3.2 Reorganizations under the German Reorganization Act . . . 140

10.3.2.1 Merger . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14010.3.2.1.1 Types of mergers . . . . . . . . . . . . . . . . . . 14010.3.2.1.2 Legal entities subject to merger . . . . . . 14110.3.2.1.3 The merger process . . . . . . . . . . . . . . . 14110.3.2.1.4 Preparation of balance sheet at

date of merger . . . . . . . . . . . . . . . . . . . 14210.3.2.2 Division . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 142

10.3.2.2.1 Types of divisions . . . . . . . . . . . . . . . . . 14210.3.2.2.2 Legal entities subject to division . . . . . 14310.3.2.2.3 The division process . . . . . . . . . . . . . . . 14310.3.2.2.4 Preparation of a balance sheet at the

date of the division . . . . . . . . . . . . . . . . 14310.3.2.3 Change of legal form . . . . . . . . . . . . . . . . . . . . . . . 144

10.3.2.3.1 Definition . . . . . . . . . . . . . . . . . . . . . . . 14410.3.2.3.2 Legal entities subject to conversion . . . 14410.3.2.3.3 The conversion process . . . . . . . . . . . . 144

10.3.3 European Company (SE) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14410.3.3.1 SEs by merger . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14510.3.3.2 Holding SEs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14610.3.3.3 Subsidiary SEs . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14610.3.3.4 SE by conversion . . . . . . . . . . . . . . . . . . . . . . . . . . 147

10.4 Tax issues arising from corporate restructuring . . . . . . . . . . . . . . . . 14710.4.1 Mergers and contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . 148

10.4.1.1 Mergers of corporations . . . . . . . . . . . . . . . . . . . . . 14810.4.1.2 Merger of a corporation into a partnership . . . . . . 14910.4.1.3 Contributions to corporations . . . . . . . . . . . . . . . . 149

10.4.1.3.1 Contribution of assets . . . . . . . . . . . . . 15010.4.1.3.2 Contribution of shares (share-for-

share exchange) . . . . . . . . . . . . . . . . . . 15010.4.1.4 Contribution to a partnership . . . . . . . . . . . . . . . . . 151

10.4.2 Divisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15110.4.2.1 Split-up of a corporation. . . . . . . . . . . . . . . . . . . . . 152

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10.4.2.2 Spin-off of a corporation . . . . . . . . . . . . . . . . . . . . 15210.4.3 Change in legal form . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153

10.5 Tax due diligence review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153

11 Taxation of individuals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155

11.1 Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15511.2 Basic principles of an individual’s liability to tax . . . . . . . . . . . . . . . 155

11.2.1 Distinction between unlimited and limited tax liability . . . . 15511.2.2 Special forms of tax liability . . . . . . . . . . . . . . . . . . . . . . . . . 156

11.3 Taxation of income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15711.3.1 Taxation of resident individuals . . . . . . . . . . . . . . . . . . . . . . . 15711.3.2 Computation of taxable income . . . . . . . . . . . . . . . . . . . . . . . 15711.3.3 Standard deductions for income-related expenses . . . . . . . . 15811.3.4 Itemized deductions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15911.3.5 Child benefit payments, child allowances . . . . . . . . . . . . . . . 16011.3.6 Private pension savings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16011.3.7 Homeowner subsidies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16111.3.8 Utilization of losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16111.3.9 Determination of tax liability . . . . . . . . . . . . . . . . . . . . . . . . 16211.3.10 Relief from double taxation . . . . . . . . . . . . . . . . . . . . . . . . . . 163

11.3.10.1 Unilateral relief . . . . . . . . . . . . . . . . . . . . . . . . . . . 16311.3.10.2 Tax treaty relief . . . . . . . . . . . . . . . . . . . . . . . . . . . 163

11.3.11 Non-resident individuals . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16411.4 Capital gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165

11.4.1 Sales of business assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16511.4.2 Sales of investments held as private assets . . . . . . . . . . . . . . 16511.4.3 Other private capital gains . . . . . . . . . . . . . . . . . . . . . . . . . . . 166

11.5 Special issues relating to investment income . . . . . . . . . . . . . . . . . . 16611.5.1 Half-income rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16711.5.2 Withholding tax on investment income . . . . . . . . . . . . . . . . . 167

11.6 Filing requirements and payment of tax . . . . . . . . . . . . . . . . . . . . . . 16811.7 Solidarity surcharge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16911.8 Basic principles of church tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16911.9 Basic principles of inheritance and gift tax . . . . . . . . . . . . . . . . . . . . 170

12 Opportunities for international investors . . . . . . . . . . . . . . . . . . 173

12.1 European investment grants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17312.2 Investment subsidy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173

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12.3 Federal and regional investment grants . . . . . . . . . . . . . . . . . . . . . . . 17512.3.1 Measures to promote investment . . . . . . . . . . . . . . . . . . . . . . 175

12.3.1.1 Subsidies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17512.3.1.2 Loans at concessionary interest rates . . . . . . . . . . . 17812.3.1.3 Guarantees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 179

12.3.2 Key areas for grants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17912.3.2.1 Research and development . . . . . . . . . . . . . . . . . . . 17912.3.2.2 Human resource development . . . . . . . . . . . . . . . . 18012.3.2.3 Environmental protection. . . . . . . . . . . . . . . . . . . . 180

13 Labor Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 181

13.1 Residence and work permits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18113.2 Employment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 181

13.2.1 Employment contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18113.2.2 Terms of employment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 182

13.2.2.1 Working hours . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18213.2.2.2 Paid vacation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18213.2.2.3 Continued payment of salary in the event of illness . 18213.2.2.4 Discrimination . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18213.2.2.5 Requests to work part-time . . . . . . . . . . . . . . . . . . 18213.2.2.6 Maternity and parental leave . . . . . . . . . . . . . . . . . 183

13.2.3 Termination of employment . . . . . . . . . . . . . . . . . . . . . . . . . . 18313.2.4 Job security legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 184

13.3 Labor regulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18413.3.1 Collective bargaining agreements . . . . . . . . . . . . . . . . . . . . . 18413.3.2 Co-determination and works councils . . . . . . . . . . . . . . . . . . 186

13.4 Labor costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18813.4.1 Wage regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18813.4.2 Social insurance system . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 189

13.4.2.1 Health insurance and nursing care insurance systems . . . . . . . . . . . . . . . . . . . . . . . . . . . 189

13.4.2.2 Public pension insurance system . . . . . . . . . . . . . . 19013.4.2.3 Unemployment insurance system . . . . . . . . . . . . . . 19113.4.2.4 Statutory accident insurance . . . . . . . . . . . . . . . . . 19113.4.2.5 International agreements . . . . . . . . . . . . . . . . . . . . 192

14 Appendix I . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 193

14.1 Table of withholding tax rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 193

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14.2 Map of development areas in Germany . . . . . . . . . . . . . . . . . . . . . . . 196

15 Appendix II . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197

15.1 KPMG Deutsche Treuhand-Gesellschaft Aktiengesellschaft Wirtschaftsprüfungsgesellschaft . . . . . . . . . . . . . . . . . . . . . . . . . . . 197

15.2 KPMG’s regional tax offices in Germany . . . . . . . . . . . . . . . . . . . . . 197Region North . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197Region West . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197Region East . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 198Region Central . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 198Region Southwest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 199Region South . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 199

15.3 KPMG tax services in Germany . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200Corporate Tax Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200Financial Services Tax. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200Global Transfer Pricing Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200Indirect Tax Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201International Corporate Tax Services . . . . . . . . . . . . . . . . . . . . . . . . 201International Executive Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201People Services, Pensions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 202Mergers & Acquisitions Tax Services . . . . . . . . . . . . . . . . . . . . . . . . 202Tax Management Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 202

15.4 KPMG’s Country Specialists . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 203

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List of tables and figures

Table 1: German population in relation to the European Union . . . . . . . . . . 2Table 2: Development of gross domestic product . . . . . . . . . . . . . . . . . . . . . . 4Table 3: Average exchange rate of the Euro . . . . . . . . . . . . . . . . . . . . . . . . . . . 4Table 4: Consumer price index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8Table 5: Bank system . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12Table 6: Classification of company size (accounting obligations) . . . . . . . . . . 42Table 7: Criteria for mandatory preparation of consolidated

financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46Table 8: Computation of income / corporate income tax rates on payment of

dividends 2008 and 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61Table 9: Taxation of a corporation and dividends paid to individuals and

corporations (assessment period 2008) . . . . . . . . . . . . . . . . . . . . . . 82Table 10: Taxation of partnerships: retained vs. distributed profits . . . . . . . . . 84Table 11: Mineral oil tax rates / energy tax rates . . . . . . . . . . . . . . . . . . . . . . . 104Table 12: Electricity tax rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104Table 13: Trade tax rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110Table 14: Tax burden for permanent establishment, partnership and

corporation (current taxation) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111Table 15: Exit tax burdens for various legal forms . . . . . . . . . . . . . . . . . . . . . . 112Table 16: Comparison of tax burden for equity and debt financing

of a German subsidiary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115Table 17: Main characteristics of German holding companies . . . . . . . . . . . . 117Table 18: Single individuals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 162Table 19: Married couples filing jointly . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 162Table 20: Classes of relationship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 170Table 21: Inheritance and gift tax classes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171Table 22: Summary of maximum subsidy rates . . . . . . . . . . . . . . . . . . . . . . . . . 177

Figure 1: German stock indices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

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1 Germany – an outline

1.1 Geography and climate

The Federal Republic of Germany is located in the center of Europe. It is one of the largest countries in Europe, covering an area of approximately 357,000 square kilome-ters (138,000 square miles) and measuring 885 kilometers (550 miles) from north to south and 595 kilometers (370 miles) from east to west. Germany’s neighboring coun-tries are Poland, the Czech Republic, Austria, Switzerland, France, Luxembourg, Bel-gium, the Netherlands, and Denmark (clockwise). Germany’s ideal location in the heart of Europe, with major international airports in Frankfurt/Main, Munich, Dues-seldorf, Cologne, Hamburg and Berlin, as well as access to the North and Baltic Seas, creates a multitude of opportunities for European and international business.

The climate in Germany is mild, with moderate rainfall throughout the year. In the lower-altitude regions, winter temperatures are usually above freezing with rare snow-falls, and summers are occasionally hot. Regions above 500 meters generally have mild summers and moderate amounts of snow in the winter.

1.2 History and political system

Under the German constitution, the Federal Republic of Germany is a parliamentary democracy with currently 16 states (Länder). The capital of Germany is Berlin. At the federal level, the executive branch consists of the Federal President (Bundespräsident) and the Federal Government (headed by the Federal Chancellor and the Cabinet). The bicameral legislature consists of the Federal Parliament (Bundestag), the delegates of which are elected in part directly and in part under a party list proportional system, and the Council of States (Bundesrat), consisting of representatives from the govern-ments of the Länder.

The origin of Germany’s civil law is Roman law. Important legislation is mainly fed-eral and is usually embodied in general codes. The judicial system is generally three-tiered (federal, regional and local courts), except for the tax courts, which are two-tiered. The Federal Constitutional Court (Bundesverfassungsgericht) is the court of last resort if constitutional issues are involved. The European Court of Justice (ECJ) is the supreme decision-making body for issues relating to the fundamental freedoms guaranteed by the EC treaty and to other questions of EU law.

Geography and climate

2

Germany – an outline



1.3 Population and language

The population of Germany is currently around 82.2 million. Table 1 shows the popu-lation of Germany in comparison with that of other EU countries. The size of its popu-lation makes Germany the largest consumer market within the European Union. Most German citizens speak one or two foreign languages, of which English, French, Span-ish, and Russian are the most common.

Table 1: German population in relation to the European Union

Country Population(inhabitants,

millions)

German State (Land) Population(inhabitants,

millions)

Germany 82.2 Baden-Wuerttemberg 10.7Austria 8.3 Bavaria 12.5Belgium 10.7 Berlin 3.4Bulgaria 7.6 Brandenburg 2.5Cyprus 0.8 Bremen 0.7Czech Republic 10.3 Hamburg 1.8Denmark 5.5 Hesse (Hessen) 6.1Estonia 1.3 Mecklenburg-Vorpommern 1.7Finland 5.3 Lower Saxony (Niedersachsen) 8.0France 63.8 North Rhine-Westphalia Greece 11.2 (Nordrhein-Westfalen) 18.0Hungary 10.0 Rhineland-Palatinate Ireland 4.4 (Rheinland-Pfalz) 4.1Italy 59.6 Saarland 1.0Latvia 2.3 Saxony (Sachsen) 4.2Lithuania 3.4 Saxony-Anhalt (Sachsen-Anhalt) 2.4Luxembourg 0.5 Schleswig-Holstein 2.8Malta 0.4 Thuringia (Thüringen) 2.3Netherlands 16.4Poland 40.0Portugal 10.6Romania 21.4Slovak Republic 5.4Slovenia 2.0Spain 45.3Sweden 9.2United Kingdom 61.3

EU: total 497.2 Germany: total 82.2

Source: Eurostat/U.S. Bureau of the Census/German Federal Statistical Office, 2008

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1.4 European influence on the economy and currency

1.4.1 General European background

The Federal Republic of Germany, one of the world’s major industrialized nations, is a founding member of what is now called the European Union, which was created in 1957 under the Treaty of Rome. The signatories to the Treaty agreed to form a com-mon market by abolishing all customs barriers within the Union: creating common external tariffs for imports from non-member countries, allowing freedom of move-ment of capital and labor within the Union, as well as harmonizing economic policies, legal and taxation systems, and social conditions. In recent years, the European Union has been increasingly active in the area of harmonization of company law, including requirements for the format of financial statements, and has issued directives on con-sumer protection, fair-trade practices, antitrust regulations, and certain taxes. On Jan-uary 1, 1993, the single European market came into existence. On November 1, 1993, the Maastricht Treaty came into force, establishing the European Union (EU). This treaty between the (at that time 15) member states of the EU defines the following three fundamental objectives:

Economic and monetary union

Common foreign and security policy

Close cooperation in legal and internal matters.

More recently, the Amsterdam Treaty entered into force on May 1, 1999, followed on February 1, 2003 by the Treaty of Nice. Both treaties seek to achieve more effective political cooperation and improvements in the rights of individual EU citizens.

On May 1, 2004 the following countries joined the EU: Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, the Slovak Republic, and Slove-nia. On January 1, 2007, Bulgaria and Romania joined the EU. Turkey, Croatia, and Macedonia are currently considered candidates for admission to the EU.

The Treaty Establishing a Constitution for Europe, commonly referred to as the Euro-pean Constitution, was international treaty intended to create a constitution for the European Union. Its main aims were to replace the overlapping set of existing treaties that comprise the EU’s current constitution, to codify uniform basic rights and demo-cratic principles throughout the EU, and to streamline decision-making. It was signed in 2004 by representatives of the member states of the European Union subject to rati-fication by all member states. This proved impossible to obtain, since several member states declined to ratify the Constitution. Following the failure of the constitutional treaty, it was decided at a European Council meeting in June 2007 to start negotiations

European influence on the economy and currency

4




on a treaty of reform as a replacement. This treaty (the Treaty of Lisbon) was signed on December 13, 2007 at a summit in Lisbon, Portugal. It amends the existing treaties of the European Union (EU). It would take effect in 2009 if ratified by all European Union member states.

1.4.2 The economy and currency

In 2007 the German gross domestic product (GDP) was € 2,423.8 billion. Over the past few years, German GDP has changed as follows:

Table 2: Development of gross domestic product

Year GDP in billion € Increase

2005 2,244.6 0.8%2006 2,322.2 2.9%2007 2,423.8 2.5%

Source: German Federal Statistical Office, 2008

In 2007, the annual inflation rate was around 2.2 %. The prime interest rate of the European Central Bank (ECB) (main refinancing operations minimum bid rate) was recently increased to 4.25 %, effective July 9, 2008.

This interest rate, which applies in the European Monetary Union (EMU), influences the exchange rate of the Euro against other currencies. The value of the Euro in other major currencies was as follows as of June 2008:

Table 3: Average exchange rate of the Euro

Country Currency Exchange Rate

United Kingdom Pounds sterling 0.79095Japan Yen 168.0Switzerland Swiss francs 1.6185USA U.S. dollars 1.5568

Source: European Central Bank, June 2008

As in all other Eurozone member countries, notes have been issued in the denomina-tions € 5, € 10, € 20, € 50, € 100, € 200, and € 500, and coins have been issued with values of 1 €-cent, 2 €-cent, 5 €-cent, 10 €-cent, 20 €-cent, 50 €-cent, € 1, and € 2.

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1.5 Monetary policy in the European Union

The third stage of the European Monetary Union (EMU) was implemented on January 1, 1999. The EMU commenced with 11 member countries (Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal, and Finland). Greece joined with effect from January 1, 2001. Slovenia qualified in 2006 and was admitted on January 1, 2007, Malta and Cyprus were admitted on January 1, 2008. Of the present 27 EU member states, 15 are now part of the Eurozone. The participating countries were deemed by the European Council to have satisfied the convergence criteria, in particular

Price stability (low inflation)

No excessive government deficits

No excessive government debt.

The fulfillment of these criteria will also be used in the future to determine which countries will be allowed to join the EMU.

Monetary policy in the participating countries is managed by the European System of Central Banks, which consists of the European Central Bank (ECB) and the national central banks. The ECB is based in Frankfurt/Main. It started work on January 1, 1999 and is an independent institution which is committed to maintaining stable prices. Subsequently, it has repeatedly refused to ease monetary policy to stimulate the econ-omy.

An important part of the EMU is the Stability and Growth Pact, under which govern-ments are committed to “reach a budgetary position of ‘close to balance or in surplus’ in the coming years”. The Stability Pact also sets up procedures on how to handle excessive deficits, which are deemed to begin at a rate above 3 % of GDP, except in extreme economic conditions. Furthermore, the ratio of gross government indebted-ness to GDP is not permitted to exceed 60% at the end of any fiscal year. In the past, a number of member states, including Germany, have struggled to meet the targets of the Stability Pact. However, the EU ministers of finance refrained from imposing sanc-tions, given the global economic downturn at the time.

The official currency in Germany and the other Eurozone member countries is the Euro (see above). The Euro was launched in 1999, at which time the exchange rates between the national currencies and the Euro were permanently fixed. The Deutsche Mark (DM) no longer exists as a currency, only as a unit of measurement: the value of one Euro is 1.95583 DM. Effective January 1, 2002, the Euro became the sole legal tender in the Eurozone. Firms and individuals can still exchange DM notes at the Ger-

Monetary policy in the European Union

6




man Central Bank (Deutsche Bundesbank) or its Regional Offices (Hauptverwaltun-gen) for an indefinite time period.

Initially, the Euro fell against the U.S. dollar, but it has since appreciated significantly. In June 2008, the exchange rate was 1.5568 U.S. dollars per Euro.

1.6 Working conditions

1.6.1 Residence and work permits

1.6.1.1 Residence permits

The residence of foreign nationals is regulated by the Residence Act (Aufenthaltsge-setz – AufenthG). Most foreign nationals from outside the EU require a residence title (Aufenthaltstitel) to enter or reside in Germany: either a visa (Visum), a residence per-mit (Aufenthaltserlaubnis), or a permission of settlement (Niederlassungserlaubnis). Persons wishing to enter Germany must normally obtain a residence title in the form of a visa in advance from an official representative of the Federal Republic of Ger-many in their home country. A short-term visa is sufficient for a stay of up to three months within a six month period without taking up paid work. Furthermore, citizens of many countries do not need a visa for private or business trips of up to three months’ duration. If the intention exists to stay for more than three months or to take up paid work, then a national visa (nationales Visum) must be obtained. A national visa must be approved by the immigration office (Ausländerbehörde) of the place where the for-eign person intends to settle. The Federal Employment Office (Bundesagentur für Arbeit) must also approve the issuance of the visa if employment is to be pursued. Nationals from EU member states do not need a visa or another residence title to enter or reside in Germany. However, they must register with the proper authorities (Ein-wohnermeldeamt) in the same manner as German citizens. They have the right to be automatically granted a residence permit where this right exists under the EU treaty (freedom of movement of workers, etc). Citizens of Australia, Israel, Japan, Canada, South Korea, the United States and New Zealand may also travel to Germany without a visa and apply for the necessary residence permit upon entry.

1.6.1.2 Work permits

Nationals from EU member states do not require a work permit due to the EU rights of freedom of movement. However, certain specific rules apply for citizens of the new member states during a transitional period: Except for nationals of Cyprus and Malta, persons seeking dependent employment still have to apply for a work permit at the local Employment Agency (Arbeitsagentur). Foreign nationals from outside the EU

7



who are not self-employed and intend to work in Germany require a work permit in addition to a residence permit. This work permit can be granted by law (for instance, permission of settlement carries automatic entitlement to work). Otherwise, any gain-ful employment must be specifically authorized in the residence title (visa or residence permit). Before granting permission to work, the immigration office must obtain the approval of the employment office. Certain persons, including members of the man-agement board of corporations and various other employees (e. g. employees on short-term foreign assignment) are exempt from the requirement of a work permit.

Highly qualified employees can be granted work and residence permits of indefinite duration. There are three groups of highly qualified employees:

Scientists with extraordinary qualifications;

High-level teachers/professors or high-level research assistants; and

Specialists and management level employees with extraordinary experience who receive an annual salary of at least EUR 85,500.

1.6.2 Business hours

The office hours of major companies are generally from Monday to Friday from 8:30 a.m. to 5:00 p.m. By passing the federalism reform on June 30, 2006, the Federal Parliament (Bundestag) transferred the legislative competence concerning retail store business hours to the states (Länder). The states (Länder) are now permitted to enact their own laws concerning retail store business hours. So far, all states (Länder) – except Bavaria and Saarland – have liberalized their laws on store business hours. In most German states, shops are now permitted by law to be open around the clock. Not all shops take advantage of these hours; many are open from 9:00 a.m. to 6:30 p.m. There is a general trend towards more flexible business hours in bigger cities. The effects on retailers are still unclear. Most government institutions have office hours in the morning only (8:00 a.m. to noon) from Monday to Friday (except on Thursdays, when they are open until 6:00 p.m.). The banks are open from 9:00 a.m. until 4:00 p.m. from Monday to Wednesday and on Friday; on Thursday they are generally open until 6:00 p.m. Automatic teller machines (ATMs) are readily available throughout the country.

1.6.3 Cost of living and housing

The cost of living in Germany varies broadly and depends mainly on the general cost of living and the place of residence. Housing in Munich, in southern Germany, is likely to be more expensive than that in Rostock, located in the northeastern part of Ger-

Working conditions

8




many. Retail price movements are identified using various consumer categories (previ-ously, a basket of goods) and documented in the form of a consumer price index by the Federal Statistical Office.

Table 4: Consumer price index

Year 2005

= 100

Change compared to previous year

in %

Food / non-alcoholic beverages 105.9 3.8Alcoholic beverages, tobacco products 106.4 3.3Clothing and shoes 100.7 1.3Accommodation, water, gas, electricity, etc. 104.9 1.9Furnishings, household goods 101.0 1.2Health care 101.3 0.8Transport 106.9 3.8Communications 94.9 – 1.1Leisure, entertainment, etc. 99.8 0.3Education 126.9 25.0Restaurant services 104.0 2.8Other goods and services 103.7 2.6

Total index 2007 103.9 2.3

Source: German Federal Statistical Office, June 2008

1.7 Foreign direct investment

1.7.1 Foreign direct investment in Germany

In the not too distant past, foreign direct investment (FDI) in Germany was rather slow, and international companies claimed that the German economy had lost its attractiveness for foreign investors. However, there has been a turnaround in FDI over the last couple of years. German industry is growing significantly again. Current trends towards tax reform should further improve opportunities for foreign investors. Recently, however, global investment confidence has diminished somewhat, which has evidently had an effect on FDI in Germany.

Foreign investment is welcomed in Germany and there are no substantial restrictions on new foreign investment (see chapter 1.8), nor are there any permanent currency controls or administrative controls on such investment. Attitudes towards foreign take-

9



overs of German firms are much more positive today than they were just a few years ago.

1.7.2 German direct investment in foreign countries

German direct investment in foreign countries amounted in 2004 to € 679.2 billion and increased by € 105 billion to € 784.6 billion in 2005 (according to the German Central Bank). Most of this investment is in other EU member states.

1.8 Attitudes towards foreign investment

There are few controls on foreign investment in Germany. In general, foreign investors are subject to the same conditions as German investors when obtaining licenses or building permits or applying for and receiving investment incentives.

Where restrictions exist with respect to a particular business activity, such as licensing and notification requirements (see below), such restrictions apply to German and for-eign firms equally.

The July 2006 Takeover Directive Implementation Act amended the Securities Acqui-sition and Takeover Act (Wertpapiererwerbs- und Übernahmegesetz – WpÜG) to bring it into line with the 2004 EU Takeover Directive. The WpÜG now is also appli-cable to cross-border takeovers as well.

As the German Federal Cartel Office (Bundeskartellamt) aims to prevent the estab-lishment of dominant market positions, large firms must register proposed takeover bids in advance based on certain criteria. The applicable criteria pertain to global mar-kets.

1.8.1 Exchange controls

The Euro is freely convertible into other currencies and the import and export of capi-tal is free, subject only to reporting requirements.

A free European capital market was created by EU Directive 88/36L and the imple-mentation of former Article 67 (now: Article 56) of the EU Treaty in national law. This Directive completely abolishes all restrictions on the transfer of capital between EU member states.

Attitudes towards foreign investment

10




1.8.2 Business regulations

1.8.2.1 Notification requirements

While freedom of enterprise is a valid principle under Section 1 of the Business Prac-tice Act (Gewerbeordnung – GewO), any business, factory, trade, or industrial estab-lishment, whether German or foreign, must notify the respective local administration and tax authorities of its business prior to commencing activities.

1.8.2.2 Regulated industries

In order to protect the general public from risky business practices, special licenses are necessary for certain businesses, including the following:

Insurance,

Commercial banking,

Brokers and agents for real estate, housing, investment, and mutual funds,

Asset-custody and security businesses,

Pawnbroking and auction sales,

Gambling.

1.8.2.3 Special business permits

Environmental regulation in Germany is strict. Business activities which are inher-ently dangerous, polluting, or otherwise clearly detrimental to the environment are subject to special authorization. The centerpiece of such legislation is the Federal Pol-lution Control Act (Bundesimmissionsschutzgesetz – BImSchG). Industrial facilities and their modifications must comply with strict standards, which are defined in the “Technical Directives”. The licensing procedure for such special business permits is very formal. Complaints are often heard from investors about the complexity of the licensing procedure. This, in turn, has led to a review of the procedure by governmen-tal and legislative bodies in Germany with the aim of reducing the complexity and burden for the investor.

1.9 German banking system, regulations and sources of finance for commerce and industry

Germany has a universal banking system, i. e. German banks are typically engaged in a full range of banking activities rather than being specialized or restricted to certain

11



activities. Despite all the differences in their legal form, size, organization and busi-ness structure, the vast majority of banks provide virtually every type of banking transaction. Large parts of the banking sector are publicly owned or controlled, or are co-operatives. These banks play an important role in the development of local com-munities.

1.9.1 The German Central Bank and the European Central Bank

The central bank of Germany is the German Central Bank (Deutsche Bundesbank). It has nine Regional Offices (Hauptverwaltungen, formerly known as State Central Banks, Landeszentralbanken), located in Berlin, Duesseldorf, Frankfurt/Main, Ham-burg, Hanover, Leipzig, Mainz, Munich, Stuttgart, and 47 branches (as of June 2008).

The duties of the German Central Bank include country-specific tasks within the framework of European monetary policy, such as joint decision-making and the imple-mentation of a common European monetary policy, and the management of currency reserves. The German Central Bank is also involved in monitoring banks and financial services institutions and is a member of the International Monetary Fund (IMF) and International Clearing Bank.

The European Central Bank (ECB) was established in June 1998 and is located in Frankfurt/Main. Under the European Treaty, the European System of Central Banks (ESCB) consists of the ECB and the national central banks of the EU member states. The key tasks of the ECB are to issue bank notes within the Euro area and to formulate monetary policy for the Euro area – in particular to determine the prime interest rate.

The ECB is independent not only of the governments of the EU member states, but also of the national central banks in the Euro system. Furthermore, the ECB has its own budget and is thus financially independent.

1.9.2 German banking institutions

In Germany, there are a large number of banks (around 2,340), with an extensive net-work of about 44,000 branches. Germany has a system of “universal” banks, i. e. engaged in the full range of banking activities. In addition, there are some banks which specialize in particular functions (e. g. mortgage banks and home loan banks). Most banks conduct both corporate and private customer business, although there is a trend towards big corporations increasingly being handled by the major banks, while small and medium-sized companies are handled by smaller, regionally based banks (e. g., savings and loan banks, credit cooperatives for trade, and agricultural credit coopera-

German banking system, regulations and sources of finance for commerce and industry

12




tives). Meanwhile, many non-banking firms, such as insurers, department stores, mail-order firms, and car manufacturers have become financial services providers.

In the past few years, the German banking sector has undergone significant consolida-tion. The most striking examples of this are the takeover of Dresdner Bank by Allianz and, in 2005, the takeover of Hypovereinsbank by Uni Credito. Even in the case of coop-eratives, there have been numerous mergers between branches. The surge towards con-centration has led to a reduction in the banking branch network in Germany (Table 5). Nevertheless, Germany is still at the European forefront in this respect, with a density of around one banking outlet per 1,766 inhabitants (including post office savings banks).

Table 5: Bank system

1995 2000 2005

Number of banksNumber of German branchesTotal number of German banking outletsNumber of foreign subsidiaries

3,78567,93071,716

579

2,91256,93659,848

714

2,34444,10046,444

685

Source: Bundesverband Deutscher Banken, 2007

Commercial banks, which account for the largest percentage of the volume of banking business, engage in most types of banking operations. They grant short-term loans, lines of credit, and medium and long-term loans; they also place issues and trade in securities for customers and for their own account. They are also allowed to own shares and participations in other industries. Postbank, which is the bank of the privatized state enterprise Deutsche Post AG (postal services company), offers the same services as the other commercial banks, with banking services available at any post office. The range of services offered by banks is becoming increasingly diversified and includes new activities such as online banking and investment banking. Moreover, the number of direct banks with no branch network has been increasing.

Savings and loan banks (Sparkassen) are mostly municipal and regional banks. They are coordinated through central institutions and serve as regional clearinghouses. Sav-ings and loan banks are also engaged in commercial banking activities. Their credit business, however, consists mostly of long-term loans, often made to state or local governments.

Credit co-operatives for trade (Volksbanken) and for agriculture (Raiffeisenkassen) generally extend lines of credit and long-term loans to their members – typically smaller businesses, but also individuals. Regional and federal central institutions serve as clearinghouses and sources of refinancing.

13



Mortgage banks (Hypothekenbanken) specialize in long-term mortgage loans and long-term loans to federal, state, and local governments. They issue bonds secured by mortgage loans and loans to public authorities.

In addition, a number of private and public banks provide highly specialized services and special forms of financing. Insurance banks and leasing companies also play an important role in the financing of industrial business.

1.10 Banking regulations and the impact of the EU

Banks, financial services institutions, and insurance enterprises in Germany are gov-erned by a state regulator, the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin). BaFin was established in 2002, following the adoption of the Act on Integrated Financial Services Supervision, by combining the former offices for banking supervision, insurance supervision, and securities supervision. BaFin functions under the auspices of the German Federal Ministry of Finance (Bundesministerium der Finanzen – BMF). Its main objectives are

to ensure the proper functioning, stability, and integrity of the German financial system (the prime objective),

to ensure the ability of banks, financial services institutions, and insurance under-takings to meet their payment obligations, and

to enforce standards of professional conduct which preserve investors’ confidence in the financial markets.

The tasks of the BaFin directorate for Banking Supervision include – among other things – constant monitoring of banks to ensure that they comply with the capital adequacy requirements, maintain sufficient liquid funds, and comply with statutory risk limits (e. g., large exposure limits). It also ensures that the banks’ bad debt provi-sions are in line with their risk exposure. The BaFin directorate for Insurance Supervi-sion is responsible, inter alia, for granting the regulatory authorization required by enterprises in order to carry out insurance business. The BaFin directorate for Securi-ties Supervision/Asset Management is responsible for ensuring, inter alia, that insider trading prohibited by the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG) does not occur.

The Deutsche Bundesbank participates in ongoing banking supervision. Its participa-tion is governed by § 7 of the Banking Act. Among other things, the Bundesbank analyses the reports and returns that institutions have to submit on a regular basis and assesses whether their capital and risk management procedures are adequate.

Banking regulations and the impact of the EU

14




The Basel Committee on Banking Supervision, founded in 1974 and based in Basel, Switzerland, is exerting an increasing influence on banking supervision. The objective of this committee, which comprises representatives from the central banks and from the banking supervisory authorities of the G10 nations, is to develop an international supervisory code and network to improve the quality of banking supervision world-wide. Of the committee’s publications, the consultative paper on the New Basel Capi-tal Accord (Basel II), which was first published in mid 2004 (and last updated in July 2006), will have a particularly significant influence on the banking sector. The pur-pose of Basel II is to create an international standard that banking regulators can use when drafting regulations on how much capital banks need to put aside to guard against the types of financial and operational risks that banks face. Basel II should help protect the international financial system from the types of problems that might arise should a major bank or a series of banks collapse. In practice, Basel II attempts to accomplish this by setting up rigorous risk and capital management requirements designed to ensure that a bank holds capital reserves appropriate to the risk to which the bank exposes itself through its lending and investment practices.

The European Union has implemented Basel II via the EU Capital Requirements Directive, which consists of Directive 2006/48/EC (Banking Directive) and Directive 2006/49/EC (Capital Adequacy Directive), published on June 30, 2006.

Germany implemented the relevant parts of the Capital Requirements Directive on January 1, 2007. Major laws, regulations and rules in this context in Germany are:

KWG – German Banking Act

SolvV – Regulation governing solvency

GroMiKV – Regulation governing large exposures and loans

MaRisk – Minimum Requirements for Risk Management

On January 1, 2004, the Investment Modernization Act (Investmentmodernisie-rungsgesetz), which transposed directives 2001/107/EC and 2001/108/EC of January 21, 2002 (UCITS III) into German law, came into force. This act has several conse-quences: First, it broadly overhauls and consolidates the investment-related fiscal regu-lations, which were previously contained in the German Capital Investment Compa-nies Act (Gesetz über Kapitalanlagegesellschaften – KAGG) and the German Foreign Investment Funds Act (Auslandsinvestmentgesetz – AuslInvestmG). Furthermore, it integrates hedge funds into the range of regulated investment funds capable of being marketed in Germany. These provisions were incorporated into an Investment Act (Investmentgesetz – InvG) and a corresponding Investment Tax Act (Investment-

15



steuergesetz – InvStG). One key feature of the legislation is that, for the first time, domestic hedge funds can be established as investment funds managed by an invest-ment management company (Sondervermögen einer Kapitalanlagegesellschaft) or as investment companies (Kapitalanlagegesellschaft). Therefore, hedge funds must meet the same requirements as investment funds, e. g. sales prospectuses, contractual terms and conditions (articles of association), and accounting.

In June 2008 the Bundestag passed the “Risk Limitation Act” (Risikobegrenzungsge-setz – RBG). The main goal of this act is to prevent undesirable activities by financial investors. The shareholder structure should be made more transparent. Larger inves-tors have to disclose their strategic objectives.

The influence of the EU on money market policy has been described in previous sec-tions of this chapter.

1.11 Stock exchanges

The most important stock exchange in Germany is the Frankfurt Stock Exchange (Frankfurter Wertpapierbörse – FWB). The institution operating FWB is Deutsche Börse AG. In addition, there are stock exchanges in Berlin, Duesseldorf, Hamburg, Hanover, Munich, and Stuttgart. The German Exchange Supervisory Authority, an institution of the German federal states (Länder), monitors the setting up, closing down, and operations of stock exchanges, and ensures that trading is properly con-ducted.

The Frankfurt Stock Exchange offers a wide range of services, providing access to both the equity and derivatives markets for companies as well as investors, in particu-lar access to the electronic trading platform Xetra – one of the leading electronic trad-ing platforms in the world. After the London Stock Exchange, FWB is the most impor-tant market for securities and derivatives in Europe.

In the beginning of 2003, FWB introduced a new segment of the equity market. The goal was the division of the market into two separate segments with different stan-dards of transparency as well as a new concept of sector indices. The legal basis for the new segment is the 4th Financial Market Promotion Act (Viertes Finanzmarkt-Förde-rungsgesetz), which resulted in a comprehensive reform of the law governing stock exchange transactions. The stock exchange admission segments distinguish between the General Standard with statutory minimum transparency requirements and the Prime Standard with high international transparency criteria. Admission to the Prime Standard requires:

Stock exchanges

16




Quarterly reporting,

The application of international accounting standards (IAS/IFRS, U.S. GAAP, see also chapter 4),

Publication of a financial calendar,

Staging at least one analyst conference per year, and

Ad hoc disclosures also in English.

The shares in the Prime Standard are quoted in the Xetra trading system. Only Prime Standard issuers qualify for all FWB indices. The largest companies by market capi-talization and sales are included in the DAX (the German Share Index). Smaller and mid-sized companies are included in MDAX and SDAX, if they operate in the classic industry sectors, and in TecDAX if they operate in the technology sector.

Figure 1: German stock indices

DAX

MDAX

TecDAX

Further Listed Companies

Prime Standard

General Standard

SDAX

Source: Deutsche Börse (German Stock Exchange), 2007

The admission of a security to the Frankfurt Stock Exchange is determined by the Listing Board for the Official Market or the Listing Committee for the Regulated Mar-ket. The admission criteria vary according to the market segment. All issuers must prepare an offering prospectus containing the information needed to evaluate the securities. Admission to the General Standard requires no further involvement from the issuer. However, if admission is sought to the Prime Standard, an application must be made by the issuer, with admission being contingent on the company’s compliance with the transparency criteria referred to above.

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2 Importing to Germany

Germany is a Member State of the European Union (EU). Goods can circulate freely within the EU, but must be cleared through customs when imported into the EU cus-toms territory from a non-EU country. This can be achieved either by importing the goods under special customs procedures (in which case customs duties often do not arise), or by clearing the goods for free circulation (as defined for customs purposes).

Clearance for free circulation generally triggers import duties. These duties include in particular customs duty, import turnover tax and, where applicable, excise duties.

The level of the customs duties depends on the classification of the imported goods within the customs tariff and on the customs value that is placed on the goods. In many cases, the Community grants tariff preferences to goods from certain non-EU coun-tries in the form of preferential customs duties.

In contrast to these customs duties, protective customs duties are becoming increas-ingly important. Trade policy instruments in the form of import permits, quantitative restrictions, and anti-dumping duties are used to direct the flow of goods and to protect local economies. Customs duties are used as a control measure particularly in the agri-cultural sector.

In addition to the above, an important security-related update of the Community Cus-toms Code has recently been introduced. This affects everyone who is involved in international trade with the EU. With effect from January 2008, the Authorized Eco-nomic Operator (AEO) concept will be introduced, under which approved importers/exporters who meet certain criteria will be encouraged to apply for registration as AEOs as a part of the EU’s continuing anti-terrorism-program. Registered AEOs may qualify for a wide range of simplified customs procedures.

The following section deals with goods cleared for free circulation on which customs duties and import VAT tax arise. This applies only to tangible items; intangible items, such as the utilization of foreign patents, production processes, and other intellectual services are not subject to customs clearance.

A discussion of customs duty exemptions and tariff reductions follows that of duties and import turnover tax.

18

Importing to Germany



2.1 Customs duties

2.1.1 German customs tariff

Germany, like the other EU member states, applies the “Common Customs Tariff of the EU” (CCT), which is the basic law for the classification of goods. The first six dig-its of the classification code numbers are based on the Harmonized System (so far adopted by 179 countries) to which further EU sub-headings of the Combined Nomen-clature (CN) are added and which determines the duty rates applied. The General Rules for the interpretation of the Harmonized System (HS) are an integral part of the CCT.

Under the case law of the European Court of Justice, the HS Explanatory Notes and HS Classification Opinion are authoritative sources of interpretation which must be adhered to by EU legislation. In addition there are Explanatory Notes (CN) of the EU and single-case regulations of the Council or Commission which must also be adhered to.

Upon application by an importer, the appropriate customs authorities must issue bind-ing tariff information (BTI). Any BTI issued by a Member State binds the customs authorities of all member states if the holder requests its application and the imported goods are identical in every respect with those described in the BTI.

2.1.2 Customs value – transaction value

Customs duties are calculated as a percentage of the value of the product (ad valorem duties). Thus, a common definition of the applicable customs value is necessary to ensure that duties are imposed uniformly within the customs union.

There are different methods of determining the value of imported goods. Normally, the customs value will be the “transaction value,” in general the actual price paid or payable for the goods when sold for export to the EU if this price is not subject to cer-tain restrictions in use (substantially affecting the value, or to certain conditions not affecting the value and not influenced by the relationship between seller and buyer).

Additionally, costs or values incidental to the production and the sale of the goods or associated with the transportation of the goods must be added if not included in the price already.

This applies to:

Commissions and brokerage (except buying commissions),

Costs of containers and packing,

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Royalties and license fees,

Resale proceeds,

Cost of transportation

While these costs must be added, certain other costs are not deemed to be a component of the customs value, provided they are distinguishable from the price actually paid or payable for the imported goods. Financing costs and buying commissions are exam-ples.

2.1.3 Origin of goods and preferences

The origin of goods is defined differently depending on the purpose and may affect the treatment of goods under customs law, foreign trade law, and also under commercial aspects. Under the Customs Code there are different rules of origin for non-preferen-tial purposes and for customs preference purposes.

The non-preferential origin of goods imported into Germany, as certified by a “certifi-cate of origin,” may be relevant for

Foreign trade purposes (import restrictions, i. e., licensees, quantity restrictions),

Statistical purposes and

Anti-dumping proceedings.

Goods have their non-preferential origin in that country in which they are wholly obtained or produced. However, if more than one country is involved in the produc-tion, goods have their non-preferential origin in the country where they underwent their last substantial, economically justified processing or re-working in an undertak-ing equipped for that purpose and resulting in the manufacture of a new product or representing an important stage in the manufacturing of the goods.

Various duty-preference agreements between the EU and other countries exist which grant exemption from customs duties or lower duty rates for goods originating from certain countries (e. g. EEA/EFTA countries, Maghreb countries, or developing coun-tries). The principles of all agreements are the same, but details of the definition of origin and other conditions may differ for certain products.

Products wholly obtained in the beneficiary country are considered to originate in that country. This corresponds largely to the non-preferential origin. For other products, the re-working or processing required on non-originating materials used in manufac-turing is generally set out in a list covering the different chapters of the CCT.

Customs duties

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The origin must be certified by a “certificate of origin”. Preferential treatment will only be granted at the request of an importer.

2.1.4 Customs regimes to avoid, reduce, or defer duty payment

In principle, goods may at any time be assigned any customs-approved treatment or use, irrespective of their nature or quantity, or their country of origin or destination. It is important for an importer to file the request and make the declaration that result in the customs procedure that minimizes duties or costs.

Customs warehousing Under the customs warehousing procedure, imported goods can be stored indefi-nitely in a customs warehouse, without as yet being subject to payment of import duties, import VAT, or excise taxes, or to the application of commercial policy measures.

Inward processing This customs procedure applies to goods imported temporarily into Germany from non-EU countries for processing and subsequent re-export in the form of compen-sating products.

Temporary use This customs procedure allows goods to be imported into Germany for a short period without triggering duties and taxes, and subsequently re-exported, e. g. goods temporarily imported in conjunction with a fair or exhibition or for testing and educational purposes.

End-use relief The customs tariff provides a customs duty exemption for certain goods if the goods are used in Germany for a specifically described purpose.

Transit procedure Under the transit procedure, goods can be moved from one point to another within the EU without incurring liability for customs VAT or excise tax, and without being subject as yet to commercial policy measures.

Tariff suspensions If goods are not available in the EU (either at all or in the same or a similar form) in sufficient quantity or quality, the shortfall can be offset by imports from non-EU countries. In this case, the suspension of tariffs serves as an incentive to import such products.

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Non-tariff customs duty exemptions These exemptions are generally linked to the use to which the goods are put or the purpose for which the goods are used. This includes personal and household items imported in connection with the relocation of residence to the EU, as well as mate-rials used in teaching, education, and research.

2.2 Anti-dumping and countervailing duties

The EU Anti-Dumping and Anti-Subsidies Regulation provides for the imposition of anti-dumping or countervailing duties in line with the GATT Anti-Dumping Code when a formal investigation has found that:

Dumping or subsidization is taking or has taken place,

Such dumping or subsidization is causing or threatening material damage to an industry segment in the EU, and

The imposition of such duties is in the interest of the EU.

If all of these requirements are fulfilled, the EU Commission may impose duties equivalent to the value of the dumping margin or the subsidy in question. Alterna-tively, it may accept a voluntary undertaking by the private party or the country involved that the dumping or subsidization will be discontinued.

2.3 Special import duties

2.3.1 Other excise duties

Germany’s main excise duties are at present the energy tax, the alcohol tax, and the tobacco tax (see chapter 8.1.2 and 7.2.1). These excise taxes are levied as a general matter when the goods are imported into Germany.

Relief from excise duties is available under certain circumstances in the form of reduced tax rates or exemption from tax.

2.3.2 Import VAT tax

The import of goods into Germany from non-EU countries is subject to German import VAT (Einfuhrumsatzsteuer), which is part of the German value added tax system (see chapter 7.1).

Anti-dumping and countervailing duties

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The standard tax rate of 19 % is subject to reductions for privileged goods (e. g., food and books). Importers who are taxable persons for VAT purposes may recover the import VAT from the tax authorities.

2.4 Starting business in Germany other than through branches or subsidiaries

Under Article 64 of the Community Customs Code, a customs declarant must have at least a permanent establishment in the EU to apply for customs clearance.

If a foreign company wishes to enter the German market without establishing a branch or a subsidiary it may make use of an

Independent sales agent,

Independent distributor, or a

Representative office employee.

Rather than setting up a branch or subsidiary in Germany, it may be worthwhile to consider using independent sales agents/distributors to perform marketing and sales functions. In this case, the company does not need to maintain its own sales force. In various industry segments, especially in the field of information technology, it has become common practice for independent distributors to deal with the end-users. Dependent employees can be used to set up a representative office in Germany.

The decision as to which of the above options is the most advantageous must be based on the individual circumstances and the specific needs of the business in question. Legal as well as business aspects should be taken into account, for example the impli-cations of the German Commercial Code (Handelsgesetzbuch – HGB). In all cases, it is advisable that agreements with representatives, distributors or agents be entered into only in writing.

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3 Company law

German law offers a broad variety of legal forms for conducting business. Foreign investors can select between several types of corporations (Kapitalgesellschaften) and partnerships (Personengesellschaften). Alternatively, operating through a branch of a foreign legal entity or – in the case of an individual – a sole proprietorship, may also be considered.

3.1 Limited liability companies and stock corporations

German law provides two major types of corporations: the limited liability company (Gesellschaft mit beschränkter Haftung – GmbH) and the stock corporation (Aktien-gesellschaft – AG). Both are separate legal entities with shareholders’ liability restricted to the value of the corporation’s assets (including outstanding contributions). The GmbH is the most common form of incorporated company under German commercial law. The GmbH is generally preferred as a vehicle for closely held companies (no IPO possible) and subsidiaries of foreign corporations due principally to the flexibility it offers. Among the special features of the law governing the GmbH which are impor-tant for the choice of entity consideration are: firstly, the ability to tailor the articles of association to the needs of the enterprise and, secondly, the right of the shareholders at the shareholders’ meeting not only to formulate general guidelines for management, but also to stipulate specific instructions for particular areas of business in which the shareholders wish to exert their influence. By contrast, the AG is the corporate form adopted by many of Germany’s largest corporations. The principal advantage of an AG is that its shares, unlike those in a GmbH, may be transferred with relative ease and can be listed on a stock exchange.

3.1.1 Formation

A GmbH or AG can be formed by one or more persons, who may be individuals or companies and need not be German nationals or domiciled in Germany.

The existence of corporate founders and the authority of their agent must be proven by certified extracts from the commercial register or other official documents.

The formation of a GmbH or AG starts with a deed, certified by a German public notary, in which the founders (or single founder) issue a declaration of formation, undertake to pay in the registered share capital (Stammkapital or Grundkapital), and

Limited liability companies and stock corporations

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stipulate the articles of association of the GmbH (Gesellschaftsvertrag) or the articles of incorporation of the AG (Satzung). The articles must include, inter alia, the compa-ny’s name and registered office (Sitz), the purpose of the enterprise, the amount of the registered share capital and – in case of a GmbH – the amount each shareholder must contribute to the registered share capital (original contribution, Stammeinlage) and – in the case of an AG – the par value or number of shares, the issue price and, if more than one class of shares exists, the class of shares subscribed by each founder. In con-trast to a GmbH, the articles of an AG may deviate from statutory provisions only where this is expressly allowed by the German Stock Corporation Act (Aktiengesetz – AktG); generally there is little ability to amend the articles in view of the many manda-tory provisions contained in the AktG. Since the laws governing GmbHs and AGs are federal laws, the location of the registered office does not affect the rules governing a GmbH or AG. The location of the registered office is the place where the GmbH or AG operates its business or where the corporation’s management is located. This location must be within Germany. In addition to the registered office, a GmbH or AG may maintain any number of branches throughout Germany and abroad.

For a GmbH, one or more managing directors (Geschäftsführer) must be appointed as provided for in the articles. This is usually stipulated in the articles, but can also be changed at a later date. Managing directors are allowed to hold an interest in the GmbH. They must be individuals, but need not be citizens or residents of Germany. The managing director(s) appointed must submit an application to register the GmbH in the commercial register (Handelsregister) maintained by the local court where the GmbH has its registered office. The GmbH comes into legal existence only upon regis-tration.

In the case of an AG, the founders appoint the auditors for the AG’s first full or partial fiscal year and appoint the initial supervisory board (Aufsichtsrat), which in turn appoints the first board of management (Vorstand). The appointment of the auditors and the supervisory board must be certified by a public notary. The members of the boards (management and supervisory) must be individuals but need not be citizens or residents of Germany. They can be shareholders, but cannot simultaneously be mem-bers of both the management and supervisory boards. The founders must also prepare a formation report (Gründungsbericht), in which they are required to describe the transactions leading up to the formation, the initial acquisition of assets, capital contri-butions in-kind, and special advantages or remuneration granted to the members of the management or supervisory boards. In addition, the formation of an AG must be exam-ined by the members of both boards and, in certain circumstances, the auditors may be required to issue an examination report. The founders and members of the manage-ment and supervisory boards must submit the application to register the AG in the

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commercial register maintained by the local court where the AG has its registered office. The AG comes into legal existence upon registration.

The registration procedure in the commercial register was simplified in 2007 by intro-ducing an electronic register. Now the necessary documents for entity formation are filed in electronic format. The local court rules on the registration promptly and there-after the documents are recorded in the electronic commercial register.

Practical Example:

Businessman A would like to form a GmbH. He has to deliver the necessary docu-ments to his notary to initiate the required registration in the commercial register. If the application form and deeds are available in hard copy only, the notary will con-vert them into an electronic format. The notary thereafter notarizes the documents and sends them in electronic form to the appropriate local court. Upon receipt, the local court will process the documents and enter the GmbH in the electronic commer-cial register. The GmbH then comes into legal existence. Registration means simulta-neous electronic publication, so anyone can view the data online at the homepage: www.unternehmensregister.de (see chapter 3.1.8).

If the founders delegate their powers to authorized representatives, they need not appear in person before the acting notary for the formation deed. Any power of attor-ney must be notarized or at least “authenticated” by a public notary. In the case of notarization or authentication by a foreign public notary, the certificate of the foreign public notary will only be recognized by German courts if it has been “legitimized” by the German Consulate in the country in which the power of attorney was notarized or authenticated. There are, however, numerous provisions in international conventions stipulating that a so-called “apostille” certificate (i. e. additional attestation by a for-eign authority) is sufficient or, indeed, that neither legalization nor attestation is neces-sary.

Several weeks may elapse between the date of notarization of the articles and the reg-istration of the GmbH or AG. During this period, the GmbH or AG is referred to as a “company in formation” (Vorgesellschaft). Such company is considered to be a sepa-rate entity, which is entitled to act through its representatives, commence business, enter into transactions, and assume liabilities. During this period any person acting in the name of the GmbH or AG is personally liable to the creditors of the “company in formation”; if more than one person acts in the name of the corporation, such persons are jointly and severally liable. Additionally, the founders may be held liable for any losses to the stated capital in proportion to their percentage holdings (i. e. not jointly and severally). Upon registration, the founders are liable for pre-registration losses


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Company law



(Vorbelastungshaftung), i. e. they are required to reimburse the GmbH or AG for any losses to the stated capital incurred prior to registration. Specific rules apply where the founders continue to conduct business despite the fact that registration of the company is no longer sought or where registration is not possible; in these cases, the founders are jointly and severally liable for the losses of the company. This also includes direct liability to the creditors of the company.

3.1.2 Registered share capital

The statutory minimum registered share capital, which must be subscribed in full, is € 25,000 for a GmbH and up to € 50,000 for an AG. If contributed in cash, only one quarter of the registered share capital of a GmbH (but not less than € 12,500) must be paid in by the date of the application for registration in the commercial register. In the case of an AG, one quarter of the registered share capital and the entire premium, if any, must be paid in. The capital of a GmbH or AG must be paid in full or security must be given in respect of outstanding capital if the GmbH or AG is established by a single shareholder. Contributions in kind must be fully contributed in such a way that the assets are permanently at the free disposition of the managing directors/board of management.

The legislation governing GmbHs and AGs is designed to ensure that registered share capital is paid up and maintained. The rules applicable to an AG are stricter in this respect. In particular, an AG is not permitted to repay share capital contributions to its shareholders regardless of whether such payment would reduce the AG’s net assets to a level below its registered share capital. A GmbH, on the other hand, is prohibited only from making payments to shareholders that would reduce the GmbH’s net assets to a level below its registered share capital.

The AG may issue share certificates either with a par value (Nennbetragsaktien) of at least € 1 per share or multiples thereof or without par value (Stückaktien). Both com-mon shares (Stammaktien) and preferred shares (Vorzugsaktien) may be issued, either as bearer shares (Inhaberaktien) or registered shares (i. e. where the name of the owner is registered in the AG’s share register, Namensaktien). Bearer shares are freely trans-ferable; the corporation is not allowed to restrict their transfer. For registered shares, the articles may provide that a transfer requires the consent of the company. In general, each share confers one vote, although preferred shares may be non-voting. Multiple voting rights are not permissible.

By contrast, the capital of a GmbH is not issued in the form of certificates. Rather, each shareholder holds a share (a business interest, Geschäftsanteil) in the company in the amount of the original contribution (Stammeinlage), which must be at least € 100,

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or any greater amount divisible by fifty. The share in a GmbH may be transferred by assignment or upon inheritance. Any contractual transfer of ownership must be nota-rized and can be made conditional upon the consent of the GmbH or other holders of shares or any other restriction stipulated in the articles of association. The GmbH is not required to maintain a share register, book, ledger, or other formal records of share ownership. The ownership of the shares is documented only in the formation deed; any subsequent transfers are documented by notarized deeds.

3.1.3 Management

A GmbH is managed and represented by its managing director(s) (Geschäftsführer) in and out of court. Unless otherwise provided by the articles, the principle of collective management and representation applies, meaning that all managing directors must act jointly.

The power of representation (Vertretungsmacht) cannot be restricted vis-à-vis third parties; only the management authority (Geschäftsführungsbefugnis) can be restricted internally, and the shareholders may exercise their right to give the managing directors instructions regarding any particular matter on which they wish to exert their influ-ence. A GmbH must have at least one managing director and can have in total as many as the shareholders wish. They must be individuals, but need not be citizens or resi-dents of Germany, and are allowed to hold an interest in the GmbH. The managing directors are appointed at a shareholders’ meeting as provided in the articles. The appointment can be revoked at any time, without prejudice to any contractual indem-nification claims. The articles can restrict the right of revocation to the reasons set forth in the articles.

The AG is managed and represented in and out of court by a board of management (Vorstand). Unless otherwise specified in the articles, all members of the board of management must act jointly in both managing the corporation and representing the corporation vis-à-vis third parties. The board of management may have internal rules, which may provide for committees and may stipulate the transactions requiring board of management consent. A limitation on the statutory authority of the board of man-agement to represent and bind the AG is not effective against third parties; only inter-nally may the management be subject to certain restrictions, e. g. specific transactions may require the approval of the supervisory board. Board members are appointed, removed, and supervised by the supervisory board. They are appointed for a term not to exceed five years and can only be dismissed during their term of office for cause. Neither the shareholders nor the supervisory board may issue instructions to the board of management.


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Company law



A recent amendment to the AktG codified the so-called business judgment rule, which up to then was a corporate law concept developed by the case law. Essentially, the busi-ness judgment rule creates a strong presumption in favor of the board of management of an AG, shielding the board members from liability for decisions that result in unforeseeable harm to the corporation. Since the managers of a GmbH are directly responsible to its shareholders, no statutory business judgment rule has as yet been enacted with regard to GmbHs.

3.1.4 Supervisory board

The supervisory board (Aufsichtsrat) is mandatory for an AG. It controls and super-vises the board of management, but may not participate in the corporation’s day-to-day management. It may, however, determine that certain categories of transactions are subject to its approval. If the approval is denied, the board of management may appeal the decision to the shareholders. The supervisory board consists of a minimum of three members with a total number of members that must be divisible by three; the maximum permissible in an AG with a registered share capital of more than € 10 mil-lion is 21 members. Except for employee representatives, whose appointment is gov-erned by special provisions, the members of the supervisory board are elected by shareholder resolution for a term not to exceed five years as set forth in the articles or in the resolution of appointment. A right to appoint members to the supervisory board (Entsenderecht) may be granted by the articles of association to specific shareholders or to the holders of specific shares. Members can be dismissed only by court order, by a 75 % majority of votes cast in a general meeting of shareholders, or by the share-holder with the right to appoint the member in question. Members may also be recalled by a simple majority of shareholder votes if they cease to meet the requirements speci-fied in the articles. The main functions of the supervisory board are:

Appointment and dismissal of the members of the board of management, including agreeing to the terms and conditions of the employment contracts of the members of the board of management;

Supervision of the board of management, including the examination of both legal and commercial aspects of management board actions;

Representation of the AG in its dealings with the board of management;

Representation of the AG (together with the board of management) in litigation relating to the validity of shareholder resolutions;

Authorization of business decisions of the board of management where required by the articles or by the supervisory board itself; and

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Appointment of the statutory auditor, review and approval of the annual financial statements.

In the case of a GmbH, a supervisory board is mandatory only if the GmbH has more than 500 employees. In all other cases, shareholders are entitled to form a supervisory or advisory board (Beirat) and to define the functions of said board in the articles.

3.1.5 Shareholders’ or general meetings

Shareholders’ decisions are made by way of shareholder resolutions taken at share-holder meetings (Gesellschafterversammlung) in the case of a GmbH and at the gen-eral meeting of shareholders (Hauptversammlung) in the case of an AG.

For a GmbH, shareholder meetings are normally called by the managing directors (or the supervisory board, if applicable), or by holders of at least 10 % of the share capital. The meetings need not be held in Germany. Votes can be cast by telex, fax etc. Unless otherwise provided in the articles of association, the statutory rights of shareholders at shareholder meetings include decisions on: appointment of managing directors, review of the activities of the managing directors, approval of the financial statements, appro-priation of profits, and amendments to the articles of association. Unless otherwise stipulated in the articles, each € 50 participation entitles the owner to one vote. Deci-sions are made by a simple majority of votes (more than 50 %), unless the articles pro-vide otherwise. In some cases a 75 % majority is required by law.

For an AG, a general meeting must be held each year within eight months of the end of the financial year and is convened by the board of management. The meeting is nor-mally held in Germany at the place where the AG has its registered office. In addition, the board of management, the supervisory board, or shareholders holding at least one-twentieth of the registered share capital have the right to call an extraordinary general meeting. The statutory rights of the general meeting include decisions regarding the appointment of members of the supervisory board; the appropriation of profits; formal approval of the board members (management and supervisory) with respect to their activities during the preceding financial year; the appointment of auditors; amend-ments to the articles of incorporation; reorganizations; and the liquidation of the AG. Decisions are made by a simple majority of votes (more than 50 %) unless:

The law mandates a greater majority, e. g. 75 % to amend the articles or to increase or decrease share capital;

The law requires the consent of certain shareholders, e. g. the consent of preferred shareholders whenever their rights are effected;


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Company law



The articles provide otherwise.

3.1.6 Amendment of the GmbH Law

On June 26, 2008 the Bundestag – the lower house of the German parliament – passed the Act for the Modernization of Limited Liability Company Law and the Deterrence of Abuses (Gesetz zur Modernisierung des GmbH-Rechts und zur Bekämpfung von Missbräuchen – MoMiG). This act is the first extensive amendment of the GmbH Law since 1980 and seeks to make the GmbH more competitive internationally as a form of business association, as well as more attractive to small and medium-sized busi-nesses.

3.1.6.1 Accelerated formation of GmbHs

At the core of the act is the facilitation and acceleration of corporate formation. Slow corporate formation was seen as a competitive disadvantage of the GmbH compared with foreign legal forms, e. g. the British limited company (ltd.), because most EU member states have lenient requirements for the establishment of a corporate entity.

In consideration of the requirements of company’s founders, who in general desire a low initial registered share capital, the act will create a so-called business company (Unternehmergesellschaft – GmbH UG). The GmbH UG will not be a new legal form; it will be a version of the GmbH that can be formed without minimum registered share capital. A GmbH UG will not be allowed to distribute its profits completely; the mini-mum stated capital of such entities will have to be saved up over the years.

Currently, each shareholder holds a business interest in the company in the amount of the original contribution, which must total at least € 100 or any higher amount divisi-ble by fifty (see chapter 3.1.2). The draft legislation would reduce the minimum value of each business interest to € 1, permitting the shares to be divided, consolidated, or sold more easily.

The bill also includes model articles of association (Musterprotokoll) for uncompli-cated incorporations. Where these model articles are used, notarial charges can be reduced.

To simplify the formation of a GmbH established by a single shareholder, the act would repeal the requirement of providing security. Currently, the capital of a GmbH must be paid in completely or security must be posted for the outstanding amount if the corpo-ration is formed by a single shareholder.

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3.1.6.2 Increasing the attractiveness of the GmbH via greater flexibility of the corporation

German company law follows the seat-of-management rule (Sitztheorie). According to this basic principle, both the corporation’s registered office and its place of manage-ment must be in Germany. Moving the place of management abroad leads to dissolu-tion of the corporation. By contrast, corporations founded in another EU member state in which the place-of-incorporation rule (Gründungstheorie) applies may transfer their place of management to Germany. Under the decisions of the European Court of Jus-tice (ECJ) in the cases Centros, Überseering, and Inspire Art, Germany has to respect the legal capacity the country of formation grants to the corporation (see chapter 3.5). Inability to transfer their place of management abroad constitutes a significant com-petitive disadvantage for German corporations. To eliminate this disadvantage, the draft legislation would enable the GmbH to select a place of management that differs from the place of registration. This place of management could even be located outside Germany.

3.1.6.3 Abuse deterrence

Another essential aim of the draft legislation is the prevention of certain abuses that have become evident in practice.

In order to make it easier to take legal action against a corporation, the bill would require GmbHs to record their domestic postal address in the commercial register. Hence, creditors could find out easily against whom they must assert their claims. This rule would also apply to AGs, sole proprietors, partnerships, and branches as well. Furthermore shareholders would be required to file an insolvency petition against the GmbH if it lacks effective management and the other conditions for insolvency are fulfilled. This is intended to make it more difficult to evade the obligation to com-mence insolvency proceedings against the GmbH. Furthermore, the circumstances disqualifying individuals for service as managing directors of GmbHs would be expanded.

The draft legislation must pass both houses of the German parliament (Bundestag and Bundesrat) before it can become law. The legislation is expected to take effect in the second half of 2008.

In summary, it is noted that the draft legislation does not contemplate a fundamental overhaul of GmbH law. It seeks to make the GmbH more competitive internationally. Simplified formation of the GmbH and the ability to select a place of management outside Germany would make the GmbH more competitive internationally as a busi-


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Company law



ness association. Whether the measures will prevent abuses remains to be seen. Never-theless, the pending legislation is a big step forward.

3.1.7 German Corporate Governance Code

The German Corporate Governance Code contains major statutory provisions for run-ning and monitoring German corporations, including nationally and internationally accepted standards for good and responsible corporate governance. The Code is intended to make corporate governance rules more transparent for national and inter-national investors and to strengthen the confidence of shareholders, associates, cus-tomers, and the public in the management of corporations. The Code describes the general legal framework for a company and insofar the functionality of the board of management and the supervisory board of German corporations.

The German Corporate Governance Code contains three types of terms: recapitula-tions, proposals and recommendations. The recapitulative terms are informational. They reiterate statutory rules already in effect, thus giving foreign investors an over-view of important German corporate governance provisions. The terms in the second category – the proposals – are recognizable by “should” or “can” phrases. While the proposals are not mandatory, they help potential investors focus attention on specific areas of management action. In the final category, the recommendations constitute accepted standards of corporate governance and are identified by “shall” phrases. Their application is also not mandatory, but corporations that decline to adhere to the recommendations must state their reasons for failing to do so. Depending on context, the recommendations relate either to the board of management or to the supervisory board or to both boards.

Under § 161 of the Stock Corporation Act (Aktiengesetz – AktG), the board of manage-ment and the supervisory board of corporations with publicly traded shares must declare annually whether the corporate management complies with the terms of the German Corporate Governance Code and identify any proposals and recommenda-tions that are not adhered to. This so-called “declaration of conformity” must be avail-able to the shareholders at all times.

The German Corporate Governance Code is intended primarily for public corpora-tions, but it is recommended that non-public corporations follow the code as well.

The German Corporate Governance Code is published by the Federal Ministry of Jus-tice in the German Federal Gazette. The Code is monitored by the Commission of the German Corporate Governance Code (Regierungskommission Deutscher Corporate Governance Kodex), which was formed by the Federal Ministry of Justice and holds

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meetings under the chairmanship of the chairman of the supervisory board of Thys-senKrupp AG. As a rule the code is reviewed at least annually and will be amended if necessary.

3.1.8 Business register – Unternehmensregister

In 2007 an electronic business register was introduced in Germany. The business reg-ister shows the records in the commercial register. Anyone may view the information online on the website: www.unternehmensregister.de. Documents that must be on record in the commercial register may now be filed in electronic form; from 2009 onwards, electronic filing is mandatory. The announcement of entry in the commercial register takes place online only. The previous process of announcement in the daily newspapers has been discontinued. In addition, the business register contains all essen-tial business data subject to publication requirements, e. g. financial statements. They are published on the website as well (so-called “one-stop-shopping”).

The introduction of the business register has lead to a debureaucratization of corporate disclosures (Unternehmenspublizität). By bringing together all essential business data in one database, the legislature sought to improve the transparency of the market.

3.1.9 Insolvency

GmbHs and AGs are considered insolvent when they cannot pay their debts as they fall due (illiquidity), or when, on the company’s balance sheet or interim statement, liabili-ties exceed the value of the assets, measured at their going-concern value. This defi-ciency of assets is known as “over-indebtedness” (Überschuldung).

If a situation of over-indebtedness or illiquidity is identified, the managers of the cor-poration must file a petition for the commencement of insolvency proceedings with the local district court without culpable delay, at the latest after three weeks. Otherwise, they may be held personally liable and be subject to criminal penalties. A petition for the commencement of insolvency proceedings may also be filed against the company by any creditor.

3.1.10 Liquidation

An AG and a GmbH may be dissolved on expiration of a period provided in the articles, by resolution of three quarters of the shareholders, upon commencement of insolvency proceedings, or by court order. Subsequent to the dissolution, the corporation is to be liquidated unless bankruptcy proceedings have begun. An AG is liquidated by the board of management and a GmbH by the managing director(s), unless otherwise


34

Company law



provided for in the articles or decided upon by a shareholder resolution. In certain cases, liquidators may be appointed by a court order requested by a certain percentage of shareholders or by the supervisory board in the case of an AG.

The liquidation must be entered in the commercial register. Financial statements must be prepared as of the date of the opening of the liquidation proceedings and for every year-end thereafter.

The creditors of the company must be notified of the liquidation and requested, through three consecutive publications in the German Federal Gazette (Bundesanzeiger), to submit their claims. Upon discharge of the liabilities, the remaining assets are distrib-uted among the shareholders in liquidation, but not earlier than one year after the third public notification to the creditors.

3.2 Other forms of corporations

3.2.1 Societas Europaea – SE

On October 8, 2001, the European Council adopted a regulation establishing a statute for a European stock corporation (Societas Europaea – SE). The SE regulation was accompanied by a directive on the involvement of employees in the SE. The SE regula-tion adopts the seat-of-management rule: Once incorporated, the SE can change its seat to another Member State without giving up its legal status. The SE can move freely within the EU and the EEA (Norway, Iceland, and Liechtenstein) Member States.

A SE can be set up by two or more stock corporations from at least two different EU Member States (see also chapter 10.3.3). Operating throughout the EU on the basis of a single set of core regulations, the SE is an alternative for corporate reorganizations on a European level. The SE is designed as a publicly held corporation comparable to a German AG with a registered share capital of at least € 120,000. Depending on the form adopted in its articles of incorporation, the SE can be governed by either a super-visory body and a management body (two-tier system) or by a single administrative body (one-tier system).

3.2.2 Limited partnership with share capital – KGaA

The Stock Corporation Act contains provisions on limited partnerships with share capital (Kommanditgesellschaft auf Aktien – KGaA). These companies are similar to stock corporations, except that one or more general partners are personally liable for the company’s debts. This business form is not frequently used in Germany.

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3.3 Other business associations

3.3.1 Partnerships

Besides GmbHs and AGs, commercial partnerships (as defined by the German Com-mercial Code) play an important role in Germany’s business life. Such partnerships include general partnerships (Offene Handelsgesellschaft – OHG) and limited part-nerships (Kommanditgesellschaft – KG). The only major difference between the two forms is the liability of partners. In an OHG, all partners are jointly and severally lia-ble for all of the partnership’s debts. In a KG, at least one general partner (Komple-mentär) is personally liable whereas the liability of the limited partners (Kommandi-tisten) is limited to their registered contribution to the partnership. For this reason, foreign investors usually choose a KG when setting up a partnership structure for their investment in Germany.

To set up a partnership, at least two partners are required to execute a partnership agreement; in principle, the partners may freely agree upon their rights and obliga-tions. The partners (general as well as limited partners) of a German partnership may be either individuals, German or foreign corporations, or other partnerships. No spe-cial form must be observed unless the agreement includes certain obligations, e. g. the transfer of real estate (in this case the agreement must be executed in a deed certified by a public notary). The partnership must be registered with the relevant commercial register. All partners are obligated to apply for registration. In order to achieve the liability protection for the limited partners, the liable contribution (Haftsumme) must be properly registered; otherwise, it is not legally effective. In the event the partnership commences business prior to registration, each limited partner who has agreed to the commencement of the business is liable in the same manner as a general partner for any debts arising from the commencement of business prior to registration, unless that partner’s status as a limited partner was known to the creditor. The transfer of any partnership interest (as limited or general partner) requires an agreement between the transferor and the transferee together with the consent of all other partners, unless the partnership agreement provides otherwise.

The partnership is managed and represented in and out of court by the general part-ners; the limited partners may only participate in the management if the partnership agreement so provides. The limited partners are also unable to act on behalf of the partnership, unless the partnership agreement confers representation authority on them.

Other business associations

36

Company law



The partners determine the affairs of the partnership through partnership resolutions, which generally must be passed unanimously, unless otherwise agreed in the partner-ship agreement.

Although an OHG or KG is not an entity entirely separate from its partners, the part-nership may carry on business, acquire, hold and dispose of property, and sue and be sued in its own name. All partnership property is owned by the partners in joint ten-ancy.

The reasons why a partnership might be preferred over a corporation include, firstly, the great flexibility in tailoring the partnership’s internal affairs to the individual needs of the partners and, secondly, less extensive publication requirements (unlike the arti-cles of a GmbH or AG, the partnership agreement need not be filed with the commer-cial register). Other factors are the greater ease of dissolution and distribution of the capital to the partners and direct management and representation by the general part-ner.

German company law does not restrict the mixing of corporate forms. A very common form of a commercial partnership is the GmbH & Co. KG, a limited partnership with a limited liability company acting as general partner. The GmbH & Co. KG combines certain advantages of partnerships with the liability limitations of corporations. Based on a large number of court decisions, the GmbH & Co. KG has emerged as a business association in its own right.

3.3.2 Silent partnerships

A silent partnership or participation (stille Gesellschaft) exists where a person contrib-utes to the capital of an existing business and shares in its profits (possibly also in its losses), without incurring any liabilities towards creditors. Silent partnerships have no entity or quasi-entity status, but are mere financial participations in another business on a contractual basis. Aside from their tax planning uses, silent partnerships are used especially to allow third parties to share profits and risks of a business without acquir-ing any rights or assuming any obligations not specifically covered in the silent part-nership agreement. Silent partnerships also permit the silent partner to avoid disclos-ing its investment, since silent partnerships are generally not registered in the com-mercial register. However, various higher regional courts have held that silent partner-ships must be registered in the commercial register if the business in which the silent partner participates is an AG, because the creation of a silent partnership is effectively an agreement to transfer a portion of the profit, which affects the distribution of total profit to the shareholders.

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3.3.3 Civil law associations

A civil law association (Gesellschaft bürgerlichen Rechts – GbR) is a partnership which has no registered business name and does not constitute an entity entirely sepa-rate from its partners. However, the GbR as such may generally conclude contracts and bear the rights and obligations thereof and can sue and be sued in its own name. All property acquired by the association in its name is owned by the partners in joint ten-ancy. All partners are jointly and severally liable for all debts incurred by the GbR unless a liability limitation is agreed with each single creditor for each transaction.

To set up a civil law association, at least two partners are required to execute an asso-ciation agreement; no registration is required. Possible partners can be either individu-als, German or foreign corporations, or commercial partnerships or other civil law associations.

The legal relationship between the different partners is determined by the rights and obligations agreed upon in the association agreement. Unless otherwise agreed, the GbR is managed and represented in and out of court by all partners, and each transac-tion requires the consent of all partners.

A civil law association is typically used for non-commercial purposes (e. g. associa-tions of professionals) and for individual transactions or contracts (e. g. construction projects), in most cases for a limited period of time.

3.3.4 Sole proprietorship

In a sole proprietorship (Einzelkaufmann), the owner is engaged in a typical commer-cial business. He is personally liable for all debts and must register the business with the commercial register.

3.4 Branches

A foreign individual entrepreneur, corporation or partnership may establish a branch in Germany. The branch must be registered in the commercial register with the local court where it has its registered office, and it must notify the local municipality when starting business operations. A branch is not a separate legal entity even though con-tracts may be concluded in its name.

To register a branch, the court will request evidence of the legal existence of the for-eign company, copies of the articles of association/incorporation, the names of all managing directors or members of management boards and their power of representa-tion, the amount of registered share capital, the location of the registered office, its

Branches

38

Company law



organization, as well as the names of the persons who will act for it in Germany. This information and all subsequent changes must be registered in the electronic commer-cial register and published on the homepage of the German Federal Gazette (Bundes-anzeiger).

Depending on the type of business the branch intends to conduct, it may be necessary – as in case of banking and insurance – to produce evidence of proper qualifications and obtain special permits. The licensing procedures have been relaxed recently as part of developments within the EU.

3.5 Companies organized under the law of a foreign jurisdiction

Since the seat-of-management rule has up till now applied to all companies formed under German law, companies organized under the laws of a foreign jurisdiction have been an attractive alternative. Following a series of decisions by the European Court of Justice (ECJ) (Centros, Überseering, Inspire Art Ltd.) it is now possible for companies organized under the law of another European jurisdiction to move their seat of man-agement to Germany if their foreign jurisdiction permits such a move. In contrast, German business associations have to liquidate in Germany when moving their seat of management to another country. However, the German cabinet intends to permit GmbHs to select a place of management that is outside of Germany (see chap-ter 3.1.6.2).

According to the ECJ, Germany is required to respect the legal capacity of companies duly formed in accordance with the law of another EU Member State, even if the for-eign company has moved its actual place of administration/management to Germany. The requirements of ECJ rulings apply to corporations as well as to other business associations.

A substantial presence in their home jurisdiction is not required. Even if the foreign company lacks any material connection with the country in which it was formed and only has a token presence in its nominal home jurisdiction, Germany may not refuse to recognize the foreign company.

All business organizations formed under the law of a Member State that follows the place-of-incorporation rule – e. g. UK, Ireland, and Netherlands – must be recognized by the German authorities and German courts. Under a bilateral agreement (1954 Ger-man-American Treaty of Friendship, Commerce and Navigation), U.S. companies (e. g. Delaware LLC) are recognized as well.

39



The formation of a foreign corporation – e. g. a UK Ltd. – might involve fewer for-malities and entail less expense compared with forming an AG or a GmbH in Ger-many. However, the operating costs of a foreign company that conducts its business in Germany often exceed the costs their German counterparts would incur. In addition, there are legal uncertainties and implications concerning the taxation of such entities which often render corporations organized under the law of a foreign jurisdiction less attractive.

Companies organized under the law of a foreign jurisdiction

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4 Accounting and reporting

4.1 German accounting principles

4.1.1 Financial statements

The German Accounting and Reporting Act (Bilanzrichtliniengesetz – BiRiLiG) was enacted in December 1985 to implement the 4th, 7th, and 8th EU Directives into Ger-man law. Since that date, there have been a number of subsequent amendments relating in particular to the transposition into German law of the EU directive on small and medium-sized companies (Council Directive 90/604/EEC of November 8, 1990), and the EU directive on different types of incorporated companies (Council Directive 90/605/EEC of November 8, 1990). Most of the provisions can be found in the third book (§ 238–342e) of the German Commercial Code (Handelsgesetzbuch – HGB), which contains regulations to be complied with by all businesses as well as supple-mentary regulations for incorporated companies, credit institutions, and insurance companies. The supplementary regulations designed for incorporated companies also apply to general partnerships (Offene Handelsgesellschaften – OHG) and to limited partnerships (Kommanditgesellschaften – KG) where no individual is personally liable (known as “KapCoGesellschaften”). In Germany, this applies particularly to the form of limited partnership known as the “GmbH & Co. KG,” which has a limited liability company (GmbH) as general partner and individuals – typically the members of the GmbH – as limited partners.

A recent amendment to the German Commercial Code (Accounting Law Reform Act, Bilanzrechtsreformgesetz – BilReG) accompanied the introduction of the EU IAS Regulation and implements several EU Directives (Modernization Directive, Thresh-old Directive, and Fair Value Directive). The BilReG led to a further alignment of German accounting law around EU legal standards.

The Federal Ministry of Justice has released draft legislation that is intended to mod-ernize German accounting law (Accounting Law Modernization Act, Bilanzrechtsmo-dernisierungsgesetz – BilMoG). The basic purpose of the changes is to make German accounting law a fully adequate und simpler alternative to the International Financial Reporting Standards (IFRS). The elimination of various capitalization, recognition, and valuation elections would bring German domestic accounting law closer to IFRS while retaining the existing accounting principles of German commercial law (see chapter 5.2.2 for detailed information of the Draft Accounting Law Modernization Act). Enactment of the act is expected for the end of 2008.

German accounting principles

42

Accounting and reporting



The Accounting Law Reform Act (BilReG) addresses such matters as size criteria, the management report, and the information to be presented in the notes. For incorporated companies (AG, KGaA, GmbH, SE) and for “KapCoGesellschaften,” which are treated in the same manner as incorporated companies, the German Commercial Code con-tains three reporting categories based on the respective company’s size: small, medium-sized, and large companies. Three criteria are used to determine the category to which a company belongs: balance sheet total, turnover, and number of employees. A company is included in a particular size class if it meets two out of the three criteria on two successive balance sheet dates (see table 6).

Table 6: Classification of company size (accounting obligations)

Balance sheet total

€ million

Turnover€ million

Number of employees

(average per year)

Small up to 4.015 8.030 50Medium-sized above 4.015 8.030 50

to 16.060 32.120 250Large above 16.060 32.120 250

The initial classification of newly established companies depends on the company’s characteristics on the first balance sheet date. However, publicly quoted companies are always deemed to be large companies.

The classification of companies by size is significant because the disclosures required by the German Commercial Code vary according to the size of the company. Large companies must prepare a balance sheet, an income statement, notes to the financial statements (comments and supplementary disclosures about items in the balance sheet and income statement, as well as additional information about such matters as account-ing policies, affiliated companies, and the remuneration of management and of the supervisory board), and a management report (containing a description of business trends and future prospects for the company), each in the complete format prescribed by law. The Accounting Law Reform Act (Bilanzrechtsreformgesetz – BilReG) expanded the scope of the information to be included in the notes regarding the nature, scope, and valuation of specific derivative financial instruments.

Since 2007 documents must be filed in electronic form with the German Federal Gazette (Bundesanzeiger) for publication on its homepage (see www.bundesanzeiger.de and www.unternehmensregister.de). Companies are not distinguished by size in this respect. Small and medium-sized companies must also file with the German Fed-eral Gazette.

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Simplifications based on size are available for small and medium-sized companies with respect to the disclosure documents. Medium-sized companies need only prepare a simplified income statement (including exemption from the requirement to analyze the gross profit figure) and simplified notes to the financial statements (including exemptions from the requirement to analyze sales by areas of activity and by geo-graphical markets and to disclose (i) the extent to which the result for the year has been affected by the application of tax concessions and (ii) any future charges that will arise therefrom).

Small companies are not required to prepare a management report, and the notes to the financial statements are largely simplified. The balance sheet may be presented in an abbreviated format.

Enterprises that are neither corporations (Kapitalgesellschaften) nor “KapCoGe-sellschaften” are not required to disclose their financial statements. There are excep-tions, however, under the Disclosure Act (Publizitätsgesetz – PublG) for large enter-prises which exceed two of the three size criteria (balance sheet total: € 65,000,000; turnover: € 130,000,000; number of employees: 5,000). Special disclosure require-ments also apply to enterprises in specific industry sectors (e. g., banking, insurance).

Corporations and “KapCoGesellschaften” must prepare their balance sheet in the accounting format prescribed by law for their size category. This method of presenta-tion is largely followed by other types of enterprises.

The income statement must be prepared by corporations and “KapCoGesellschaften” in vertical form using either the cost-summary method or the cost of sales method. For each of these two methods, the organization of the income statement is prescribed by law. Enterprises which have a different legal form are only required, when selecting the form of presentation of the income statement, to comply with the principle that financial statements must be clear and understandable; in practice, the form of presen-tation used for corporations is usually followed.

Irrespective of the legal form of the enterprise, every business is required to maintain accounts that reflect its business transactions and its financial position in accordance with German principles of proper accounting. These principles are derived from a variety of sources and are frequently amended.

Specifically, German accounting principles require that entries be complete, correct, and chronological; that annual financial statements be prepared; that all computations be made on a Euro currency basis; and that books and records be maintained in a liv-ing language and retained for a certain period of time. “Loose-leaf” accounting (Lose-blattbuchführung), “open item accounting” (Offene-Posten-Buchhaltung), and IT-


44




based accounting systems are acceptable if they meet certain requirements. Invento-ries of goods must generally be compiled, valued, and recorded in the accounts at the balance sheet date. Reliance on perpetual inventory records is permissible if they are in conformity with the legal requirements and show the inventory on the balance sheet date. Additionally, a physical inventory of movable fixed assets must be taken at each balance sheet date, unless perpetual inventory records are maintained. Such records are also sufficient for tax purposes, provided certain requirements regarding detailed information on the respective assets are met.

Furthermore, commercial law requires that the accounting system be set up in such a way that an independent professional is able, within a reasonable amount of time, to obtain an overview over the assets, liabilities, and operations of the company. The provisions, however, focus on accounting and reporting by companies. The objective is to ensure that companies present a true and fair view of their net assets, financial posi-tion, and operational results. If this is not accomplished by the balance sheet and income statement alone, additional information must be provided in the notes to the financial statements.

In principle, tax law incorporates by reference the requirements under commercial law and relies on the financial statements prepared for commercial purposes. In other words, the commercial financial statements form an authoritative basis for tax account-ing purposes. However, there are also certain specific tax accounting rules (see chap-ter 6). The option exists to apply numerous special tax rules in the commercial finan-cial statements. However, in some cases there are mandatory differences between the commercial and tax accounting. Differences therefore commonly arise between the commercial financial statements and the tax accounts.

One unavoidable difference between the commercial financial statements and the tax accounts results from provisions for anticipated losses on transactions in the course of completion (pending transactions). Such provisions are mandatory under commercial law, but not permitted in the tax accounts.

German accounting regulations require the application of a strict historical cost prin-ciple under both commercial and tax law. If the value of an asset at a later date exceeds its historical cost, the increase may not be recognized in the balance sheet until a real-ization event occurs (e. g. on sale of the asset). The principle of the lower of cost or market value applies in a different form for fixed and current assets. Any reductions in the value of the asset should be reflected in its balance sheet valuation. If the value of the asset subsequently increases, write-backs are mandated in the tax accounts and, for incorporated companies, in the commercial financial statements.

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Fixed assets must be stated in the balance sheet at their purchase or manufacturing costs less accumulated amortization or depreciation. Assets are generally amortized or depreciated over their estimated useful lives using the straight-line method, the declin-ing-balance method, the declining-balance combined with the straight-line method, or an output-related method, depending on the type of asset involved. For tax purposes only the straight-line method and the output related method are applicable. If diminu-tion in the value of an asset is believed to be permanent, the asset must be written down to the lower value in accordance with the principle of the lower of cost or market referred to above. If there is a temporary diminution in the value of the asset, an enter-prise may make an exceptional write-down in the commercial financial statements, but not in the tax accounts. In the case of corporations, such write-downs are only permit-ted in the commercial financial statements for financial fixed assets. If the value of the asset increases subsequent to an exceptional write-down, a write-back must be made in the financial statements of the company.

Current assets should be stated at purchase or manufacturing cost and written down to the lower of cost or market. A write-down is only permissible for tax purposes where the diminution in the value of the asset is believed to be permanent. If the value of the asset subsequently increases, write-backs are mandatory in the tax accounts and, for incorporated companies, in the commercial financial statements.

For commercial accounting purposes, provisions must be created for liabilities of an uncertain nature and for anticipated losses on transactions in the course of completion. In addition, provisions may be made in the commercial balance sheet for individual obligations (expense provisions). The creation of provisions for tax purposes is restricted.

4.1.2 Consolidated financial statements

For companies that are not publicly traded, the requirements for the preparation of consolidated financial statements and the consolidation and valuation principles to be applied in consolidation accounting are set out in the German Commercial Code (Han-delsgesetzbuch – HGB). In addition, the German Federal Ministry of Justice (Bundesjustizministerium) issues supplementary recommendations for the application of group accounting principles. These recommendations are drawn up by the German Accounting Standards Committee (GASC). For publicly traded parent companies, the application of the IAS Regulation is mandatory (see chapter 4.2).

Under the German Commercial Code (Handelsgesetzbuch – HGB), corporations (i. e. AG, KGaA, GmbH, and SE) and “KapCoGesellschaften” (see chapter 4.1.1) that are the parent company of a group of companies and resident in Germany must prepare


46




worldwide consolidated financial statements. All the companies under the control of a domestic parent company are deemed to be members of the group. Companies are always controlled where the parent company holds a majority of their voting rights or is entitled to appoint the majority of members of their boards of management or super-visory boards, as well as where the parent company controls the other companies by virtue of a management control agreement.

In general, both domestic and foreign companies must be included in the consolidated financial statements. Group financial statements comprise a consolidated balance sheet, a consolidated income statement, and notes to the financial statements, as well as a report on the business trends and outlook of the group (management report). The consolidated financial statements must include a cash-flow-statement showing the cash flows of the period and a statement of changes in equity showing the changes in con-solidated equity and comprehensive income. Optionally, segment reporting may be added to the consolidated financial statement.

Table 7: Criteria for mandatory preparation of consolidated financial statements

Balance sheet total

€ million

Turnover€ million

Number of employees

(average per year)

Pre-elimination figure exceeds 19.272 38.544 250Consolidated figure exceeds 16.060 32.120 250

Consolidated financial statements must be prepared if at least two of the above criteria have been met on both the reporting balance sheet date and the preceding balance sheet date. The financial statements which are included in the consolidated financial statements must be prepared using the same accounting and valuation policies as those of the parent company. Exemptions from this rule apply only where tax regulations do not permit the valuation policies in the original financial statements to be modified for consolidation purposes.

For group reporting purposes, the equity accounting method is mandatory for certain investments (associated enterprises) which are included in the group financial state-ments. An associated enterprise is one over which the group exercises significant influ-ence and which is neither a subsidiary nor a joint venture (German Accounting Stan-dard 8). This situation is deemed to exist if the reporting company holds more than 20 % of the voting rights of a company. Under the equity method of accounting, all post-acquisition movements in the equity of the associate are either debited or credited to the investment account in the books of the parent company in proportion to the par-ent company’s share of equity in the associate.

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The consolidation of shareholders’ equity follows the purchase method, under which the difference between the book value of the investment (cost) and the portion of the shareholders’ equity to be consolidated at the time of the acquisition is allocated to the assets and liabilities of the acquired company to the extent possible (fair value account-ing), with the remainder, if any, being presented as goodwill. In accordance with Ger-man Accounting Standard 4, the share of the assets and liabilities attributable to the minority shareholders should be stated at fair value (total revaluation).

An interest in a joint venture with outsiders or other non-consolidated parties should be included in the consolidation using the proportionate consolidation method or the equity method (German Accounting Standard 9). This consolidation method means that all assets and liabilities, income, and expenses are included in the group accounts pro-rata to the interest in the joint venture, so that no minority interest arises.

Generally, inter-company profits and losses should be eliminated. However, this rule may be waived if sales or services were made or rendered on customary market terms and the calculation of inter-company profits or losses would cause unreasonable expense. However, if this exception is relied on, this must be disclosed in the notes to the consolidated financial statements.

The obligation to prepare consolidated financial statements in accordance with Ger-man accounting regulations exists even if the German parent company is itself the subsidiary of a foreign group of companies (sub-group financial statement). However, there are significant exceptions to this rule. The German parent company is exempt from the requirement to prepare German (sub-group) consolidated financial statements if the foreign parent company prepares consolidated financial statements (exempting consolidated financial statements) which include the German sub-group, provided these exempting consolidated financial statements comply with EU-Directive 83/349/EEC of June 13, 1983, and fulfill a number of other requirements (e. g., examination of the exempting consolidated financial statements by qualified auditors). In such cases it is irrelevant whether the parent company is domiciled in the EU, in the European Eco-nomic Area, or in a third country. This exemption does not, however, apply if the Ger-man parent company is a stock corporation (AG) with shares which are listed and traded on a recognized stock exchange. If the foreign parent company holds at least 90 % of the shares in the German parent company, the exemption from the obligation to prepare consolidated financial statements depends on the consent of all the other shareholders. If the foreign parent company holds less than 90 % of the shares in the German parent company, other shareholders holding 10 % of the shares (in the case of an AG, KGaA or SE) or 20 % of the shares (in the case of a GmbH) may block the exemption.


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4.2 International Financial Reporting Standards (IFRS)

4.2.1 Consolidated financial statements

On July 19, 2002, the European Parliament and the European Council issued a regula-tion on the application of International Accounting Standards (IAS Regulation). The objective of the IAS Regulation is to harmonize the financial information presented by companies in order to achieve a high level of transparency and comparability in the financial statements, thereby ensuring the efficient functioning of the capital market in the EU. The IAS Regulation stipulates that, from 2005, publicly traded companies must prepare consolidated financial statements in accordance with IAS, since renamed International Financial Reporting Standards (IFRS). Furthermore, the IAS Regulation permits Member States to decide whether the application of IFRS to the consolidated financial statements of non-publicly traded companies and/or to individual company financial statements shall be optional or mandatory.

As mentioned in chapter 4.1.1, the Accounting Law Reform Act (Bilanzrechtsreform-gesetz – BilReG) governs the transition to IFRS accounting. It mainly addresses pub-licly traded parent companies – kapitalmarktorientierte Unternehmen – i. e. compa-nies whose securities are traded on a regulated market in any Member State of the EU. The obligation of publicly traded companies to prepare their consolidated financial statements in accordance with IFRS starting in 2003 is not, however, explicit under the German Commercial Code (Handelsgesetzbuch – HGB). It is instead based on the IAS Regulation. Sec. 315a (2) HGB goes beyond the obligatory requirements of the IAS Regulation in that it requires parent companies to prepare their consolidated financial statements in accordance with IFRS if they have filed an application for admission of their securities to trading on a regulated market. Non-publicly traded parent compa-nies may now meet their legal requirements by preparing their consolidated financial statements in accordance with IFRS. Under the IAS-Regulation, publicly traded com-panies that prepared their accounts under the regulations of a non-EU/EEA market (e. g. U.S. GAAP) were permitted to continue doing so until 2006. This exception also applied to companies that had only publicly traded debt securities. Starting in 2007, the application of IFRS is obligatory for all EU/EEA parent companies publicly traded on a regulated market in the EU/EEA.

4.2.2 Financial statements

In order to fulfill certain requirements for publication and reporting, companies may replace their regular annual financial statements with annual financial statements pre-pared in accordance with IFRS. This will allow these companies to compete on an equal footing for financial resources on international capital markets. For the assess-

49



ment of dividends and for tax filing purposes, annual financial statements must, how-ever, continue to be prepared in accordance with the principles of German commercial law.

4.3 Enforcement

The Accounting Control Act (Bilanzkontrollgesetz – BilKoG) of December 15, 2004 introduced a two-stage enforcement procedure into German law. In the first stage, an independent financial reporting enforcement panel audits the financial statements of publicly traded companies at the request of the Federal Financial Supervisory Author-ity (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin). Requests are made if there are indications of infringement of financial reporting requirements and for gen-eral sampling purposes.

The findings are disclosed to the audited company and to the Federal Financial Super-visory Authority. Errors identified by the panel are published and must be corrected by the company. If the company fails to co-operate with the auditor, the Federal Financial Supervisory Authority may order a second audit.

Enforcement

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5 Recent and proposed changes in fiscal policy

5.1 Current legislation

Following the September 2005 election of a new Bundestag (Federal Parliament), negotiations between the Christian Democrats (CDU/CSU) and the Social Democrats (SPD) led to formation of a new governing coalition at the end of November 2005. The so-called “Grand Coalition” then elected Angela Merkel as Chancellor. Peer Stein-brück was named as Minister of Finance. The major business tax reform that was announced by the coalition partners shortly thereafter takes effect as of January 1, 2008. There is also other recent tax legislation. The following sections outline these changes.

5.1.1 2008 Business Tax Reform Act

The tax reform’s central feature is the reduction of the tax burden for corporations to less than 30 %. However, the law makes changes that broaden the tax base, such as a limitation on the deductibility of interest. The highlights of the 2008 Business Tax Reform Act are summarized below.

5.1.1.1 Tax relief for corporations

The tax burden for corporations falls from 39 % to just under 30 %, assuming an aver-age trade tax multiplier of 400 %. The corporate income tax rate is reduced from 25 to 15 % and the trade tax base rate decreases from 5.0 to 3.5 %. After the reduction of the corporate income tax rate, the effective overall tax rate depends even more heavily on the trade tax, which varies among the municipalities.

5.1.1.2 Earnings stripping rules

The 2008 Business Tax Reform Act repeales the German thin capitalization rules and introduces earnings stripping rules in German tax law for the first time. The new rules are broader than the previous thin capitalization rules since all third party debt financ-ing (even if not back-to-back) is covered. Furthermore, the new rules apply to all busi-ness activities regardless of their legal form, not just to corporations.

Under the earnings stripping rules, interest expense is deductible to the extent the tax-payer earns positive interest income. Interest expense in excess of interest income is

Current legislation

52

Recent and proposed changes in fiscal policy



deductible only up to 30 % of EBITDA (interest deduction ceiling). Non-deductible interest expense may be carried forward. The interest deduction ceiling does not apply where (i) interest expense exceeds positive interest income by less than € 1 m (de mini-mis threshold), (ii) the business is not a member, or is only a proportional member, of a controlled group or (iii) businesses forming part of a controlled group satisfy the conditions of the escape clause. To qualify for the escape clause, the taxpayer must prove that the equity ratio of the business in question is not more than 1 percentage point less than that of the controlled group as a whole (equity ratio pursuant to IFRS, alternatively GAAP of an EU member state or U.S. GAAP). The exemption for non-controlled businesses and the escape clause apply to corporations only if no detrimen-tal shareholder financing (schädliche Gesellschafterfremdfinanzierung) exists (see chapter 6.2.1.4 for details).

5.1.1.3 Trade tax addbacks

Fundamental changes are made in the tax treatment of financing expenses for trade tax purposes. Under § 8 no. 1 Trade Tax Act (Gewerbesteuergesetz), one fourth of the sum of the following payments is added back in calculating trade income: loan remunera-tion, recurring payments, profit shares of a silent partner, one fifth of rental payments for movable assets, 65 % of rental payments for immovable fixed assets, and one-fourth of royalty payments. The addbacks occur only where the aggregate amount of financ-ing expenses exceeds a de minimis threshold of € 100,000.

5.1.1.4 New change-in-ownership-rules

The previous change-of-control rules (§ 8 (4) Corporate Income Tax Act – Körper-schaftsteuergesetz) allowed the use of loss carryforwards where the corporation claim-ing a loss was legally and economically identical to the one that suffered the loss. Under the new change-in-ownership rules, a transfer of more than 25 % of a corpora-tion’s shares or voting rights results in forfeiture of existing loss carryforwards in pro-portion to the percentage of shares transferred (pro rata forfeiture). A transfer of more than 50 % of a corporation’s shares or voting rights triggers forfeiture of all loss car-ryforwards (total forfeiture). The same applies for trade tax purposes.

5.1.1.5 Transfer pricing changes

The legislation codifies the comparable uncontrolled price method, the cost plus method and the resale minus method as the preferred methods for determining arm’s length transfer prices. Where the transfer prices chosen by the taxpayer are outside of a narrowed range, a correction is made to the median of the narrowed range. A hypo-

53



thetical arm’s length test applies where it is impossible to determine arm’s length prices on the basis of a recognized transferring method.

5.1.1.6 Retained earnings of partnerships and sole proprietorships

The law brings the tax burden on the retained earnings of sole proprietors and partner-ships owned by individuals into line with that of corporations. This is accomplished by subjecting the retained earnings of partnerships and sole proprietorships to a reduced tax rate of 28.25 % (29.80 % including solidarity surcharge). The reduced tax rate applies, upon request by the partner/sole proprietor, separately for each business and partnership interest, subject to certain de minimis rules. The tax allocable to retained earnings is recaptured upon their withdrawal.

5.1.1.7 Flat tax for income from capital and capital gains

The 2008 Business Tax Reform Act creates a flat tax on income from capital and capi-tal gains. The flat tax will take effect as of the 2009 tax assessment period and apply only to individuals, not to corporate taxpayers.

The income tax on income from capital and capital gains is fixed at 25 % regardless of an individual’s personal income tax rate. A taxpayer can also apply for taxation at his or her personal income tax rate instead. Where income from capital is subject to with-holding tax, the income tax liability is deemed to be satisfied by the tax withheld. The flat tax is not levied in addition.

5.1.2 Real Estate Investment Trust Act – REIT Act

For many years, German tax law provided no means of indirect investment in real estate with transparent taxation at the level of the investor. Passage of the REIT Act has created such a vehicle. A REIT corporation is completely exempt from German corporate income tax if it meets various requirements.

The REIT corporation must be organized in the legal form of a joint stock corporation (Aktiengesellschaft) with both its registered office and its actual seat of management in Germany. Its shares must be registered for trading on a public exchange in a member state of the EU or EEA. At least 75 % of its gross revenues must be derived from the rental, lease, or sale of real estate, as opposed to trading in real estate. The corporation must fulfill certain requirements regarding the composition of assets and capital, dis-persed stock ownership, and profit distributions.

A corporation meeting all these requirements is exempt from German corporate income tax, trade tax, and solidarity surcharge retroactive to the date of registration in

Current legislation

54




the commercial register (Handelsregister). Exemption at the corporate level generally means full taxation at the shareholder level. Dividends paid by a REIT to foreign inves-tors are subject to a definitive 25 % withholding tax. However, many tax treaties pro-vide for reduction of German withholding tax to 15 %. Foreign investors are thus in many cases able to derive income from a German REIT subject to a German tax bur-den of only 15 %. Depending on the relevant tax treaty, capital gains on the sale of REIT stock held by foreign investors may be exempt from German taxation as well.

The failure of a REIT corporation to meet the above mentioned requirements for REIT status may trigger the forfeiture of the tax exemption, or fines could be imposed by the tax authorities.

5.1.3 2008 Tax Act

Numerous changes in German tax law are made by the 2008 Tax Act (Jahressteuerge-setz 2008 – JStG 2008). The Act took effect on January 1, 2008. Its highlights are as follows.

5.1.3.1 Recapture taxation of carryover EK 02

The equity accounts of many corporations still contain previously untaxed earnings classified as EK 02 under the old corporation tax credit system in force until 2001. The 2008 Tax Act provides for definitive, one-time recapture taxation of carryover EK 02, which is separately assessed for the last time as of December 31, 2006. Irrespective of any actual disposition of EK 02, a flat tax of 3 % of EK 02 is imposed. Later distribu-tion of these equity funds triggers no further taxation at the corporate level.

5.1.3.2 Application of § 8b (3) KStG to shareholder loans

The 2008 Tax Act denies any deductions for reductions in profits that result from loans made, or comparable transactions engaged in, by substantial shareholders (direct or indirect holding of at least 25 % of the shares), persons related to substantial sharehold-ers under § 1 (2) German Foreign Transactions Tax Act (Außensteuergesetz – AStG), and third parties with a right to recourse against the aforementioned persons. The denial would not apply if the lender can prove that an unrelated party would have made the loan on the same terms.

5.1.3.3 Redesign of general anti-abuse provision

The changes in § 42 (1) Tax Procedure Law (Abgabenordnung – AO) are intended to provide greater specificity concerning the situations covered by this general provision

55



denying tax effect to legal transactions that are abusively structured. Inappropriateness remains the standard by which one determines whether an arrangement is abusive. When scrutinizing an arrangement for abuse, a threshold question is whether a com-parison of the tax consequences of the chosen legal structure with those of an appro-priate legal structure shows that the taxpayer or a third party has derived a tax benefit. Only if the tax benefit is not contemplated by the tax code is the chosen structure fur-ther scrutinized for abuse. Even if the chosen structure is inappropriate, it is neverthe-less not abusive under § 42 (2) Tax Procedure Law (Abgabenordnung – AO) if the taxpayer can demonstrate non-tax reasons for the arrangement that are relevant con-sidering all the facts and circumstances.

5.1.3.4 Changes in the Foreign Transactions Tax Law

In its Cadbury-Schweppes decision, the ECJ held that the British rules respecting imputational taxation of the income of controlled foreign corporations (CFC rules) infringe the freedom of establishment to the extent that they apply to arrangements that are not wholly artificial in nature. In response, § 8 (2) of the Foreign Transactions Tax Act (Außensteuergesetz – AStG) was amended so that it no longer applies to the income of companies having their registered office or place of management in an EU/EEA country, provided the foreign company is shown to carry out a genuine economic activity in its country of residence.

5.2 Pending Legislation

Despite the astonishing number of bills already enacted by the German government, there are currently several new bills pending. Selected features of the pending legisla-tion are described below.

5.2.1 Act for the Modernization of the Legal Framework for Equity Investments

The German Bundestag adopted an Act for the Modernization of the Legal Framework for Equity Investments (Gesetz zur Modernisierung der Rahmenbedingungen für Kapi-talbeteiligungen – MoRaKG) that is intended to create incentives for the private sector to provide capital needed to found and develop new business ventures. Included in this act is the New Venture Capital Promotion Law, which allows companies to qualify as venture capital investment companies (Wagniskapitalgesellschaften) if they meet cer-tain requirements. Venture capital investment companies are organized as partner-ships and hold shares only in corporations. Their activities would be deemed to consti-tute passive asset management that is not subject to trade tax. If the statutory require-

Pending Legislation

56




ments are fulfilled, all taxation would take place at the level of the investor. The legis-lation also contains a list of standard situations in which the activities of a venture capital investment company exceed the limits of passive asset management, resulting in commercial business income.

The act amends various other laws to facilitate investment in small and medium-sized companies.

5.2.2 Draft Accounting Law Modernization Act

The German government has adopted draft legislation that is intended to modernize German accounting law (draft Accounting Law Modernization Act). The basic pur-pose of the changes is to make German commercial accounting law a fully adequate and simpler alternative to International Financial Reporting Standards (IFRS). The balance sheet according to German domestic commercial law (German GAAP) would remain the basis for fixing the limits of permissible dividend distributions as well as for determining taxable income. In addition, the draft legislation contains relief from various requirements for certain companies.

The enactment of the Accounting Law Modernization Act is expected at the end of 2008. Most provisions shall apply for annual periods beginning after December 31, 2008.

The most significant changes are highlighted in the following.

5.2.2.1 Improvement of information content

Various capitalization, recognition, and valuation elections would be eliminated in order to bring German GAAP closer to IFRS. The aim is to enhance the informational content of the financial statements while retaining the existing accounting principles of German commercial law. For these purposes, the principle of reverse linkage (umgekehrte Maßgeblichkeit) would be abandoned. Furthermore, internally generated intangible assets would have to be recognized in the balance sheet. Financial instru-ments that are acquired for trading purposes would have to be valued at fair value on the balance sheet date. The valuation of provisions would be changed so that they are discounted at a market rate and with respect to rises in pricing and costs. Amongst other provisions, several depreciation elections would be eliminated.

5.2.2.2 Relief from certain requirements

Sole proprietors that are not capital-market-oriented would be exempted from the requirement of keeping books and preparing financial statements if their income does

57



not exceed € 50,000 and their sales revenues do not exceed € 500,000 on the balance sheet dates of two consecutive fiscal years.

The size limits that determine which reporting requirements companies must fulfill would be raised by 20 %, permitting more companies to take advantage of the reduced requirements for smaller companies.

5.2.3 Draft Inheritance Tax and Valuation Law Reform Act

In 2007, the federal government released draft legislation reforming the inheritance tax and valuation laws. Changes in the principles underlying the taxation of succession are mandated by the Federal Constitutional Court’s 2006 ruling that the current inher-itance and gift tax system based on assessed value is unconstitutional.

The draft bill would value business assets, real estate, and non-publicly traded shares at fair market value. In general, the new valuation system would result in higher values compared with the assessed values applicable up to now. By way of compensation, the tax exempt amounts would be raised for spouses, children, and grandchildren, so that close family members would in most cases not owe any inheritance tax. A preference would be created for the transfer of businesses, provided jobs are preserved for at least 10 years and the business is continued over a period of at least 15 years.

The Reform Act would take effect on January 1, 2009. However, provisions concern-ing inheritance would be retroactive to January 1, 2007.

5.2.4 Draft 2009 Tax Act

Numerous changes in German tax law would be made by the draft 2009 Tax Act (Jahressteuergesetz 2009 – JStG 2009). The law is expected to be approved by the end of 2008 and enter into force on January 1, 2009. The highlights of the draft are sum-marized below.

5.2.4.1 Losses with a foreign nexus

In response to decisions by the ECJ and a pending EC treaty infringement proceeding, the draft act would limit the application of § 2a Income Tax Act (Einkommensteuerge-setz – EStG) to losses arising in non-EU/EEA countries. The bill would permit the losses arising in EU or EEA countries to be netted against German-source income where the applicable tax treaty avoids double taxation under the credit method. For-eign losses would be disregarded in Germany where the exemption method applies.

Pending Legislation

58




5.2.4.2 Taxation of non-resident taxpayers

As under current law, the tax withheld on income from employment or from capital and the tax withheld under § 50a Income Tax Act would still constitute satisfaction in full of a non-resident taxpayer’s German tax liability. However, the exceptions to this principle would be materially expanded, thus subjecting non-resident taxpayers to the assessment procedure in many cases in the future.

The draft legislation contains further changes in the taxation of non-resident tax-payers.

5.2.4.3 Treaty and directive shopping

The withholding tax on certain income from capital (such as dividends) received by foreign corporate entities will be reduced from 25 % to 15 %. The provision intends to adjust the withholding tax rate to the corporate tax rate of 15 %. The reduction is lim-ited to recipients meeting the activity and substance requirements of § 50d (3) Income Tax Act.

5.2.4.4 Bookkeeping in a foreign country

The draft act authorizes the tax authorities to grant a taxpayer request to transfer its computer-based accounting system and other electronic records to another member country of the EU or EEA where certain requirements are met.

5.3 Summary

The unifying theme of the government’s tax legislation is the attempt to make the Ger-man tax system more competitive internationally. In addition, EU legislation and deci-sions by the European Court of Justice (ECJ) have had a great impact on German law and required German legislative action. As a result, Germany’s attractiveness as a des-tination for investment has been further enhanced from a tax standpoint.

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6 Business taxation

6.1 Comparison of legal forms

A company’s tax status depends, first of all, on the legal form chosen by its organizers. Corporations (i. e. Aktiengesellschaft – AG, Gesellschaft mit beschränkter Haftung – GmbH, Kommanditgesellschaft auf Aktien – KGaA, and Europäische Gesellschaft – SE) are taxable entities subject to corporate income tax (Körperschaftsteuer), trade tax (Gewerbesteuer), and the solidarity surcharge (Solidaritätszuschlag).

Partnerships (non-corporate entities, i. e. Offene Handelsgesellschaft – OHG, Kom-manditgesellschaft – KG, and Gesellschaft bürgerlichen Rechts – GbR), are not tax-able entities for corporation or income tax purposes. The income determined at the level of the partnership is allocated to the individual partners. The partnership pre-pares returns for informational purposes, and the partners declare their respective shares of partnership profits or losses on personal tax returns. The partnership itself is subject only to trade tax. The determination of income at the level of a partnership is generally similar to that of a corporation. However, the income of a non-commercial partnership can also be determined under a different method. The main aspects of income determination are explained below. Specific issues affecting the taxation of partnerships are highlighted in chapter 6.3.

The foreign investor can also operate through a permanent establishment in Germany. But a permanent establishment is not a legal form (for the taxation of permanent estab-lishments see chapter 6.4).

6.2 Taxation of corporations

6.2.1 Corporate income tax

6.2.1.1 Companies subject to taxation

Corporations resident in Germany are subject to tax on their worldwide income (unbe-schränkte Steuerpflicht). Corporations not resident in Germany are subject to tax on their income from sources in Germany (beschränkte Steuerpflicht), which includes income derived from a permanent establishment (Betriebsstätte) or a permanent repre-sentative in Germany, gains from the sale of shares in a German corporation, income from agriculture and forestry, rental income, investment income, and certain catego-ries of income subject to withholding tax. No differentiation is made between publicly

Comparison of legal forms

60

Business taxation



and closely held corporations. Capital gains on the sale of real estate located in Ger-many are also subject to German corporate income tax.

A corporation is considered resident in Germany if it maintains either its registered office (as determined by its articles of incorporation) or its principal place of manage-ment in Germany. The principal place of management is where key decisions are regu-larly made and the place from which day-to-day business operations are managed. Corporations lacking either of these nexuses are considered non-resident. Residence determines whether a corporation is subject to tax in Germany on its worldwide income or only on its German-source income.

6.2.1.2 Basic principles

6.2.1.2.1 Resident corporations

Corporations are classified as trading entities (Gewerbebetriebe) by virtue of their legal form under civil law and therefore all of their income constitutes trade income (gewerbliche Einkünfte), irrespective of its source.

Profits are subject to a corporate income tax rate of 15 % at the level of the corporation plus a solidarity surcharge of 5.5 % (15 % plus 5.5 % of 15 % = 15.825 %). When profits are distributed to an individual, half of the amount distributed is subject to tax at the level of the individual (hence the term “half-income system”).

From the 2009 assessment period onwards, a flat-rate tax of 25 % (plus solidarity sur-charge, 5.5 % of 25 %) applies in principle to income from capital and capital gains received by individuals. A taxpayer may also elect to be taxed at his or her individual income tax rate instead should such tax rate be lower. The flat tax is not applicable to income from capital that also falls into another income category, e. g. income from trade or business. In such cases 40 % of the received income is tax exempt and 60 % of the related expenses are deductible as business expenses (“partial-income system” from 2009 onwards).

If the shareholder is a corporation, the distributed profits are exempt from taxation. However, an amount equivalent to 5 % of a corporation’s dividend income is treated as a non-deductible business expense. Thus, only 95 % of the dividend income received is effectively tax-exempt. Costs actually incurred are deductible without limit. This rule applies to dividends which are paid by domestic or foreign corporations. The de facto 95 % tax exemption for dividends received by corporations does not apply for credit institutions and insurance companies if special requirements are met. As a conse-quence, these dividends are completely subject to tax. If the shareholder is a partner-

61



ship, the dividends are taxed for corporate or income tax purposes at the level of the partners and not at the level of the partnership.

The corporation paying the dividend must deduct withholding tax (Kapitalertrag-steuer) on the dividend, generally at a rate of 20 % (from 2009 onwards 25 %), and remit such tax to the tax authorities. The shareholder can offset the amount so with-held against its ultimate tax liability.

The required calculations can be illustrated as follows:

Table 8: Computation of income / corporate income tax rates on payment of dividends 2008 and 2009

Assessment period 2008

Type of shareholder Individual: Half-income

system

Corporation

Income of corporation 100.0 100.0– Corporate income tax (15 %) 15.0 15.0

= Income after tax 85.0 85.0Dividend 85.0 85.0

– WHT (20 %) 17.0 17.0

= Cash dividend 68.0 68.0

Taxable income of shareholder (50 %/5 %) 42.5 4.3– Income tax (45 %) 19.1– Corporate income tax (15 %) 0.6+ Creditable withholding tax 17.0 17.0

Income after taxation 65.9 84.4

Taxation of corporations

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Business taxation



Assessment period 2009

Type of shareholder Individual: Final with-holding tax

Individual: Partial-income

system

Corporation

Income of corporation 100.0 100.0 100.0– Corporate income tax (15 %) 15.0 15.0 15.0

= Income after tax 85.0 85.0 85.0Dividend 85.0 85.0 85.0

– WHT ( 25 %) 21.3 21.3

= Cash dividend 63.7 63.7

Final WHT (25 %) 21.3taxable income of shareholder (60 %/5 %) 51.0 4.3

– Income tax (45 %) 23.0– Corporate income tax (15 %) 0.6+ Creditable withholding tax 0.0 21.3 21.3

Income after taxation 63.7 62.0 84.4

Please note that for simplification purposes trade tax and solidarity surcharge have not been considered in the above tables.

Capital gains arising on the sale of shares held by a corporation are also exempt from corporate income tax. Similar to the treatment of dividends, 5 % of the capital gain is treated as a non-deductible business expense. Costs incurred in connection with the sale reduce the net amount of the capital gain and are thus not separately deductible as business expenses, but do reduce the base on which deemed non-deductible business expenses are calculated. Losses on the sale of shares and write-downs due to impaired value are likewise not tax deductible.

In conjunction with the change in 2000/2001 from the imputation system of corporate taxation to the “half-income” system, a tax credit arose equivalent to the difference between the previous corporate income tax rate on retained earnings (40 %) and the previous corporate income tax rate on distributed earnings (30 %). Corporations could therefore claim a tax credit when profits were distributed that were previously subject to the 40 % retained earnings rate. The corporate income tax credit equaled 1/6th of the distributed profits and could be offset against the corporate income tax liability for the year in which the distribution was made. The legislature allowed corporations until 2019 to distribute old retained earnings and realize the associated credit. At the end of 2006, the rules were simplified. Refunds no longer depend on dividend distributions. The remaining corporate tax credit balance is determined definitively as at 31 Decem-

63



ber 2006 and refunded in ten equal annual installments over the period from 2008 to 2017.

In conjunction with the system change, a further transitional rule applied to equity previously classified as so-called EK 02, which was German-source tax-exempt income that arose under the imputation system. When amounts were distributed out of equity previously classified as EK 02, the corporate income tax was increased by 3/7 (42.86 %) of the distributed amount. The legislature has changed this transition rule as well effective in 2008. The system of increasing the income tax is replaced by a partial payment. The amount of carryover EK 02 is determined by separate assessment for the last time as of 31 December 2006. Irrespective of any actual disposition of EK 02, a flat tax of 30 % is imposed on 1/10th of the amount EK 02 retained at this date. Future distributions of these equity funds will not trigger any further taxation at a company level. Economically speaking, this means that tax will be payable in the amount of 3 % of the amount of EK 02 determined to exist on 31 December 2006. This tax will be payable in ten equal annual installments. Corporations may elect instead to pay a sin-gle installment, which will then be discounted at a rate of 5.5 %.

Constructive dividends (verdeckte Gewinnausschüttungen) occur when a corporation confers a benefit on its shareholders or on persons affiliated with shareholders which it would not normally confer on unrelated third parties. Constructive dividends result in increased taxable income either through the disallowance of a tax deduction claimed (e. g. excessive service fees paid to an affiliate) or an increase in an income item (e. g. below-market interest rate charged on a loan to an affiliate).

Constructive dividends are, in general, taxed the same way as declared distributions. Hence, constructive dividends received by a corporation are in effect 95 % tax exempt. An exception to this basic rule – the congruency principle – was introduced into Ger-man tax law in 2007. Under the congruency principle, the 95% tax exemption on divi-dends received is limited to dividends that have not reduced the taxable income of the distributing corporation. This means that a constructive dividend that is deducted as a business expense at the level of the distributing corporation will not be tax exempt in the hands of a recipient corporation.

6.2.1.2.2 Non-resident corporations

For non-resident corporations, the tax treatment of certain types of income depends on whether the tax is levied via a filing and assessment procedure (the case for e. g. busi-ness income derived through a permanent establishment, income from agriculture and forestry, rental income from immovable property, and interest income secured by real property located in Germany) or by means of a withholding tax procedure (the case for


64

Business taxation



dividends, interest, rental income from movable assets, and royalties). The standard 15 % corporate income tax rate generally applies in assessment procedures. Withhold-ing tax rates vary depending on the kind of income and the person who bears the with-holding tax.

6.2.1.3 Determination of taxable income

There is an underlying principle in Germany that tax accounting is based on commer-cial accounting (Maßgeblichkeitsprinzip). Accordingly, the determination of taxable income is based on the results shown in the annual accounts (see chapter 4), as adjusted to comply with pertinent tax provisions. If the books of account are not kept in a lawful manner, the tax authorities are entitled to estimate taxable income.

All assets and liabilities must be valued as of the balance sheet date, i. e. the end of the fiscal year. Unrealized losses must be recognized (subject, however to a restriction for provisions for anticipated losses on pending transactions; see below), whereas unreal-ized profits are not recognized. Assets are carried at cost, less depreciation if applica-ble, or at their lower going concern value (Teilwert). Going concern value is defined as the amount or fraction of the total purchase price which a purchaser of the entire busi-ness would allot to a specific asset assuming the purchaser intends to continue the business. This lower going concern value may only be recognized if the impairment in value is considered to be of a lasting nature. If the reason for the impairment in value no longer exists, the write-down must be reversed. In general, all assets with a useful life in excess of one year must be capitalized on the balance sheet. An exception applies for depreciable movable assets whose acquisition or production costs are 150 € or less – so-called assets of minor value (geringwertige Wirtschaftsgüter). These assets must be expensed in the year of the acquisition or production. Assets purchased at prices from € 150.01 to € 1,000 must be aggregated for each assessment period and depreci-ated over five years. Intangible assets must be reflected on the balance sheet if acquired for consideration, in which case they are amortized over their useful life. Capitaliza-tion is prohibited for self-created intangible assets and intangible assets acquired gra-tuitously.

Inventories must be valued at the lower of cost or market price. For essentially similar goods, a weighted average is allowed. The German Income Tax Act (Einkommen-steuergesetz – EStG) explicitly permits the use of the last-in-first-out method (LIFO) if this is in accordance with generally accepted accounting principles.

Provisions (Rückstellungen) must be established for contingent liabilities if there is a reasonable expectation that a liability will materialize in the future. In particular, pro-visions are required for anticipated guarantee and warranty costs. General and specific

65



allowances (Wertberichtigungen) must be recognized for the general risk of non-col-lection and for specific doubtful debts. A pension provision must be recognized if the employer’s obligation to make pension payments is documented in a written promise and the employee has a legal right to one-time or periodic pension benefits. Pension claims are generally vested and not contingent on the employee’s continuing in the service of the employer if the employee is more than 30 years old and the pension promise has been in existence for at least 5 years. The pension provision must be actu-arially calculated annually for each employee using an interest rate of 6.0 %.

Provisions for anticipated losses from pending transactions must be recognized where applicable for financial reporting purposes. For tax purposes, however, it has not been possible to recognize such provisions since January 1, 1997. Tax rules also stipulate stricter recognition criteria for a number of provisions, including provisions for infringement of patents, copyrights or similar industrial rights, and provisions for long-term service awards. Provisions (and liabilities) must be discounted for tax pur-poses using an interest rate of 5.5 % (except pension provisions, see above). Only short-term provisions and liabilities (maturing within 12 months of the balance sheet date) or interest-bearing amounts are excepted from this requirement.

Some of the major items in determining taxable income are considered below:

Capital gains are, in general, treated as ordinary income and taxed at ordinary rates (except gains form the sale of shares, see above). 100 % of gains realized on the sale of real estate and buildings may be offset against the cost of similar assets acquired in the year of sale, the preceding year, or the following 4 years (6 years for buildings – roll-over relief).

Non-taxable income includes declared and constructive contributions to capital.

Organizational expenses incurred as a result of forming a corporation or increas-ing its capital may not be capitalized. They must instead be deducted in the year incurred. Organizational expenses include accountant and attorney fees and regis-tration fees, among other things.

Salaries and other compensation paid for the services of shareholder-employees are deductible. The compensation must be at arm’s length or a constructive divi-dend may be imputed.

Rental expense in connection with the business may be deducted as incurred.

Interest expenses are generally deductible unless they relate to tax-exempt income (other than dividends and capital gains from the sale of shares). But the deduction


66

Business taxation



of interest expenses is restricted due to the earnings stripping rules (see chap-ter 6.2.1.4).

Repair and maintenance expenses are deductible in the period incurred.

Depreciation is, in general, allowed on tangible or intangible fixed assets with a useful life of more than one year. Land and investments in other corporations can-not be depreciated, but may be written down to a lower going-concern value. Please note that write-downs of investments in other corporations are not deductible for corporate income tax purposes (§ 8b (3) KStG). The 2008 Tax Act expanded this rule to cover shareholder loans. The denial of a deduction does not apply if the lender proves that the loan is at arm’s length. Goodwill acquired for consideration can be amortized on a straight-line basis over 15 years. The basis for amortization is the last balance sheet value before the start of amortization.

Depreciation is based on the acquisition or production cost of an asset. The straight-line, declining-balance, and units-of-production methods can be used. A taxpayer may change from the declining-balance to the straight-line method, but not vice versa. Rates under the declining-balance method may not exceed twice the appli-cable straight-line rate, or 20 %, whichever is less. As part of legislation enacted in early 2006, special depreciation rates apply with respect to goods produced or acquired after December 31, 2005 and before January 1, 2008. Qualifying goods may be depreciated using the declining-balance method at rates up to three times the applicable straight-line rate, capped at 30 %. Except for buildings, depreciation rates are not fixed by statute, however, the Federal Ministry of Finance publishes guidelines on useful asset lives in officially recommended tables. The declining-balance method was abolished for assets produced or acquired after December 31, 2007.

Typically accepted straight-line rates are: buildings 2 %; office buildings and facto-ries 3 % where the building permit was applied for later than March 31, 1985; com-mercial and residential buildings are under certain circumstances eligible for higher rates; plant equipment 5 % to 20 %; office equipment and furniture 10 % to 20 %; machinery 10 % to 20 %; motor vehicles 20 %; EDP equipment 33 1/3 %.

Depreciable movable assets not exceeding € 150 (excluding VAT) (assets of minor value) can be expensed in full in the year of acquisition or production.

A write-down to a lower going-concern value to reflect technical or economic obsolescence is possible for tax purposes.

67



Charges by a foreign parent for providing certain assets or services to its German subsidiary are deductible if at arm’s length. To the extent that they exceed an arm’s length price, they are treated as constructive dividends.

Excise taxes, and real estate tax are all deductible for corporate income tax pur-poses.

Corporate income tax and trade tax are not deductible expenses, however.

Other non-deductible expenses include expenses relating to tax-exempt income; in addition, as a general rule, expenses for hunting rights, yachts or guest houses not located on business premises, and 50 % of fees paid to members of the supervisory board are not deductible.

Business gifts worth up to € 35 per recipient per year are deductible if they are accounted for separately.

Only 70 % of reasonable business entertainment expenses are deductible.

Deductions for charitable contributions are limited to 5 % of income or 0.2 % of the sum of sales and payroll. Contributions for scientific and cultural purposes may be deducted up to the level of 10 % of income.

6.2.1.4 Earnings stripping rules

New earnings stripping rules replaced existing thin capitalization rules with general effect as of January 1, 2008. For a non-calendar fiscal year 2007/2008 earnings strip-ping rules can be applying before 2008: The earnings stripping rules are applicable for business years beginning after May 25, 2007 and not ending before January 1, 2008.

The earnings stripping rules apply in general to all types of debt financing of sole pro-prietorships, partnerships and corporations. The scope of the new rules is far broader than the previous thin capitalization rules as all third party debt financing (whether or not there is a back-to-back financing) is included. Interest expense is completely deductible from the tax base only to the extent the taxpayer earns positive interest income in the same financial year. Interest expense in excess of interest income (net interest expense) is deductible only up to 30 % of tax EBITDA (interest deduction ceil-ing). Tax EBITDA is defined as taxable profit before application of the interest deduc-tion ceiling, increased by interest expenses and by fiscal depreciation and reduced by interest earnings.


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De minimis threshold (Freigrenze)

The interest deduction ceiling does not apply where interest expense exceeds positive interest income by less than € 1 m. (tax threshold). Thus, small and medium sized business enterprises are in many cases unaffected by the new earnings stripping rules.

Non-group businesses (Konzernklausel)

The interest deduction ceiling also does not apply to businesses that are not part of a controlled group. An enterprise is regarded as part of a controlled group if it is or could be included in consolidated financial statements in accordance with IFRS, Ger-man GAAP or U.S. GAAP.

The exemption for non-controlled corporations applies only if the corporation estab-lishes that remuneration on shareholder debt accounts for at most 10 % of net interest expense. Shareholder debt is defined as debt capital received from a substantial share-holder (more than 25 %), an affiliated person, or a third party having recourse against a substantial shareholder or an affiliated person.

Escape clause

For businesses which are part of a controlled group, a so-called escape clause applies. If the equity ratio of the entity in question is equal to or greater than the equity ratio of the controlled group, the interest deduction ceiling will not apply. There is a 1% safety cushion for the equity ratio of the business in question. As a consequence, the escape clause is still met when equity ratio of the entity is 49 % and the equity ratio of the controlled group is 50 %. The escape clause applies only if the corporation establishes that remuneration on shareholder debt accounts for at most 10 % of net interest expense. Shareholder debt is defined as debt capital received from a substantial shareholder (more than 25 %), an affiliated person, or a third party having recourse against a substantial shareholder or an affiliated person.

Interest carry forward

Interest expense that is not deductible in the period in which it arose may be carried forward. It increases interest expense in the following year, but is not taken into account to determine tax EBITDA. Interest expense carried forward will, however, be erased in reorganizations and where the change-of-control rules apply.

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Tax groups (Organschaft)

For purposes of the earnings stripping rules, the controlling company and controlled companies of a tax group are treated as a single entity.

6.2.1.5 Loss relief

Tax losses which cannot be offset in the current year may be carried back one year up to an amount of € 511,500 for corporate income tax purposes. To the extent that the losses exceed € 511,500 or cannot be fully offset against the previous year’s income, they may be carried forward indefinitely. However, the so-called Basket II Legislation limits the offset in any one year beginning with the 2004 tax assessment period – so called “minimum taxation” provisions. Under this legislation, losses carried forward may be offset without restriction against profits only up to an amount of € 1 million. Losses carried forward in excess of this amount may offset no more than 60 % of tax-able income in the current period. There are no time limitations on the use of loss car-ryforwards. The taxpayer can elect whether to carry back the losses or not and may also decide, within the limits described above, the amount to be carried back.

Changes in the ownership of corporations can, however, cause forfeiture of losses for tax purposes – so-called change-in-ownership rules. The restriction proceeds in two steps. Acquisitions of more than 25 % and less than 50 % of a corporation’s shares or voting rights within a five year period by a person or parties related thereto triggers pro rata forfeiture of losses. The forfeiture of losses is total where more than 50 % of the shares or voting rights are transferred. The statute covers both direct and indirect transfers. The rules also operate where shares are transferred to a group of purchasers with convergent interests. The change-in-ownership rules were introduced into Ger-man tax law with effect from 2008 and apply to transfers of shares on or after January 1, 2008.

Different loss limitation rules applied in the past: no use could be made of existing loss carryforwards if a corporation’s economic identity had changed. A change of eco-nomic identity was assumed if more than 50 % of the shares in the corporation were transferred and the corporation recommenced or continued its trade or business with predominantly new assets. The old loss limitation provisions are last applicable where more than 50 % of the shares in a corporation are transferred within a five-year period beginning prior to January 1, 2008 and predominantly new business assets are injected prior to January 1, 2013. There is thus a period during which the old and new rules overlap and apply cumulatively.


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The losses of a foreign permanent establishment whose income is exempt from Ger-man tax under a tax treaty are disregarded in computing taxable income. There is some doubt, however, whether this restriction is consistent with EU law. If the income of the permanent establishment is not exempt from taxes under a tax treaty, its losses can be deducted in Germany only if the permanent establishment is deemed to engage in “active” operations (such as manufacturing and delivering goods, extracting natural resources, or providing commercial services). If the operations of the permanent estab-lishment are deemed to be “passive,” its losses may only be offset against foreign source income of the same kind from the same country (per country limitation).

6.2.1.6 Tax groups (Organschaft)

Although consolidated tax returns are not allowed by German tax law per se, the rules governing tax groups (Organschaft) provide similar relief. Under the Organschaft sys-tem, the income or loss of a controlled company (Organgesellschaft) is attributed to a controlling company (Organträger). In order to qualify, the controlling and the con-trolled company must enter into a profit and loss pooling agreement (Ergebnisabfüh-rungsvertrag), and the controlled company must be financially integrated into the con-trolling company. This requires that the controlling company hold a majority of the voting rights in the controlled company. Financial integration can be achieved through direct or indirect shareholdings. The profit and loss pooling agreement must be entered into for a minimum of five years.

A profit and loss pooling agreement only becomes effective after the shareholders of both the parent and subsidiary company approve the contract by a majority of 3/4ths of the votes cast and after the contract has been entered in the commercial register of the subsidiary company. The relevant shareholder resolutions must be notarized. This applies not only to stock corporations (AGs), for which the above requirements are stipulated by the Stock Corporation Act (Aktiengesetz – AktG), but also to limited lia-bility companies (GmbHs), for which the case law of the Federal Court of Justice (Bundesgerichtshof – BGH) establishes comparable requirements in the absence of explicit statutory provisions.

The Stock Corporation Act contains specific provisions for any “enterprise agreement” (Unternehmensvertrag) entered into by a stock corporation (AG) or a limited partner-ship with share capital (KGaA). Enterprise agreements (which include inter alia profit and loss pooling agreements) only become effective after the relevant resolution has been approved at a general meeting of shareholders. The management board of the AG or KGaA is required by law to submit a comprehensive written report which must describe the nature of the enterprise agreement, the individual terms of such agree-

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ment and, in particular, the type and extent of compensation and consideration paid to minority shareholders. The report must substantiate the various aspects of the agree-ments from a legal and financial perspective. It must also draw attention to any special difficulties in valuing the businesses of the contracting parties and the potential conse-quences for the interests of the shareholders. The enterprise agreement must be audited by qualified independent auditors unless all of the shares of the controlled company are held by the controlling company.

For Organschaft purposes, the controlling company can be a corporation with its place of management in Germany or a registered branch of a foreign corporation. A partner-ship resident in Germany may also be the controlling company if it engages in com-mercial activities. The controlled companies must be corporations, however.

6.2.1.7 Double taxation and relief for foreign taxes

6.2.1.7.1 Methods of relief

In the absence of a tax treaty, a corporation resident in Germany is also subject to tax on its income from foreign sources. However, the foreign income taxes paid on that income may be credited against its German tax liability. The foreign tax credit must be determined separately for each foreign country and may not exceed the German tax attributable to the income from the respective country (per country limitation). For this purpose, foreign source income is defined by the German Income Tax Act and includes income generated in a foreign country from agriculture and forestry activi-ties, other commercial activities, the sale of certain assets and shares, income from certain investments, and income from the lease of real estate. Only foreign taxes equivalent to German corporation/income taxes can be credited against the German tax liability. Taxpayers may elect either an offset (if creditable) or a deduction (if not creditable) of the foreign taxes. No carryforward is available for foreign taxes which cannot be offset or deducted in the period for which they accrued.

6.2.1.7.2 Tax treaties

For corporations resident in Germany, tax relief may also be available under the tax treaties that Germany has concluded with approximately 88 countries (as of January 1, 2008). Typically, these treaties grant the right of taxation either to the country where income has its source (country of source) or to the country where the recipient is resi-dent (country of residence), while exempting the income from taxation in the other country. In some cases, alternatively, they provide relief from double taxation by allow-ing a foreign tax credit.


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In most treaties, the treatment of certain categories of income follows the OECD Model Tax Convention, as outlined below – assuming Germany to be the country of residence:

Business profits derived through a permanent establishment in the other treaty country are, in general, exempt from tax in Germany.

Dividends paid to a German corporation may be subject to a reduced withholding tax rate of up to 15 % in the other country and are taxable in Germany (subject to the tax exemption rules stated below). Normally, the withholding tax would be creditable against the German tax liability. However, due to the tax exemption for dividend income at the level of the recipient corporation, the withholding tax is not creditable in most cases.

Under most tax treaties with developed countries, interest income is tax-exempt in the country of source and taxable in Germany, unless it is attributable to a perma-nent establishment.

Royalties, unless attributable to a permanent establishment, are usually exempt from tax in the country of source and taxable in Germany.

Capital gains are, in most cases, taxed only in Germany unless the property sold is attributable to a permanent establishment in the other contracting state.

Income from immovable property (including capital gains on the sale of such prop-erty) may be taxed in the country of location (situs). Income from foreign real property is therefore, in most cases, exempt from tax in Germany.

6.2.1.7.3 Subject-to-tax clause

The 2007 Tax Act (Jahressteuergesetz 2007) unilaterally modified Germany’s appli-cation of its tax treaties by adding a generally applicable subject-to-tax clause to Ger-man domestic tax law for the first time. Germany’s avoidance of double taxation by the exemption method under the terms of its tax treaties can in some cases cause the income in question to escape taxation altogether (so-called “white income”). This is the case where the other treaty country fails to tax the income that Germany has exempted, for instance because the two countries classify the income differently for treaty purposes (qualification conflict) or have different interpretations of a particular treaty provision.

Under the subject-to-tax-clause, Germany does not avoid double taxation by the exemp-tion method under its tax treaties to the extent the other treaty state

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classifies the income under a different treaty provision, causing it to be exempt in, or to be taxed at a reduced rate by, the other treaty state, or

fails to tax the income because it is derived by a person that is not subject to tax in the other state by reason of the person’s domicile, residence, place of management, registered office, or other similar criterion.

The subject-to-tax clause does not apply to dividends that are excluded from the Ger-man tax base under a tax treaty. But the subject-to-tax clause does apply if the divi-dends in question reduced the income of the distributing corporation.

6.2.1.8 EU directives relating to direct taxation

6.2.1.8.1 EU Parent/Subsidiary Directive

As implemented in Germany, the Parent/Subsidiary Directive allows the payment of dividends free of withholding tax by a direct 15 % subsidiary resident in Germany to its parent resident in another EU Member State, provided the appropriate application is filed with the German Federal Central Tax Office (Bundeszentralamt für Steuern). Furthermore, a minimum holding period of 12 months is required to qualify for zero rate withholding tax.

Dividends paid by a German subsidiary to a non-German permanent establishment in the EU which is maintained by a qualifying EU parent company are also exempt from withholding taxes. The same applies if such a permanent establishment is maintained by a German parent company, provided the relevant shares are effectively connected with the German company’s EU permanent establishment.

Furthermore the currently required minimum shareholding of 15 % is reduced to 10 % if a German subsidiary distributes a dividend to an EU parent company and such a dividend is not subject to tax in the parent company’s jurisdiction, provided dividends distributed from this state to 10 % German parent companies are likewise not subject to withholding tax (reciprocity principle – Gegenseitigkeitsklausel).

A directive amending the 1990 Parent/Subsidary Directive was adopted by the Euro-pean Council on December 22, 2003. The most important provision reduced the mini-mum percentage shareholding required to qualify as a “parent company” under the directive from 25 % to 10 %. Member States are required to implement the reduction in three phases (i) 20 % in 2005, (ii) 15 % in 2007, (iii) 10 % in 2009 (see also Appendix 12.1).

Non-EU based parent companies may therefore benefit by establishing a holding com-pany in the EU. However, the German fiscal authorities may disallow the reduction of


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the withholding tax rate for dividends paid by a German subsidiary to, for example, a Dutch holding company, if (i) the foreign company is owned by persons who would not be entitled to the reduction if they derived the income directly, and (ii) any one of the following additional conditions is met:

the interposition of the foreign company is not supported by economic or other valid reasons or

the foreign company does not derive more than 10 % of its total earnings from its own economic activities or

the foreign company does not engage in general economic activity through a busi-ness organization appropriate to its business purpose.

Whether the elements of the statute are fulfilled is determined solely with reference to the situation of the foreign company. The provision aims to counter abuse of the EU Parent/Subsidiary Directive by interposition of foreign companies without economic function for the purpose of obtaining benefits under the directive (so-called directive-shopping).

6.2.1.8.2 EU Merger Directive

The EU Merger Directive covers various transactions within European groups of com-panies. Its scope is limited to specific transactions (certain types of mergers, divisions, transfer of assets, and exchanges of shares), not all of which are familiar, or legally permissible, in all Member States. In broad terms, the objective of the EU Merger Directive is to allow specific types of reorganizations to take place without triggering tax.

In 2006 German tax treatment of business reorganizations was revised in response to changes in European law and to redefine the tax consequences of inbound and out-bound asset transfers. New types of business associations – the European Company (societas europaea: SE) and the European Cooperative (SCE) – were created and recent amendments to the EU Tax Merger Directive were transposed into German law. The so-called SE Introductory Act (“Tax Act Accompanying the Introduction of the European Company and Amending Other Tax Provisions”) also responds to recent decisions of the European Court of Justice, such as the SEVIC case on cross-border mergers (see chapter 10).

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6.2.1.8.3 Interest and Royalties Directive

Beginning January 1, 2004, payments of interest, royalties, and licensing fees are gen-erally exempt from withholding tax pursuant to EU Directive 2003/49/EC, provided the payments are made between associated enterprises within the European Commu-nity (minimum shareholding of 25 %). This rule also applies to royalty payments between permanent establishments of affiliated enterprises within the European Union. Germany implemented the Directive in late 2004, applicable retroactively to payments made on or after January 1, 2004. Generally, the entire tax amount is with-held and remitted to the tax authorities. Taxpayers may then apply for a refund. It is, however, also possible to obtain an exemption certificate from the German Federal Central Tax Office (Bundeszentralamt für Steuern). A payment is only exempt from withholding taxes where, at the time of payment, the payor has a valid exemption cer-tificate.

6.2.1.9 Transfer pricing

All transactions between related companies must comply with the arm’s length prin-ciple. Where corporate transfer prices are not in line with market prices, constructive dividends or constructive contributions generally result. In this case the tax adminis-tration is entitled to adjust the profits of the German corporation. The position of the tax administration is contained in transfer pricing regulations (so-called “Administra-tive Principles”) issued in 1983. The German tax authorities issued comprehensive transfer pricing documentation and procedure regulations on April 12, 2005. These regulations supplement § 90 (3) Tax Procedure Law (Abgabenordnung – AO) and the Profit Allocation Documentation Regulation (Gewinnabgrenzungsaufzeichnungsver-ordnung - GAufzV). The effective date for the documentation and cooperation duties set out in the new regulations relates back to the issuance of the GAufzV. Accordingly, the new regulations are generally effective for fiscal years beginning after Decem-ber 31, 2002. However, some of the penalty provisions contained in the regulations are first effective for fiscal years beginning after December 31, 2003.

In general, the new regulations address two documentation duties – the duty to docu-ment all facts and circumstances relevant to establishing and evaluating transfer prices (“factual documentation”), and the duty to document the appropriateness of the tax-payer’s transfer prices (“appropriateness documentation”). In order to fulfill these duties, the taxpayer must compile and submit extensive documentation, and must cooperate with the tax administration in the clarification of all relevant facts and cir-cumstances. The failure to comply with such duties can lead to the estimation of the taxpayer’s income and/or to the imposition of penalties. The new regulations also


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address permissible transfer pricing methods, procedural rules applicable to the tax administration, and EU Mutual Agreement and Arbitration procedures.

Further information on transfer pricing regulations in Germany is provided in chap-ter 9.5.

6.2.1.10 Filing requirements and payment of tax

The competent tax office (tax office with jurisdiction over a taxpayer) is determined by the taxpayer’s central place of management or its registered office or the location of the main capital asset. Corporate income tax returns (Körperschaftsteuererklärungen) must be filed annually for the calendar year, based on the corporation’s fiscal year-end-ing with or within the calendar year. The returns must be filed by May 31st, with an automatic extension until December 31st if the return is prepared by a professional tax advisor. Further extensions may be granted on application.

Additional documents to be filed with the return include: the corporation’s financial statements; a copy of the auditor’s report; a reconciliation between financial statement figures and those shown in the tax accounts or a separate balance sheet for tax pur-poses; a copy of the resolution of the supervisory board approving the financial state-ments, or, in the alternative, a copy of the shareholder resolution to this effect, and a copy of the shareholder resolution on the distribution of the profit for the year.

After receipt of the annual tax return, the tax office will issue a notice of assessment (Steuerbescheid), possibly “subject to change on audit” (unter Vorbehalt der Nachprü-fung). Administrative appeals (Einspruch) against assessments must be lodged within one month.

Taxes must be paid in advance on a quarterly basis. The amounts due on March 10th, June 10th, September 10th, and December 10th are determined by the tax office based on the preceding year’s tax liability or on estimated profits. The notice of assessment will show the balance payable, which must be paid within one month, or the balance receivable (i. e. in case of overpayment), which will be refunded or credited against other tax liabilities.

Taxes paid more than 15 months after the end of the tax assessment year are subject to interest at an annual rate of 6 %. The taxpayer may claim interest for overpaid taxes (tax refunds) in similar circumstances.

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6.2.1.11 Taxation in the event of liquidation

The taxation of corporations in the event of liquidation (winding-up) is dealt with in the Corporate Income Tax Act (Körperschaftsteuergesetz – KStG). The liquidation gain is computed by deducting the book value of the assets at the beginning of the liquidation from the market value of the assets which are distributed to the sharehold-ers at the end of the liquidation. For tax purposes, the liquidation period should in general not exceed three years.

In the hands of the shareholder, the liquidation gain is divided into the liquidation gain per se and the amount deemed to constitute net available equity, i. e. refund of the bal-ance of the so-called tax-specific capital contribution account (steuerliches Ein-lagekonto).

The taxation of shareholders depends on the type of payment received. Liquidation installments (profits) in the form of payments out of revenue reserves, and from previ-ously hidden reserves (stille Reserven) are subject to tax as income from capital in accordance with the general rules (half-income system, from 2009 flat tax rate or partial-income system for individuals or de facto 95 % exemption from tax for corpo-rations).

Where stated capital and amounts from the tax-specific capital contribution account are repaid to individuals who hold at least 1 % of the shares as a private investment, the amounts so repaid are taxed in accordance with the “half-income” system (from 2009 onwards: “partial-income system”) to the extent the repayments exceed the original cost of investment. If the investment in the corporation (irrespective of the percentage shareholding) is held by an individual as a business asset or by a corporation, the repayment of stated capital and amounts from the tax-specific capital contribution account are subject to income or corporate income tax (“half-income system” or “par-tial-income system” for individuals or de facto 95 % exemption from tax for corpora-tions), to the extent these amounts exceed the carrying amount of the cost of invest-ment. Liquidation installments received by corporations are therefore also de facto 95 % exempt from taxation.

6.2.1.12 Withholding taxes

Corporations, whether subject to unlimited or limited tax liability in Germany (i. e. resident corporations subject to tax with respect to their worldwide income or non-resident corporations subject to tax with respect to their German-source income), are required to withhold taxes at the source on the following types of payments and to


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remit such taxes to the tax authorities (the same applies to individuals and partner-ships):

Wage tax (Lohnsteuer) must be withheld by the employer and remitted to the tax authorities.

Dividends, other profit distributions, and income from a silent partnership or profit participating loan are subject to withholding tax (Kapitalertragsteuer) at a rate of 20 % (from 2009 onwards 25 %).

The EU Parent/Subsidiary Directive requires Germany to reduce the withholding tax on qualifying dividends paid to a parent company in another EU State to zero effective as of July 1, 1996 (see “EU Parent/Subsidiary Directive”).

In addition, payments to non-residents are subject to taxation in the following cases (unless modified by tax treaty):

Royalty income is subject to withholding tax at a rate of 20 %.

Supervisory board fees paid to non-residents are subject to withholding tax at a rate of 30 %.

The income of artists, writers, journalists etc. from independent services per-formed in Germany is subject to withholding tax at a rate of 20 %.

The tax rate applicable to non-resident corporations is 15 %. The tax rate was reduced effective January 1, 2008 to reflect the reduction in the corporate income tax rate.

With certain exceptions, interest paid to non-residents is not generally subject to with-holding tax. The 30 % interest withholding tax (Zinsabschlagsteuer) applies only to interest paid to residents.

6.2.1.13 Solidarity surcharge

Since 1995, income and corporate income tax in Germany has been subject to a soli-darity surcharge (Solidaritätszuschlag). The solidarity surcharge was originally intro-duced for a limited period to help finance the reunification of Germany. It was subse-quently extended beyond the originally envisaged period.

The solidarity surcharge is levied on, among other things, the assessed amount of cor-porate income taxes, corporate income tax prepayments, and withholding taxes. The rate of the solidarity surcharge is 5.5 %. The tax rate for corporations of 15 % is there-fore increased by the solidarity surcharge to 15.825 % (15 % plus 5.5 % of 15 %) and

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the 20 % withholding tax rate is increased to 21.1 %. From 2009 onwards, withholding tax plus solidarity surcharge will amount to 26.375 % (25 % plus 5.5 % of 25 %). If, however, a tax treaty is in place which reduces the withholding tax on dividends, e. g. to 5 %, no solidarity surcharge can be levied upon the withholding tax.

6.2.1.14 Binding rulings (verbindliche Auskunft)

It is possible to request a binding ruling from the tax authorities. The 2007 Tax Act authorizes the tax authorities to charge fees when a taxpayer requests such a ruling.

The amount of the fee depends on the potential tax consequences of the matters set forth in the request. For this purpose, the tax owing under the taxpayers’ interpretation of the law is compared with the tax owing in the event of contrary interpretation. The difference between these two amounts is the basis for calculating the fee (amount at stake in the binding ruling). The minimum fee is € 121, the maximum € 91,456. If the amount at stake cannot be estimated, the time required to issue the ruling will be charged at € 50 per half hour, at least € 100.

The fee for binding rulings requested is payable even if (i) the tax authorities reject the taxpayers’ interpretation of the law, (ii) the tax authorities ultimately refuse to issue any binding ruling, or (iii) the taxpayer withdraws its request. Waiver of the charge by the tax authorities is possible in the latter case, however.

6.2.2 Trade tax


Trade tax (Gewerbesteuer) is based on federal law, but is levied by local municipalities on a corporation’s “trade income” (Gewerbeertrag).

Certain corporations (e. g. public corporations) can claim an exemption on income up to € 3,900. The trade income is multiplied by a basic tax rate (Steuermesszahl) of 3.5 % to arrive at the so-called base amount (Steuermessbetrag).

The relevant multiplier (Hebesatz) for each local municipality is then applied to the base amount. These multipliers typically range between 300–490 %, i. e. a factor of 3.0 to 4.9, yielding a tax rate of 10.5–17.15 %. A sample tax calculation for income tax purposes is included in chapter 6.2.2.4. In order to eliminate so-called trade tax havens, the law was changed effective 2004 to require municipalities to set their multipliers at or above 200 %.


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Where a company has permanent establishments in different municipalities, the base amount is apportioned among the municipalities based on the proportion of payroll expenses of the respective permanent establishments.

With certain exceptions (public enterprises acting in the public interest, farmers, archi-tects, engineers, lawyers, doctors, accountants, and other professionals), the trade tax applies to all businesses. The business of corporations is always treated as a trade. The mere administration of property, on the other hand, is not a “trade” and therefore not subject to trade tax, provided certain requirements are met.

6.2.2.2 Determination of trade income

Trade income is determined by the taxable income for income tax or corporate income tax purposes modified by certain additions and deductions.

The additions include one-fourth of the sum of following items, which must be added back when computing income for trade tax purposes:

Loan remuneration (e. g. interest),

Recurring payments,

Profit shares of a silent partner,

20 % of rental and leasing payments for movable fixed assets,

65 % of rental and leasing payments for immovable fixed assets,

25 % of payments to obtain license rights for a limited time period, except for licenses that merely confer entitlement to license to third parties the rights derived thereunder.

The addbacks apply only to the extent payments exceed an exemption amount of € 100,000.

Additionally, the following items must be added back when computing income for trade tax purposes:

Dividends that are not included in the computation of income for corporate income tax purposes, where the requirements of exemption for trade tax purposes are not fulfilled (see below).

Distributive share of the losses of domestic or foreign partnerships.

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The additional deductions (Kürzungen) include:

1.2 % of 140 % of the assessed value (Einheitswert) of real property.

Distributive share of profits from an interest in a domestic or foreign partnership.

Dividends from a domestic corporation in which the taxpayer holds at least a 15 % interest as of the beginning of the calendar year, to the extent this income was included in the computation of the profit.

Dividends from a non-resident corporation in which the taxpayer holds an interest of at least 15 % (10 % in case the EU Parent/Subsidiary Directive is applicable), provided this corporation has little or no passive income. This also applies to indi-rect holdings in a second-tier subsidiary. Taxable income is only reduced to the extent this income was included in the computation of the profit. However, the active business requirement is not applicable with respect to companies resident in an EU Member State or in a country which is within the European Economic Zone.

Charitable contributions.

As a result of the various additions and reductions relating to dividends, dividend income is effectively 95 % exempt from trade tax at the level of a corporation if the receiving corporation holds an interest of at least 15 % in the corporation paying the dividend. If the interest held is less than 15 %, the dividend (less the expenses relating to the dividend which were non-deductible for corporate income tax purposes) must be added back for trade tax purposes. Since the 15 % threshold must be met at the begin-ning of the calendar year, dividend income arising in the year the shareholding is acquired is subject to trade tax. Gains on the sale of shares in a corporation are also de facto 95 % exempt from trade tax.

Trade losses (Gewerbeverlust) can be carried forward from preceding years and deducted against future trade income. No loss carry back is available. The minimum taxation rules also apply mutatis mutandis to trade tax: up to a limit of € 1 million, loss carryforwards may be fully set off against earnings in the tax assessment period in which such earnings are generated. Beyond this limit, loss carryforwards may be off-set against no more than 60 % of the trade income in the current period. There is no time limit for the use of loss carryforwards.

Prepayments are due February 15th, May 15th, August 15th, and November 15th. Any balance due upon final assessment is payable within one month.


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6.2.2.3 Tax groups (Organschaft)

The Organschaft system (see chapter 6.2.1.6) also applies to the trade tax. The require-ments are the same as described for corporate income tax purposes.

The controlled corporation is treated as a permanent establishment of the controlling entity. The trade income of controlled and controlling entities is combined. The trade tax is assessed at the level of the controlling entity and levied by the relevant munici-palities.

This treatment does not apply to a non-resident controlling entity unless it has a per-manent establishment in Germany.

6.2.2.4 Sample tax calculation

Assumption: the multiplier is 400 %. The effective tax rate for trade tax on income can be calculated using the following formula:

Effective tax rate = Multiplier x assessment rate = 400 % x 0.035 = 14%

Table 9: Taxation of a corporation and dividends paid to individuals and corpora-tions (assessment period 2008)

Type of shareholder Individual: Half-income

system

Corporation: Shareholding

< 15 % ≥ 15 %

Income before taxes 100.0 100.0 100.0= Income subject to corporate income tax 100.0 100.0 100.0– Trade tax (e. g., 14 %) 14.0 14.0 14.0– Corporate income tax 15.0 15.0 15.0

= Income after tax 71.0 71.0 71.0Dividend 71.0 71.0 71.0

– Withholding tax (20 %) 14.2 14.2 14.2= Cash dividend 56.8 56.8 56.8+ Credit for withholding tax 14.2 14.2 14.2

= Net cash-flow 71.0 71.0 71.0Taxable dividend 35.5 3.6 3.6

– Trade tax (14 %) 9.9¹ 0.5²

Income / Corporate income tax base 35.5 3.6 3.6– Income tax (e. g., 45 %) 16.0

Corporate income tax (15 %) 0.5 0.5

= Net cash-flow 55.0 60.5 70.0

1 14 % x 71.0 (see chapter 6.2.2.2)2 14 % x 3.6

Please note that for simplification purposes the solidarity surcharge has not been considered in the above example.

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6.2.3 Net worth tax

Following a decision of the Federal Constitutional Court (Bundesverfassungsgericht) dated June 22, 1995, the levying of net worth tax (Vermögensteuer) in Germany was suspended effective as of the tax year 1997. The Federal Constitutional Court ruled that the existing law contained an unacceptable preference for the valuation of real estate compared with other assets. Net worth tax has not formally been abolished and could be reinstated if the appropriate changes were made to the valuation rules.

6.3 Taxation of partnerships

6.3.1 Income tax

6.3.1.1 Determination of taxable income

The most important forms of partnership in Germany are civil law associations (Gesellschaft bürgerlichen Rechts – GbR), general partnerships (Offene Handels-gesellschaft – OHG), and limited partnerships (Kommanditgesellschaft – KG). A part-nership is not subject to income or corporate income tax, but it may be subject to trade tax.

For income / corporate income tax purposes, the profits of a partnership are allocated to the partners in proportion to their interest in the business (transparency principle). The partner’s income from the partnership is then subject to income tax (in the case of an individual) or corporate income tax (in the case of a corporation) at the appropriate tax rate, unless the taxpayer elects flat-rate taxation. Flat-rate taxation may only be elected by individuals. The flat rate of 28.25 % (plus solidarity surcharge) is applicable to retained profits. Later distribution of these profits triggers an additional tax of 25 % (plus solidarity surcharge).

Taxation of partnerships

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Table 10: Taxation of partnerships: retained vs. distributed profits

Partnership Retention Distribution

Income before taxes 100.0 100.0– Trade tax (14 %) 14.0 14.0

= Income after trade tax 86.0 86.0

– Income tax retained profits (28.25 %) 24.3 0.0– Income tax distributed profits (45 %) 6.31 45.0+ (Trade) tax credit 13.3 13.3= Income after tax 68.7 54.3

Distribution 86.0Tax base distributed profits 61,7

– Subsequent taxation (25 %) 15.4

= Net cash-flow 53.3 54.3

1 At the level of the partners, trade tax is treated as distributed profits for income tax purposes.

Please note that for simplification purposes the solidarity surcharge has not been considered in the above example.

The nature of the income allocated to the partners (see chapter 11.3.1 for details of income categories) is based on how the income is classified at the level of the partner-ship. A partnership generates income from trade or business (Einkünfte aus Gewerbe-betrieb) if it is a trading entity (Gewerbebetrieb). To qualify as a trading entity it has to operate autonomously on a continuing basis, generate profits, and participate in gen-eral commerce. Activities relating to agriculture and forestry and self-employed work are excluded. The scope of the activities must constitute more than the mere manage-ment of private assets. A typical GmbH & Co. KG qualifies by virtue of its legal form as a trading entity with trade income.

Since the determination of income and the allocation of that income to the partners are separate processes, the determination of the income of a commercial partnership must be made in two stages:

Step 1: Determination of income at the level of the partnership

The determination of income at the level of the partnership follows the same rules as the determination of income for corporations, but with the following specific features:

If the acquisition costs exceed the carrying amount of equity attributable to the partner, it is necessary to recognize the excess amount in a separate supplementary tax balance sheet (steuerliche Ergänzungsbilanz). In this supplementary (off-the-books) balance sheet, the difference must be allocated to assets and liabilities in

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proportion to their individual going-concern values (Teilwerte). If the excess amount as described above is greater than the individual going-concern values of the assets and liabilities previously recognized by the partnership, the remaining difference must be recognized in the supplementary tax balance sheet as goodwill. If the excess amount is allocated to depreciable or amortizable assets (including goodwill), they can be depreciated/amortized in subsequent years in accordance with the rules applicable to the relevant asset. In other words, when an interest in a partnership is purchased, it is possible to amortize, with tax effect, the goodwill included in the purchase price (this is not possible in the case of the acquisition of shares in a corporation). Any losses arising from a partner’s supplementary tax balance sheet are allocated to the partner.

“Special remuneration” (Sondervergütungen) paid by the partnership to its partner for services (e. g., directors’ remuneration), loans (interest), and the use of assets (rental expenses) are deducted in step 1. For tax purposes, the remaining income is then allo-cated to the partners in accordance with the applicable profit allocation key.

Step 2: Special remuneration, special business income and expenses

In a second step, the above mentioned special remuneration is added back to the profit/loss of the partnership. Hence, special remuneration neither reduces the taxable profit (nor increases the losses) of the partnership.

At this stage, so-called “special business income” (Sonderbetriebseinnahmen) and “special business expenses” (Sonderbetriebsausgaben) must be taken into account. This relates to a partner’s income and expenses generated or incurred as a result of an economic link to the investment in the partnership. Special business income includes interest income on loans granted by a partner to a third party in the interest of the partnership (for example to the landlord of a building rented by the partnership). In particular, dividend income from a GmbH acting as the general partner of a GmbH & Co. KG qualifies as special business income. Similarly, the costs of financing and administering the investment and the costs (including financing costs, and deprecia-tion) in connection with assets provided for use by the partner to the partnership qual-ify as special business expenses. It should be noted that special business expenses incurred abroad may also be taken into account in the determination of the income of the German partnership.

As part of the process of allocating taxable profits to the partners, it should be noted that special remuneration and special business income and expense are only allocated to the partners who received or incurred them.


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6.3.1.2 Loss relief

Partners must consider the following issues relating to the offset of tax losses:

Under German tax law, loss carryforwards may be set off in full against only the first € 1 million of net income, and can be set off against only 60 % of the remain-ing current period net income. Retained profits with respect to which flat-rate taxa-tion has been elected may not be offset against losses carried forward.

Limited partners and other partners with comparable liability are subject to a sepa-rate restriction regarding tax losses. Under these rules, losses from a partnership (negative income from trade or business) can only be offset against profits of the same partnership if the limited partner’s capital account is negative or becomes negative as a result of the loss allocation. In effect, the amount of losses which can be offset is limited to the amount of the partner’s capital account.

6.3.1.3 Trade tax credit against income tax

Partners who are individuals may credit a standard amount of the partnership’s trade tax against their income tax liability, thus reducing the double taxation otherwise resulting from income tax and trade tax. The amount that can be credited against income tax is equivalent to 3.8 times the partner’s share of the partnership’s trade tax base amount (see chapter 6.3.2.1 below). Each partner’s share must be computed using the applicable profit allocation key.

6.3.1.4 Tax group (Organschaft)

A German-resident partnership may be the controlling company of a tax group (Organ-schaft) if it has commercial activities. The controlled companies of the tax group, however, must be corporations.

6.3.1.5 Sale of an interest in a partnership

The gain on the sale of an interest in a partnership (consideration less cost of sale and the partner’s capital account) is taxed as trade income. If a partner who is at least 55 years of age disposes of his or her entire interest in the partnership and the gain does not exceed € 136,000, a once-in-a-lifetime allowance of € 45,000 is available. In addition, other relief is available when the entire interest in a partnership is sold.

The book values of the assets/liabilities of the partnership are increased by the amount by which the purchase price paid by the new partner exceeds the amount of the capital account acquired. This increase is recognized in a supplementary tax balance sheet.

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The assets shown in this balance sheet are depreciated or amortized in subsequent years in accordance with the general rules. The resulting expense reduces the partner’s share of profits in subsequent years (see also chapter 6.3.1.1 above).

6.3.2 Trade tax


Whereas corporations automatically constitute trading entities (Gewerbebetriebe) by virtue of their legal form and are subject to trade tax, partnerships are basically only subject to trade tax if they have commercial activities, i. e. generate trade income. The partnership must therefore engage in qualifying commercial activities to be subject to trade tax. But regardless of the nature of its activities, a partnership in the legal form of a GmbH & Co. KG (see chapter 3.3.1) is generally deemed to be subject to trade tax by virtue of its specific structure.

Trade tax (unlike income tax) is levied at the level of the partnership, i. e. it is the part-nership which is subject to trade tax.

Trade income is derived from the profit/loss of the partnership computed in accor-dance with income tax rules. This corresponds to the combined result of the two steps of profit determination (see chapter 6.3.1.1). This figure is then adjusted for specific additions and deductions as in case of corporations (see chapter 6.2.2).

Like individuals, partnerships can claim an exemption on the first € 24,500 of trade income. After deducting this amount, trade income is multiplied by the basic trade tax rate (Steuermesszahl) of 3.5 %. That amount is multiplied by the local municipal mul-tiplier to determine the trade tax.

6.3.2.2 Loss relief

A trade tax loss may be carried forward but not back. The minimum taxation rules apply to trade tax analogously (see above). A trade tax loss can be offset against future trade income provided the identity of the business and partners remains unchanged through the period in which the tax losses are offset. A portion of the tax losses there-fore ceases to be available for offset when a partner leaves the partnership. The busi-ness is deemed to retain the same identity if the activities pursued by the partnership in the period of tax loss offset are the same as in the year in which the loss arose.


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6.3.2.3 Sale of an interest in a partnership

A gain on the sale of a partner’s interest in a partnership is not subject to trade tax where the partner is an individual who held a direct interest in the partnership. By contrast, a sale by a corporation, by another partnership, or by an individual who pre-viously held an indirect interest in the partnership is subject to trade tax at the level of the partnership.

6.4 Taxation of permanent establishments

6.4.1 Definition of permanent establishment

Under German tax law permanent establishments are any fixed place of business or facility which serves the business of an enterprise (§ 12 Tax Procedure Law, Abgaben-ordnung – AO). In particular the place of management, branches, offices, factories, and warehouses are permanent establishments. Under German tax law, a permanent representative (§ 13 AO) is similar to a permanent establishment (§ 13 AO). A permanent representative need not be an employee of the corporation. A permanent representative within the meaning of § 13 AO conducts business on behalf of a company on an ongo-ing basis and is subject to the company’s instructions.

A right of taxation under German domestic tax law by virtue of a permanent establish-ment or permanent representative maintained by a foreign resident in Germany may be modified by a tax treaty.

Under typical German tax treaties, which follow the OECD Model Tax Convention, permanent establishments are any fixed place of business in which the business of the enterprise is wholly or partly carried on. In particular the place of management, branches, offices, and factories are permanent establishments. Warehouses are not permanent establishments, in contrast to German tax law. A person acting in Germany on behalf of a foreign enterprise is deemed to be a permanent establishment in Ger-many if the person has, and habitually exercises in Germany, an authority to conclude contracts in the name of the enterprise. This does not apply when the activities of the person are limited to the purchase of goods or merchandise for the enterprise. Further-more a foreign enterprise is not be deemed to have a permanent establishment in Ger-many merely because it carries on business in Germany through a broker, general commission agent, or any other agent of an independent status, where such persons are acting in the ordinary course of their business.

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6.4.2 Taxation of German-source income of a permanent establishment

6.4.2.1 Income taxes

Germany’s tax treaties typically provide that the income and the assets of a permanent establishment may be taxed in the country in which the permanent establishment is located. Hence, foreign investors are subject to tax in Germany with respect to their German-source income attributable to a permanent establishment.

The investor’s tax status is relevant for determining the level of taxation of the income attributable to the permanent establishment. If the investor is a corporation (from a German tax perspective), the investor is subject to corporate income tax and to the solidarity surcharge. If the investor is an individual, the investor is subject to income tax and to the solidarity surcharge. If a partnership owns the permanent establishment, the profits are allocated to the partners in proportion to their respective ownership interests and taxed at the level of the partners. Partners are accordingly liable to per-sonal or corporate income taxes and to the solidarity surcharge.

6.4.2.2 Trade tax

A domestic permanent establishment earning trade or business income is subject to trade tax. Where the foreign investor is a corporation, the corporation is subject to trade tax. The same applies if a partnership is the owner of the permanent establish-ment. The German-source income is allocated to the partnership and taxed at that level. For trade tax purposes, the partnership is treated as an separate taxpaying entity. The partners themselves are not liable to trade tax. If an individual owns the perma-nent establishment, trade tax arises on the level of the owner.

6.4.3 Determination of taxable income

Because the head office and its permanent establishment legally form a single unit, contractual obligations between head office and permanent establishment, e. g. loan or rental agreements, are not possible from a legal standpoint. Profits from such internal transactions will not be recognized.

Because a permanent establishment is merely a part of the overall enterprise, only a portion of the overall profits of the enterprise is allocable to the permanent establish-ment. The required allocation of business profits between head office and permanent establishment is made using either the direct or the indirect profit allocation method.

Taxation of permanent establishments

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Under the direct method, the income of the domestic permanent establishment is deter-mined separately under German taxation principles. Assets which contribute to the operations or the functions of the permanent establishment are attributed to it. These include primarily assets intended for exclusive use by the permanent establishment.

Under the indirect method, the whole income of the enterprise is apportioned between the head office and the permanent establishment on the basis of an appropriate for-mula. The following formulars are acceptable: sales for enterprises providing services and trading in goods, revenue from premiums for insurance companies, the share of working capital for banks, and wage and salary expense for manufacturing enter-prises.

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7 Indirect Taxes

7.1 Value added tax (VAT)

The value added tax (Mehrwertsteuer) system was introduced in West Germany in 1968. The completion of the internal market of the EU required the elimination of fis-cal frontiers between member states of the EU. From January 1993 onwards, the impo-sition and abatement of taxes on goods crossing the German border applies only to transactions carried out with territories outside the EU (non-EEC countries). The tran-sitional arrangements introduced in the EU on January 1, 1993 are still in force and apply to intra-EC movements of goods.

7.1.1 Liability for VAT

All entrepreneurs (individuals and entities) who are engaged independently in a trade, business, or profession with the objective of earning income are liable for VAT. As a result, sole proprietors and self-employed professionals are subject to VAT as well as commercial entities, whether incorporated or not (e. g. partnerships, companies, asso-ciations).

VAT liability begins – independently of the formation of the corporation or the part-nership by civil law – with the inception of sustained entrepreneurial transactions. It ends when the entire legal relations of the entrepreneur are completed.

VAT liability arises regardless of citizenship, residence, principal place of manage-ment, or the place of billing or payment. The only criterion for liability for German VAT purposes is that the entrepreneur executes taxable transactions within Germany in excess of certain limits.

Persons who acquire, retain, and sell interests in companies are not liable for VAT. Where a holding company is actively engaged in the day-to-day business of the subsid-iary, the acquisition, retention, and realization can be treated as entrepreneurial activ-ity that is liable for VAT. The same applies if an investment was acquired to perform management services for subsidiary companies (e. g. administrative, financial, or tech-nical services).

Individuals who manage and represent companies in which they are partners or share-holders may act as self-employed persons if certain criteria are met. Corporations are considered to always act as self-employed, even if the corporation must comply with instructions adopted by shareholder resolution. Exchanges of services between a com-

Value added tax (VAT)

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pany and one of its shareholders are also liable to VAT if the exchanges are not based on the shareholder relationship.

Generally, where one or more entrepreneurs in Germany are “integrated” – according to the definition below – with each other in substance, they are treated as a single entrepreneur for German VAT purposes under the Organschaft rules. An Organschaft requires a controlling company (Organträger) and a controlled company (Organge-sellschaft). The latter must be a corporation (see also chapter 6.2.1.6). Integration for VAT purposes is required financially, economically and organizationally:

Financial integration – the members of the Organschaft must be under common control (control being defined as more than 50 % of voting rights);

Economic integration – the controlling company in the Organschaft must exercise actual influence over the business of the controlled company and the controlled company must serve, promote, and supplement the business of the entire Organ-schaft; and

Organizational integration – the controlling company in the Organschaft must be in a position to ensure that its instructions are followed by the controlled company, for example by restricting the controlled company’s freedom in relation to person-nel, tax, legal, and accounting issues, by coordinating business planning, account-ing, and correspondence, by sharing the same business premises, by imposing internal reporting requirements, and by having identical management boards.

As soon as all of the above criteria are met, an Organschaft for German VAT purposes comes into existence until such time that the criteria are no longer met.

The controlling company is considered to be the sole entrepreneur for German VAT purposes. Supplies between Organschaft members are disregarded for German VAT purposes, i. e. intra-group supplies of goods and services are not subject to VAT. In the case of an international group of companies, the Organschaft is limited to the German entities (companies, partnerships, branches, etc.) of the group. In this case, the most significant of the entities in Germany from a business point of view is deemed to be the entrepreneur for VAT purposes.

7.1.2 VAT registration

A German entrepreneur is normally allocated a single tax reference number for all taxes including VAT. Furthermore, on application, a VAT identification number is issued for each registered entrepreneur. Entrepreneurs and individual members of an Organschaft can also request a separate VAT identification number from the tax

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authorities to be quoted on invoices received and issued in relation to intra-EC supplies of goods.

7.1.3 Taxable transactions

The German Value Added Tax Act (Umsatzsteuergesetz – UStG) covers the following transactions which are within the scope of German VAT:

Supplies of goods (Lieferungen) and services (Leistungen) which an entrepreneur delivers or renders for consideration (monetary or non-monetary) within Germany (this does not include the Isle of Helgoland and the Swiss enclave of Buesingen and warehouses, etc. with special customs status).

The private (i. e. non-commercial) use of business assets (both goods and services) of an entrepreneur with a registered office in Germany and of a foreign entrepre-neur’s permanent establishment in Germany.

Gratuitous supplies of goods and services within Germany by a partnership to its partners or by a corporation to its shareholders or to third parties affiliated with a partner or a shareholder.

The importation of goods from territories outside the EU into Germany is subject to German import turnover tax (Einfuhrumsatzsteuer).

Movements of goods into Germany from another territory within the EU are sub-ject to acquisition VAT (Erwerbsteuer).

It is noted that, as long as certain criteria are met, the sale of a business as a going concern is not normally seen as a taxable transaction.

7.1.4 Place of supply

7.1.4.1 Goods

Only supplies that are deemed to take place in Germany are subject to German VAT. The general rules for determining the place of supply of goods for VAT purposes are as follows:

Goods – where the goods are located at the time that the buyer acquires control of the goods.

Imports into an EU territory from outside the EU where the supplier is liable for the import VAT – the country of import.


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Movements from a special customs warehouse regime into free circulation within the EU – the location of the goods when they are put into free circulation.

7.1.4.2 Services

Services are generally deemed to be rendered for VAT purposes where the entrepre-neur has its place of business; if those services are rendered through a permanent establishment, then the location of the permanent establishment will be deemed to be the place where the services are rendered.

Notable exceptions to this general rule include the following:

Services relating to a specific land or property site – where the land or property is located.

Transportation services – where the transport is performed. (Note: special rules apply in case of intra-community transportation)

Work on moveable goods (e. g. valuation, inspection, repair) – where the goods are located when the work is performed (this rule may not apply where the goods do not remain at the same location throughout).

Use of patents, copyrights, and trademarks, advertising, legal, tax, technical and management consulting services, financial services, use of information and know-how, provision of personnel, leasing of goods (but not vehicles) – where the cus-tomer is located, unless the customer is in another EU country and is not an entre-preneur, in which case the general rule above applies.

Telecommunication services – where the customer is located, unless the customer is in another EU country and is not an entrepreneur (in which case the general rule above applies). In addition, if the services are performed by a non-EU entrepreneur but are used and enjoyed within the EU, then the place of supply is where the ser-vices are used and enjoyed.

7.1.4.3 Intra-EC movements of goods

The place of an intra-EC acquisition of goods is normally deemed for VAT purposes to be the place where the goods are located at the time when the transport to the person acquiring them ends. VAT (here: acquisition VAT, Erwerbsteuer) is normally paid by the recipient in the country of destination.

There are numerous exceptions to the practical day-to-day application of this rule, the most notable being the situation where the recipient is registered for VAT purposes

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with a VAT identification number in the EU country of destination or where the sup-plier does not hold adequate proof of the shipment of goods. In these cases, VAT is payable by the supplier in the EU country from which the goods are dispatched.

Where goods are moved from Germany to another EU country without any change in legal and/or economic ownership, German VAT is due unless proof of shipment is held and the German entrepreneur is registered for VAT purposes in the country of destina-tion. This rule applies even if the goods only remain in the ownership of the German entrepreneur for a short time in the country of destination and are destined for sale to a single customer in that country (i. e. consignment stock).

7.1.4.4 Reverse charge procedure

Under the reverse charge procedure, the liability for the tax is transferred to the recip-ient of a supply of goods or services. The scope of the reverse charge procedure includes services and work supplies of foreign entrepreneurs, supplies within the scope of the Real Estate Transfer Tax Act (Grunderwerbsteuergesetz), construction works, supplies of gas and electricity, and supplies of objects transferred by way of security. As of 2007, the reverse charge procedure does not apply in the case of services of for-eign entrepreneurs or foreign performance companies connected to the access authori-zation for domestic fairs, exhibitions or congresses.

7.1.5 VAT rates

Two different VAT rates apply in Germany. The standard rate for supplies of goods or services taking place in Germany is 19 %. This rate was increased from 16 % to 19 % at the beginning of 2007.

Certain goods and services are subject to the lower rate of 7 %. The most common examples are books (but not electronic books), newspapers, and food.

Certain goods and services are exempt from VAT altogether. The most common exam-ples are intra-EC deliveries of goods and exports of goods to a non-EU destination and services related to these deliveries.

The exemption from VAT also applies to certain specified services, including medical, educational, charitable or financial services, and services relating to real estate. VAT on expenditure relating to all of these services cannot normally be recovered (there are various exceptions to this rule: the main exception being certain financial services provided outside the EU). It is possible for the supplier to opt to charge VAT on some of these exempt supplies (mainly land and property, and financial services), thus allow-ing the supplier to recover VAT on related expenditure.


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7.1.6 Collection, filing and payment of tax

7.1.6.1 Output tax

The entrepreneur must pay to the tax authorities the VAT due on its supplies, regard-less of whether the VAT has been collected from the entrepreneur’s customers. The only exception to this rule is where it can be proven that the customer is unlikely to ever pay for the supplies it has received. In addition, if an entrepreneur issues a VAT invoice incorrectly showing VAT due on a supply, this VAT amount shown on the invoice becomes payable to the tax authorities. In order to avoid such tax liability, the entrepreneur can correct the invoice. Here, the issuance of a corrected invoice is con-ditioned on the prior consent of the tax authorities. This consent will be granted only if the threat to the treasury of lost tax revenue has been eliminated. This means that the issuer must show either that the invoice recipient did not claim an input tax credit based on the improper invoice or that any input VAT deducted has been repaid to the tax authorities.

7.1.6.2 Input tax

The entrepreneur can reduce the payment of VAT due to the tax authorities by the amount of VAT charged to it by its suppliers on business expenditure (note: certain employee expenditure may not qualify) to the extent that the entrepreneur generates sales subject to VAT. However, in order to deduct input VAT in this manner, the entre-preneur must be in possession of valid VAT invoices from its suppliers and must either have paid the suppliers or actually received the goods or services from the suppliers. All invoices issued on or after January 1, 2004 must show either the tax registration number or the VAT ID number of the taxable person who supplied the goods or ser-vices. Otherwise, the invoice recipient is unable to deduct the related input VAT. Under certain circumstances, German entrepreneurs are permitted to issue VAT invoices to themselves on behalf of their German suppliers (self-billing).

7.1.6.2.1 Electronic invoice transmission

German VAT regulations allow the electronic transmission of invoices. Such electroni-cally transmitted invoices entitle the recipient entrepreneur to deduct input VAT, pro-vided that, in addition to the generally applicable invoice requirements, they safeguard the authenticity of their source and the integrity of their contents.

There are two means by which this can be safeguarded:

Through the use of a qualified electronic signature or the use of a qualified elec-tronic signature with vendor accreditation;

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Through the electronic data interchange (EDI) process supplemented by an addi-tional invoice in paper or electronic form confirming the transaction, provided the electronic invoice includes at least a qualified electronic signature.

Accordingly, invoices an entrepreneur receives via e-mail that do not contain a quali-fied electronic signature will not be recognized for input VAT deduction purposes.

7.1.6.2.2 Amendment of the input tax deduction within the scope of § 15a UStG

Under § 15a Value Added Tax Act (Umsatzsteuergesetz – UStG), a deduction of input tax must be amended where the conditions upon which the original claim for an input tax deduction were based change substantially during the use of an asset.

Input tax deduction adjustments under § 15a UStG are made with respect to fixed and current assets and with respect to services (sonstige Leistungen).

For real estate, the adjustment period is ten years. For all other fixed assets, the adjust-ment period is generally five years. The adjustment must be made at the time of actual use – whereby it is irrelevant when such use takes place.

7.1.6.3 VAT returns

Most German entrepreneurs must file a preliminary VAT return with the tax authori-ties for each calendar month (under certain circumstances for each calendar quarter) and pay the net VAT amount due to the tax authorities at the same time. The normal deadline for filing and payment is the 10th working day after the end of the calendar month, but the tax authorities will normally extend this deadline by one month upon request. A final VAT return has to be filed as well for the calendar year, summarizing the information already reported in the preliminary monthly returns and correcting any errors which are found in them. This annual return must be submitted by May 31st of the following year. Extensions may be granted by the tax authorities. Any additional VAT due to the tax authorities for that year must be paid to the tax authorities within four weeks of the submission date of the annual return.

7.1.6.4 EC sales lists

Where a German entrepreneur is involved in the intra-EC sale of goods, an EC Sales List (zusammenfassende Meldung) must be completed for each calendar quarter and submitted to the tax authorities within the same deadlines as agreed for the submission of preliminary VAT returns. The EC Sales List must show the VAT identification num-ber of the recipient of the goods and the value of the intra-EC supply made to the recipient. Each of the Organschaft members involved in the sale of goods within the


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EU must complete a separate EC Sales List (i. e. it is not acceptable to submit one EC Sales List for the entire Organschaft).

7.1.6.5 Intrastat declarations

If a German entrepreneur acquires goods from or delivers goods to other EU countries in excess of € 300,000 in a calendar year, then the entrepreneur must submit monthly “Intrastat Declarations” to the tax authorities. These declarations contain information about the goods being shipped, including inter alia the method of transportation, the part of Germany in which the goods originated, the weight of the goods, and an intra-stat product classification number. In case of an Organschaft, each of the Organschaft members involved in intra-EC movements of goods must complete a separate Intrastat Declaration (i. e. it is not acceptable to submit a single Intrastat Declaration for the entire Organschaft).

7.1.7 Foreign entrepreneurs

As a general rule, entrepreneurs not registered for VAT in Germany can recover VAT incurred on German purchases only if they themselves do not supply goods or render services in Germany (except for supplies of goods or services where the recipient is responsible for paying the German VAT thereon to the tax authorities) and they do not have a permanent establishment there. The major purpose of the new VAT warehouse regime is to permit taxable persons not established in Germany to avoid German VAT registration if the only supplies they effect in Germany relate to merchandise in a VAT warehouse. The normal VAT recovery rules for German entrepreneurs (see above) will be applied to them. When applying for a refund, foreign entrepreneurs must submit the original VAT invoices from the German suppliers to the German tax authorities.

7.1.8 Enforcement

7.1.8.1 Tax audits

Normally, tax audits of German entrepreneurs are carried out by the tax authorities. Such audits include, amongst other things, an audit of VAT returns submitted. Any errors found will result in assessments for additional VAT due to the authorities. Assessments for unpaid VAT normally do not extend back for more than four years.

The tax authorities now have the power to visit an entrepreneur’s business premises without warning and demand access to business records. German business records must be retained for ten years.

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7.1.8.2 Electronic audits

With effect from January 1, 2002, Germany introduced new legislation to increase the audit powers of the tax authorities by requiring that German entrepreneurs store all electronically produced tax-relevant data in electronic form for immediate electronic access by the tax authorities upon demand. This may present problems for interna-tional businesses which store records for their German operations in another country.

7.1.8.3 Fraud

Recent legislation allows the tax authorities to shift the liability for any VAT fraud that occurs to other parties involved in the supply chain. This may present problems for purchasers of goods from fraudulent suppliers if they cannot prove that they did not have knowledge that fraud was taking place.

To protect tax revenue, the recent legislation imposes VAT liability on the assignee of a receivable where the assignee collects or reassigns the receivable and the assignor fails to remit all or part of the VAT owing on the supply that gave rise to the receivable. This is applicable to receivables that are assigned, pledged, or attached after November 7, 2003.

Furthermore, the supplier of movable property pursuant to a rental or quasi-rental agreement which was entered into after November 7, 2003 can be held liable for a customer’s failure to pay the tax owed by reason of a downward adjustment in the input tax credit allowable to the customer of supply. The supplier may be held liable for the resulting tax assessed against the customer. This provision was repealed effective Jan-uary 1, 2008.

7.2 Taxes on consumption (excise duties)

7.2.1 General

The main characteristic of excise duties is that they are levied on the utilization and consumption of certain commodities. The country-of-destination principle applies, i. e. the duties are levied in the country in which they are actually used or consumed. The most important excise taxes in Germany are the energy tax (on mineral oil, coal, natu-ral gas, and gasoline), the alcohol tax, the tobacco tax, the coffee tax, the beer tax and, last but not least, the electricity tax. The last-mentioned tax will be discussed sepa-rately.

Excise tax is levied indirectly via the selling price of the goods, meaning that the end-user acts as the ultimate taxpayer. The customs authorities are responsible for collect-

Taxes on consumption (excise duties)

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ing the tax from the party legally liable. This is the owner of the manufacturing opera-tion or an excise duty warehouse, or the importer in the event of import from a non-EU country. This procedure limits the number of parties liable for the tax, considerably reducing the administrative burden compared with a direct tax levy.

7.2.2 Tax territory and commodity subject to tax

The tax territory comprises the Federal Republic of Germany excluding Buesingen and the Isle of Helgoland. A number of specific rules apply for trade with other EU countries (see chapter 7.2.5).

Whether or not a commodity is subject to excise duties depends in most cases on its classification in the Electronic Customs Tariff (see chapter 2.1.1). If a commodity can be assigned to a particular caption in the Electronic Customs Tariff, it constitutes an object of taxation within the meaning of the relevant excise duty law.

7.2.3 Time of tax liability and parties liable

The levying of excise taxes is linked to actual utilization or consumption of the goods. As a consequence of this principle, goods should remain untaxed until the time of use or consumption. This is achieved by the so-called “tax suspension procedure.” Pro-vided certain conditions are fulfilled, it covers the manufacture, processing, storage, and transportation of goods, both within Germany and the EU.

Goods subject to excise duties that are imported into Germany from a non-EU country can either be cleared for free circulation immediately at the time of import (with the consequence that the tax is levied at this time) or they can be transferred into the tax suspension arrangements (postponing the levying of the tax until they are cleared for home consumption).

The party liable for tax is in each case the owner of the excise duty warehouse, the owner of the manufacturing operation, or the importer.

7.2.4 Tax concessions

The excise tax regulations provide for various tax exemptions and tax concessions. They apply for the most part where products subject to excise duties are passed on to a certain group of purchasers or where goods are processed into particular products or are used for particular purposes. In addition to or alongside the individual tax conces-sions, the individual excise tax laws also cover other situations where excise duties may be abated or reimbursed. This includes, for example, concessions available to manufacturing commercial enterprises (Unternehmen des produzierenden Gewerbes)

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in the area of energy tax on heating oil, natural gas, and electricity introduced in con-junction with the ecological tax reform (see chapter 8.1).

7.2.5 EU directives

The establishment of the EU internal market created the need for uniform EU excise duty laws to prevent differing excise duty regulations in the individual member coun-tries from undermining the functioning of the EU internal market. The EU therefore issued a number of harmonization directives. While these did not directly affect the tax revenues and administrative sovereignty of the member states, they did result in a convergence of excise duty rates and the organization of tax concessions.

It should be noted that the harmonization directives only refer to harmonized excise duties, i. e. mineral oil, alcohol and alcoholic beverages, and tobacco products. In 2006 Germany implemented Council Directive 2003/96 restructuring the Community framework for the taxation of energy products and electricity. In addition, the Euro-pean Commission reviews the derogations of this Directive in order to achieve greater transparency and greater coherence in the energy tax legislation.

Under the so-called “System Directive,” excise duties on dutiable goods generally arise when they are manufactured or imported into the territory of the Community. If the goods are initially transferred into a customs procedure at the time they enter Com-munity territory (see chapter 2.1.4), the time of import is deemed to be the date of withdrawal from this procedure.

Excise duties are not levied while the goods are still subject to tax suspension arrange-ments. The transportation of products subject to excise duties within the EU is also part of the tax suspension procedure. Under the country-of-destination principle, taxes should be levied in the country of actual utilization or consumption.

An exception to the country-of-destination principle exists for goods purchased by private individuals for their own use. In this case, the country-of-purchase principle applies.

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8 Other taxes

8.1 Ecological taxes

8.1.1 Electricity tax

An electricity tax was introduced in Germany in April 1999.

The geographic area within which the electricity tax is levied corresponds to that for other excise duties (see above). The commodity subject to tax is similarly determined by its classification in the combined customs regulations.

The tax arises when electricity provided by suppliers resident in the tax territory is withdrawn from the supply network (electricity grid) by the final consumer. In this context, the term “supplier” means an energy supply company within the meaning of the German Energy Act (Energiewirtschaftsgesetz – EnWG). In addition, the electric-ity tax is also triggered when a supplier withdraws electricity from the supply network for its own use and when other generators (so-called “self-generators”) withdraw elec-tricity for their own use. In the first two cases (i. e. electricity withdrawn by consumers or by a supplier for its own use), the tax is levied at the level of the supplier. In the third case, the tax is levied at the level of the self-generator. Operators of small electricity-generating systems are defined as “self-generators”.

The party liable for the tax must file returns on a monthly or an annual basis and remit the amount due with the return. Suppliers generally pass on the tax burden to their customers via the electricity price. Manufacturing commercial enterprises can obtain a tax refund or credit under certain circumstances. Renewable energy sources are tax-exempt.

8.1.2 Energy tax

The general comments in chapter 7.2 above (Taxes on consumption (excise duties)) also apply to energy tax.

One point worthy of mention is the interplay of the energy tax with the electricity tax: If an entity qualifies as a manufacturing commercial enterprise that is entitled to a reduced electricity tax rate and can claim an additional abatement or reimbursement down to a base amount (Sockelbetrag), it can also claim a reduction in the rate of the energy tax for certain kinds of mineral oil (in particular heating oil and natural gas).

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Other taxes



The taxation of energy in Germany recently underwent fundamental reform. Parts of the EU Energy Tax Directive were implemented in connection with this reform. The previous Mineral Oil Tax Act (Mineralölsteuergesetz) was repealed and replaced with the Energy Tax Act (Energiesteuergesetz) with effect from August 2006 as part of this reform. Compared with the prior tax situation, the legislation broadens the range of items subject to taxation. Under the new law, both brown coal and black coal are taxed and new regulations regarding the taxation of natural gas are introduced.

8.1.3 Rates of ecological tax

Table 11: Mineral oil tax rates / energy tax rates

Tax rate (in €)1

Tax rate per 1000 liter of petrol/gasoline 654.502

Tax rate per 1000 liter of diesel 470.402

Tax rate3 per 1000 liter of light heating oil 61.354

Tax rate3 per 1000 kilogram of heavy heating oil 25.00Tax rate3 per 1 megawatt of natural gas 5.50

1 From January 1, 2003 onwards.2 Sulfur content ≤ 10 mg/kg (sulfur-free).3 When used for heating purposes. Mineral oil abatement or refund available to manufacturing commercial

enterprises and agricultural and forestry enterprises.4 Sulfur content ≤ 50 mg/kg (from January 1, 2009 onwards).

Table 12: Electricity tax rates

Period Normal rate (€ per mwh1)

Reduced rate2

(€ per mwh1)

From January 1, 2003 onwards 20.50 12.30

1 Mwh = megawatt hour.2 For manufacturing commercial enterprises and agricultural and forestry enterprises. In case of consumption

less than 25.0 mwh per year the normal rate applies.

8.2 Miscellaneous taxes

8.2.1 Real estate transfer tax

Real estate transfer tax (Grunderwerbsteuer) is generally imposed on any transaction that causes a change in the ownership of real property situated in Germany, or in the person empowered to dispose of such property. Transferor and transferee, whether or

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not resident, are jointly and severally liable; usually the contract specifies which party will pay the tax.

German real estate transfer tax is also triggered by direct or indirect transfers of at least 95 % of the interests in a partnership owning German real property to new part-ners within a five year period. The 95 %-requirement is determined in this case by the interest in the assets of the partnership (Beteiligung am Gesellschaftsvermögen).

Furthermore, an acquisition of shares in a corporation owning German real property that results in a direct or indirect holding of at least 95 % of the shares is also subject to German real estate transfer tax. The same applies if the shares of such a corporation are not held by a legal entity or sole proprietor after the acquisition, but rather by a group of controlled companies (e. g. members of a tax group).

Various transfers, such as acquisition by inheritance or donation, as well as acquisi-tions by spouses or descendants, are exempt from real estate transfer tax. The tax is normally assessed on the basis of the consideration given. Otherwise, the tax is based on the value of the real estate as established under the German Valuation Act (Bewer-tungsgesetz). With effect from January 1, 1997, the tax rate is 3.5 %. Following adop-tion of Art. 105 (2a) of the German Constitution (Grundgesetz – GG) as part of the 2006 federalism reform, the states (Länder) have the right to determine the tax rate in their respective state. The state of Berlin was the first to increase its tax rate – to 4.5 %.

8.2.2 Real estate tax

Real estate tax (Grundsteuer) is an annual tax levied by German municipalities on real property. It is payable by the owner of the property irrespective of residence. The tax is levied on the assessed value (Einheitswert) of the property using the basic tax rate of 0.35 %. To the resulting base amount (Steuermessbetrag), the municipalities apply their respective multipliers to arrive at the final tax due. The multipliers vary by municipality and may be different for industrial or agricultural property. Multipliers for industrial property typically range from 150 % to 600 %.

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9 Taxation of inbound investments

9.1 Choice of legal form and location

9.1.1 Types of inbound investments

A foreign investor planning to set up a business in Germany has a wide range of options. If the activities on the German market are only intended to be short-term, the investor may choose not to establish a physical presence, but instead prefer direct transactions with his business partners. If, however, business activities are intended to be of a longer term nature and require a physical presence in Germany, the foreign investor may establish:

a branch or permanent establishment,

a partnership,

a corporation.

Income taxation in Germany differs depending on the legal form chosen (see chap-ter 6). In general terms, the tax treatment of the various vehicles for doing business in Germany is as follows:

Direct transactions In principle no tax accrues where a foreign investor has neither a permanent estab-lishment, a permanent representative, nor a business entity (company or partner-ship) in Germany. Imports from other countries to Germany are in themselves not taxable events under German tax law.

Permanent establishment/permanent representative A permanent establishment is defined as a fixed business facility or plant which serves the activities of a business and over which the entrepreneur (here: the for-eign investor) exercises control. This definition does not require human interven-tion, so that the presence of an internet server or an oil pipeline on German terri-tory may constitute a permanent establishment. A permanent representative is defined as an individual who is required to follow the instructions of a foreign entity and runs that entity’s business on an ongoing basis in the absence of a per-manent establishment. The existence of a permanent establishment or permanent representative in Germany exposes the investor to German tax liability.

Choice of legal form and location

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Taxation of inbound investments



An applicable tax treaty may modify the concept of a permanent establishment or a permanent representative. For example, the OECD Model Tax Convention (OECD MTC) requires that a permanent representative have the authority to enter into con-tracts. Furthermore, under most tax treaties, agents of an independent status do not constitute permanent representatives and therefore do not, in themselves, subject a for-eign entity to tax liability.

Partnerships A partnership is not itself a taxable entity for income tax purposes. Its income is determined at the level of the partnership, but taxed in the hands of the partners. However, a partnership is a taxable entity for trade tax purposes (Gewerbesteuer – GewSt) if its business activity qualifies as a trading activity. A number of differ-ent forms of partnership are available (see chapter 3.3 for further details):

− General partnership (Offene Handelsgesellschaft – OHG): All partners of an OHG are jointly and severally liable.

− Limited partnership (Kommanditgesellschaft – KG): The general partners of a KG (Komplementäre) are personally liable, while the limited partners (Kom-manditisten) are liable only up to their subscribed and registered contribution to the partnership.

− GmbH & Co KG: This is a specific form of limited partnership (KG) in which a corporation (limited liability company) acts as the general partner.

Corporations A (domestic) corporation is subject to both trade tax and corporate income tax. Shareholders, whether individuals or corporations, are taxable on the profits dis-tributed to them. The following types of corporations are available (see chapters 3.1 and 3.2 for further details):

− Limited liability company (Gesellschaft mit beschränkter Haftung – GmbH): the most common corporate form in Germany. It is often chosen by foreign investors to carry out business in Germany.

− Stock corporation (Aktiengesellschaft – AG): a corporate form usually selected for large corporations, as only stock corporations can be listed on a German stock exchange.

− Limited partnerships with share capital (Kommanditgesellschaft auf Aktien – KGaA): a fairly rare corporate form, under which at least one of the partners has personal liability and the remaining partners own shares and have only limited liability.

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The choice of the most appropriate legal form depends on a number of factors, includ-ing employee co-determination rights, the structure of the management and supervi-sory bodies, equity funding requirements, credit rating, reporting and audit require-ments, incorporation costs, etc. The following sections discuss the tax-relevant charac-teristics of the various legal forms.

9.1.2 Taxation of current income

The effective tax rate of an investment usually depends on a number of factors such as the applicable categories of tax, tax rates and tax bases.

Where a foreign corporation carries on business activities, corporate income tax, trade tax, and a solidarity surcharge (a supplementary tax based on the corporate income tax assessed) are levied on the German income generated, regardless of whether the invest-ment is structured as a permanent establishment, a partnership, or a corporation.

The tax base for corporate income tax purposes is based on the income for financial reporting purposes under the German Commercial Code (Handelsgesetzbuch – HGB). The income for financial reporting purposes, however, is adjusted in several respects in accordance with German tax law and regulations. These adjustments relate in par-ticular to depreciation and the deductibility of certain expenses (see chapter 6.2). For trade tax purposes, taxable income is further adjusted by certain deductions and add-backs. The 2008 Business Tax Reform made major changes in the addbacks, requiring for instance that 25 % of the interest expense on all liabilities be added back to taxable income (previous rule: addback of 50 % of interest on long-term debt only).

A uniform corporate income tax rate applies whether profits are retained or distrib-uted. Effective 2008, the corporate tax rate has been reduced to 15 % to increase Ger-many’s international tax competitiveness.

Apart from corporate tax, German businesses are generally subject to trade tax. Although trade tax is governed by federal law and the trade tax base is therefore com-puted in the same way throughout Germany, the actual trade tax burden varies sharply from municipality to municipality, because each municipality is entitled to determine its own trade tax multiplier (Hebesatz). The multiplier determines the rate at which trade tax is levied. Smaller municipalities, in particular those adjoining larger towns, can make their location more attractive by setting their multiplier below that of their neighbors. However, the trade tax multiplier must be at least 200 %. Table 13 illustrates the effect of different multipliers on the trade tax rate.


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Table 13: Trade tax rates

Location of business1 Multiplier Trade tax rate

ConurbationAdjoining areas

400 %200 %

14 %7 %

1 These examples are illustrative only. Trade tax multipliers in Germany cannot be less than 200%. At the moment, Munich has the highest multiplier: 490%.

Where a permanent establishment is maintained, the foreign investor is subject to tax on the German-source income attributable to the permanent establishment. If the for-eign investor is a corporation, the foreign corporation is subject to trade tax, corporate income tax, and solidarity surcharge. The same applies where business is carried on through a German partnership. However, the partnership as such is liable to trade tax, whereas for income tax purposes the profits of the partnership are allocated to the partners in proportion to their respective ownership and are subject to tax in their hands.

In the case of investment in a corporation, the distribution of profits triggers withhold-ing tax (Kapitalertragsteuer), normally 20 % of the gross dividend (increasing to 25 % in 2009). If the non-resident recipient of the dividend is a corporation, the withholding tax rate is often reduced by a tax treaty. A summary of the withholding tax rates in tax treaties between Germany and other industrial countries is included in Appendix I (chapter 14.1 below). Where the requirements of the Parent-Subsidiary Directive are met, withholding tax on dividends paid to a corporation resident in another EU coun-try is reduced to zero.

The following table compares the effective tax rates for permanent establishments, partnerships, and corporations. The calculations assume that the German corporation distributes all of its profits and that the withholding tax is reduced to 5 % by a tax treaty.

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Table 14: Tax burden for permanent establishment, partnership and corporation (current taxation)

Type of investment Permanentestablishment

Partnership Corporation

Income before tax 100.00 100.00 100.00Trade tax (multiplier: 400 %) 14.00 14.001 14.00

Income before corporate income tax 100.00 100.00 100.00- Corporate income tax (15 %) 15.00 15.00 15.00- Solidarity surcharge

(5.5 % of CIT) 0.83 0.83 0.83

= 70.17 70.17 70.17– Withholding tax (5 %) 0.00 0.00 3,512

= Net amount after German taxes 70.17 70.17 66.66

German tax burden3 29.83 % 29.83 % 33.34 %

1 Trade tax arises at the level of the partnership; income before trade tax is allocated to the partners and taxed at their applicable tax rate. This two-step profit determination is discussed in chapter 6.3.1.

2 If the foreign parent company is located in another EU country, the withholding tax on dividends can be avoided. Assumption: foreign investor is a corporation.

3 Assumption: foreign investor is a corporation.

If the foreign investor is an individual or a partnership with individuals as partners, the result for permanent establishments and partnerships would be different: the profits would be subject to income tax at the individual’s applicable tax rate (between 25 % and 45 %) instead of corporate income tax.

Specific problems may arise where special remuneration is paid by a German partner-ship to an individual or corporate shareholder (e. g. interest on partners’ loans). The tax authorities treat such remuneration as part of the partnership’s profits. However, tax treaties may contain special rules dealing with this issue.

9.1.3 Exit taxation

The issue of exit taxation should always be considered, in particular where the invest-ment is only expected to be of a short duration.

If the investment is structured in the form of a permanent establishment or an interest in a partnership, any gain on winding-up or liquidating the permanent establishment/partnership in Germany is subject to tax at the level of the foreign entity. If the foreign entity maintaining the permanent establishment is a corporation, the gain is subject to corporate income tax (plus solidarity surcharge) and to trade tax. If it is an individual or partnership, the gain is subject to income tax (plus solidarity surcharge in each


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case). Germany’s tax treaties generally permit it to tax the gain on the sale of a perma-nent establishment or an interest in a partnership.

Where the German investment takes the form of a corporation, a foreign corporate shareholder will profit from the capital gains exemption, as the sale of shares in a cor-poration by another corporation is exempt from corporate income tax. However, since 5 % of capital gains are qualified as non-deductible expenses for corporate income tax purposes, effectively 95 % of the capital gain is tax-exempt. Where the foreign seller is an individual or a partnership with individuals as partners, the gain on the sale is sub-ject to the “half-income” rule, whereby only half (as of 2009 60 %) of the gain is sub-ject to income tax. It should be noted that a 25 % minimum tax rate applies (as is the case for all individuals with non-resident tax liability). Germany’s tax treaties typically assign the right to tax capital gains on the sale of shares to the seller’s country of resi-dence.

The following table compares the German tax burden on capital gains on the sale of German permanent establishments, partnerships, and corporations. The table assumes that no tax treaty is applicable and that the seller is a foreign corporation.

Table 15: Exit tax burdens for various legal forms

Type of investment Permanent establishment

Partnership Corporation

Capital gain on sale 100.00 100.00 100.00– Trade tax (multipl.: 400 %) 14.00 14.00 0.00= Income before corp. income tax 100.00 100.00 100.00– Corporate income tax (15 %) 15.00 15.00 0.75– Solidarity surcharge

(5.5 % of CIT) 0.83 0.83 0.04

= Income after tax / net gain 70.17 70.17 99.21

German tax burden 29.82 % 29.82 % 0.79 %

9.2 Financing of inbound investments

9.2.1 Permanent establishments and partnerships

In addition to the legal form of the inbound investment, thought must also be given to how it will be financed and what its distribution policy will be. The limited status of a partnership as a legal entity and the fact that a permanent establishment is not a sepa-rate legal entity are considerations relevant both to the choice of legal form and to the financing options.

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A German permanent establishment is part of the foreign investor’s business. Hence, loan agreements between the head office and the permanent establishment are not accepted legally or for tax purposes. However, interest expenses attributable to the German permanent establishment may be deducted in Germany.

Loan agreements between a foreign partner and its German partnership are in princi-ple recognized for tax purposes. However, interest deducted at the level of the partner-ship is added back at the level of the respective partner to determine the income of the partnership as such and the profit share of the individual partner. Hence, loan agree-ments between a foreign partner and a domestic partnership are only relevant for the profit allocation between the partners.

9.2.2 Corporations

German corporate subsidiaries can be financed by one or more of the following meth-ods:

Equity financing The minimum capital of a corporation depends on its legal form. The minimum registered share capital of a limited liability company (GmbH) is € 25,000; for a stock corporation (AG) it is € 50,000. Additional capital may be paid into the cor-poration at any time by means of a formal increase of registered share capital or by a simple transfer of amounts to the capital reserve (Kapitalrücklage).

Debt financing Contractual relationships with the parent company are recognized for tax pur-poses. Loans may be granted by the parent, by affiliated companies, or by third parties (secured where necessary by the parent or a related company).

Internal financing Internal financing results from reinvestment of retained earnings in the business and deductions without impact on cash-flow (such as depreciation). Naturally, internal financing is only possible where a business is profitable.

A foreign investor carrying on business activities in Germany should compare the tax implications of debt and equity financing. While dividends are not tax deductible, interest is in principle deductible under German tax law. However, there are restric-tions on the deduction of interest expense. Until 2007, German thin capitalization rules applied to any (domestic or foreign) debt financing by a shareholder or a related party. Starting January 1, 2008, new earnings stripping rules replace the thin capitalization rules. Unlike the thin capitalization rules, the new rules apply to all types of debt financing (shareholder and third party debt). They also apply not just to corporations,

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but to all businesses, including sole proprietorships, partnerships, and consolidated tax groups (Organschaft).

Under the new rules, net interest expense is deductible for tax purposes only up to 30 % of EBITDA. Interest expense is fully deductible to the extent of interest revenue. Net interest expense is defined as interest expense less positive interest revenue. EBITDA for tax purposes is taxable income plus interest expense and depreciation/amortization and less positive interest revenue.

Interest expense may be carried forward where it is not deductible in a particular year.

By way of exception, interest is fully deductible in the following cases:

Net interest expense of the entity is less than € 1 m.

The entity is not part of a controlled group (Konzern) and, if a corporation, has no detrimental shareholder debt financing.

The entity is part of a controlled group, but has no detrimental shareholder debt financing and proves that its equity ratio is not more than one percentage point less than that of the controlled group as a whole (equity ratio pursuant to IFRS, alterna-tively local GAAP of EU member state or U.S. GAAP).

Interest that is not deductible under the earnings stripping provisions may be carried forward infinitely and used in future tax periods. Termination or transfer of a business leads to forfeiture of the interest carryforward. Where the entity in question is a part-nership, the interest carried forward is forfeited pro rata when a partner withdraws from the partnership.

For further details on the German rules limiting interest deductions, please refer to chapter 6.2.1.4.

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Table 16: Comparison of tax burden for equity and debt financing of a German subsidiary

Type of financing Equity Debt

Additional financing amount 2,000.00 2,000.00Income before tax and interest 200.00 200.00

– Interest expense (10 %) 0.00 200.00– Trade tax (multiplier: 400 %) 28.00 3.501

= Income before corporate income tax 200.00 0.00– Corporate income tax (15 %) 30.00 0.00– Solidarity surcharge (5.5 % of CIT) 1.65 0.00= Income after tax 140.35 0.00

Cash dividend / interest payment 140.35 196.50– Withholding tax (5 %/0 %) 7.18 0.00= Cash-flow after tax 133.17 196.50

German tax burden 66.83 (33.42 %) 3.5 (1.75 %)

1 One-fourth of the interest expenses are added back when computing income for trade tax purposes. The add-back applies only where the de minimis threshold of € 100,000 is exceeded.

9.3 German holding companies

Although Germany has no specific holding company regime for foreign investors, the German corporate income tax system does have features that make Germany an attrac-tive jurisdiction in which to base holding companies. Above all, there is a capital gains exemption where a corporation sells shares in other corporations and a dividends-received exemption for intercompany dividends.

Where a corporation sells shares in another domestic or foreign corporation, any resulting capital gain is tax-exempt under Germany’s participation exemption. How-ever, 5 % of the capital gain is treated as a non-deductible business expense, thus reducing the exemption to 95 %. Conversely, losses on the sale of shares in corpora-tions are not tax deductible. Under the dividends-received exemption, (effectively) 95 % of the dividends paid by a domestic or foreign corporation to a German corpora-tion are tax-exempt. However, any expenses connected with such dividends are fully tax deductible.

The exemptions referred to apply for corporate income tax (and solidarity surcharge) purposes. The capital gains exemption also applies for trade tax purposes. Dividends received are, however, only exempt from trade tax if the parent owns at least 15 % of the shares of the German corporation – so-called trade tax participation exemption (gewerbesteuerliches Schachtelprivileg). Additionally, the dividends-received exemp-

German holding companies

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tion is denied for trade tax purposes where the participation in question was not held at the beginning of the calendar year in which the dividend is paid (minimum holding period).

For investments in foreign corporations, the parent corporation must, in addition to satisfying the 15 % ownership and minimum holding period requirements, hold shares in a subsidiary (i) that generates income from an active business within the meaning of § 8 para. 1 nos. 1 to 6 of the German Foreign Transactions Tax Act (Außensteuergesetz – AStG) or (ii) that earns income from stakes of at least 25 % held for at least twelve months in corporations with active business income in the same country. However, the requirement of active business income need not be met if the foreign subsidiary is resident in another EU member state or if a tax treaty with a non-EU member state is in place which provides for application of the exemption method for dividends.

The fact that dividend income and capital gains on the sale of corporate shares are 95 % tax exempt makes Germany, in comparison with other European countries, an attractive location for operations organized through holding companies. Since these advantages also apply to investments of a German entity in a foreign corporation, it has become more attractive to structure investments (both German and foreign) under a German holding company.

Table 17 summarizes the main characteristics of German holding companies from a tax perspective.

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Table 17: Main characteristics of German holding companies

Holding company criteria

1. Normal tax rate on holding company income 22.83 % to 32.89 %1

2. Tax exemption for foreign dividend income (§ 8b para. 1 KStG) 95 %

3. Tax exemption for German dividend income (§ 8b para. 1 KStG) 95 %

4. Tax exemption for capital gains on sale of shares in foreign corporations 95 %

5. Tax exemption for capital gains on sale of shares in German corporations 95 %2

6. Utilization of losses arising on corresponding sales no 7. Capital tax on capital contributions no 8. Deductibility of financing costs for investments in foreign

corporations yes 9. Deductibility of financing costs for investments in German

corporations yes10. Tax loss carry-forwards

Subject to time limit: noMinimum taxation restrictions: Deduction in each of the subsequent years:

fully deductible € 1 m + exceeding income up to 60 %

11. Tax exemption for profits from foreign permanent establishments, generally yes

12. Utilization of losses generated by foreign permanent establishments (generally excluded under tax treaty) no

13. Extensive tax treaty network, low treaty withholding rates yes14. EU membership (e. g., no withholding tax on distributions to

corporations in other EU countries) yes15. Controlled foreign corporation regime (AStG) yes16. Corporate taxes on incorporation no17. Transfer tax/stamp duty on transfer of shares no18. Capital taxes levied no19. Income tax rate for employees of a holding company (max.) 42 %3

1 CIT= 15 % plus sol. surcharge of 5.5 % on CIT; trade tax = 7–17.15 %.2 Special anti-abuse clauses may apply.3 A tax rate of 45 % applies to the portion of income that exceeds € 250,001/€ 500,001 (single/married).

9.4 Taxation of controlled foreign corporations (CFC rules)

If a German corporation, partnership, or permanent establishment (in this section referred to as a German entity) holds an investment in a foreign corporation, Germa-

Taxation of controlled foreign corporations (CFC rules)

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ny’s CFC rules (Hinzurechnungsbesteuerung) under the German Foreign Transactions Tax Act (Außensteuergesetz – AStG) must be considered.

Taxation in accordance with the CFC rules will apply at the level of the German entity if the foreign corporation is deemed to be an interposed company (Zwischen-gesellschaft). Particular care must be exercised in the case of a German holding com-pany.

CFC rules apply where the following conditions are cumulatively met:

Shareholding in the foreign corporation Shareholders who are tax resident in Germany hold (alone or jointly, directly or indirectly) more than one half of the shares or more than one half of the voting rights in the foreign corporation. Shares or voting rights held in the foreign corpo-ration by an interposed entity are taken into account pro rata (§ 7 para. 2 sent. 1 and 2 AStG). The minimum investment requirement is reduced to 1 % where the foreign entity generates significant passive income with investment character (Zwischeneinkünfte mit Kapitalanlagecharakter) (e. g. interest). If more than 90 % of the foreign entity’s income is passive income with investment character, no minimum investment requirement applies, unless the foreign corporation is listed on a “recognized” stock exchange.

Passive income of the foreign corporation The foreign corporation generates passive income. Passive income is defined as income not listed as active income in § 8 para. 1 no. 1–9 AStG. The following income qualifies as active income:

− Agriculture and forestry;

− Manufacturing and assembly of goods;

− Income of credit institutions and insurance companies, unless they primarily provide services to their German majority shareholders;

− Income from trading, unless a German shareholder (or a related party) assists in preparing, concluding, or performing the trade transactions;

− Income from supply of services, unless such services are exclusively rendered to or performed with the assistance of a German shareholder (or a related party);

− Income from rental and lease of real estate, provided that comparable income of the shareholder would be tax exempt under a tax treaty;

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− Income from the licensing of intellectual property (e. g., rights, plans, and knowledge), provided that any research and development activity of a German shareholder is neither exploited nor involved;

− Income from commercial rental and lease of moveable property, unless a Ger-man shareholder (or a related party ) is involved;

− Interest income, provided the underlying capital is raised on foreign capital markets and lent to enterprises which conduct active businesses as outlined above;

− Dividends received from corporations;

− Capital gains from the sale of investments, gains on the liquidation of an entity or from a reduction in capital, to the extent these gains do not result from the sale of assets used to earn passive income with investment character.

Low rate of taxation at the level of the foreign corporation The income of the foreign corporation is subject to low taxation. This is assumed where the overall income tax rate is lower than 25 %, unless the low level of taxa-tion results from the offset with income from other sources. Low taxation is also assumed where income tax of at least 25 % is owed, but is not effectively col-lected.

Whether the above mentioned criteria are met is determined with reference to the cir-cumstances at the end of the fiscal year of the foreign corporation. If the above criteria are met, the passive income is imputed to the German entity on a pro rata basis and is thus subject to taxation in Germany (corporate income tax / income tax, trade tax, and solidarity surcharge). Any passive income derived by a lower tier subsidiary of the foreign company will be attributed to the foreign company and consequently to the domestic shareholder on a pro rata basis. Passive income of such lower-tier subsidiaries will not be included if it is directly related to activities of the intermediary company that generate active income and does not constitute passive income with investment character.

Where income of a foreign corporation has been taxed under the CFC rules at the level of the shareholder, dividends paid by the foreign corporation are fully exempt from taxation, provided the shareholder can establish that the passive income has already been imputed under the CFC rules during the last seven years. Otherwise, standard dividend taxation applies. Dividends paid to a corporate shareholder are 95 % tax exempt. Dividends paid to an individual (or a partnership) are 50 % tax exempt under the “half-income” rule.

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Since the amounts imputed under the CFC rules include the passive income of corpo-rations resident in other EU countries, the compatibility of the CFC rules with Euro-pean law has been questioned, as has the treatment of income generated by a foreign permanent establishment which would constitute CFC income if it was a foreign cor-poration. Such permanent establishment income is denied any exemption which would otherwise apply under a tax treaty. Instead, double taxation is avoided under the credit method (treaty overriding).

In Cadbury Schweppes (decision of 12 September 2006, C-196/04), the European Court of Justice held that CFC regimes may violate the freedom of establishment under the EC Treaty. They are, in the court’s opinion, justified only where they relate to wholly artificial arrangements designed to avoid the payment of taxes normally due, and where the terms of the CFC regime do not go beyond what is necessary to prevent such tax avoidance. The intention to obtain tax relief is not in itself a sufficient basis on which to conclude that an arrangement is wholly artificial. Moreover, CFC rules may not be applied where the foreign company has an actual establishment for purposes of carrying on genuine economic activities in the foreign state.

The German tax authorities reacted to the decision of the ECJ by an administrative decree, according to which the German CFC rules in principle will continue to apply. However, tax authorities will refrain from the application of the CFC rules to foreign corporations resident in an EU/EEA member state where, inter alia, the foreign com-pany is engaged in active business in the state of residence and employs regular staff to carry out its business. By legislation entering into force from 2008, German CFC regime has been brought in line with the decision of the ECJ (see chapter 5.1.3.4).

Therefore, an exemption from the CFC rules applies for a CFC with its registered office or place of management in a EU/EEA member state provided the company car-ries on genuine economic activities in this country. Genuine economic activities require a fully fledged business with an appropriate office, employees and technical equipment. Generally “genuine economic activities” are determined by the criteria stated by the European Court of Justice in the Cadbury Schweppes decision. Only such income that is attributable to the genuine economic activity which is derived by that particular activity (and only insofar as the arm’s length principle is observed in respect of that income) is exempt from the CFC rules.

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9.5 Transfer pricing

9.5.1 Transfer pricing principles

When an investor decides to carry on business activities in Germany via a German subsidiary, the transactions between the German corporation and its foreign affiliates may give rise to issues of how income should be allocated for tax purposes.

Based on the “separate entity concept,” the arm’s length principle has become the accepted approach in dealing with transactions on an international level. Prices and terms and conditions agreed on for transactions between related parties will be accepted for tax purposes only where the terms and conditions of the transaction do not differ from those on which unrelated parties would have agreed. The same approach must be used to determine the acceptable level of profit mark-up under cost-plus arrangements. The inter-company prices agreed on for the exchange of goods or ser-vices are referred to as transfer prices (Verrechnungspreise).

The standard transfer prices methods confirmed by the legislature are the comparable uncontrolled price method, the resale price method, and the cost-plus method. The transactional net margin method and the profit split method are also accepted transfer pricing methods, subject to certain conditions. In the event only a range of arm’s length transfer prices can be determined, the resulting range is narrowed in accordance with applicable regulations. Where the transfer price chosen by the taxpayer is outside of the narrowed range, a correction is generally made to the median value in the range. A hypothetical arm’s length test is applied where it is not possible to determine arm’s length transfer prices on the basis of an accepted transfer pricing method.

For instance, under the comparable uncontrolled price method interest expenses for inter-company loans may not exceed the amount which banks would charge under similar circumstances. Royalties must correspond to uncontrolled prices agreed on by third parties.

Special rules apply for so-called base shifting (Funktionsverlagerungen), which involves the transfer of business functions, including opportunities, risks, and assets. As a rule, a payment in consideration of the transfer is calculated for the transfer as a whole (transfer package). The transfer price is based on the impact of the function shifted on the profits of the transferring and receiving companies. Where subsequent actual developments differ substantially from the original assumptions, a (rebuttable) presumption arises with regard to material intangible assets that uncertainties existing at the time of contracting would have prompted uncontrolled parties dealing at arm’s length to include an adjustment clause in their contract. If a substantial change in the relevant circumstances occurs within ten years after the initial business transaction

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and the related parties have not agreed on an adjustment clause in advance, the tax authorities are entitled to make a one-time adjustment to the taxpayer’s income (com-mensurate with the transferee’s income).

9.5.2 Documentation requirements

In 2003, the Tax Preference Reduction Act (Steuervergünstigungsabbaugesetz – StVergAbG) introduced statutory transfer pricing documentation requirements. There-fore, with regard to cross-border relationships between group entities, it is necessary to document the legal and commercial bases of transfer price arrangements and any other business relationships subject to the arm’s length principle. At the request of the tax authorities, the documentation must be presented within 60 days. Although a request will generally be made only in the context of a tax audit, requests in other circum-stances are possible. If no documentation is presented, the tax authorities are entitled by law to assume that the profits of the German entity have been reduced because of inappropriate transfer prices and to make appropriate adjustments to taxable income by way of an estimate. Further, the tax authorities have the option of levying additional payments and reversing the burden of proof, placing it on the taxpayer. The taxpayer may avoid such sanctions by filing proper transfer pricing documentation in a timely manner and by basing its transfer pricing arrangements on the relevant parameters.

The authorities require that the transfer pricing documentation include the following information:

General information on the ownership relationships, the business operations, and the organizational structure: The tax authorities require documents revealing any interests held in related parties within the meaning of the Foreign Transactions Tax Act, the organizational and operating group structure, and the taxpayer’s area of business. Any changes in these matters must also be disclosed.

Business relationships and transactions with related parties: Taxpayers must docu-ment the nature and scope of their business dealings and their underlying contrac-tual basis. Documents must also list the taxpayer’s significant intangible assets that are involved in the related-party transactions.

Function and risk analysis: Information on the functions performed and risks borne, the relevant contractual relations, market conditions and competition, and a description of the supply chain within the network.

Transfer pricing analysis: Information on the transfer pricing method applied, the basis for its application, documents describing the analyses, and the prices used for comparison.

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Supplemental information: Information on, inter alia, business strategies, cost sharing arrangements including an allocation key, advance pricing agreements, and other advance rulings from foreign tax authorities, and price adjustments resulting from transfer pricing corrections.

In order to facilitate the preparation of transfer pricing documentation, the tax authori-ties permit aggregation of comparable business transactions and the adoption of gen-eral transfer pricing guidelines for the group.

With regard to extraordinary business events (such as reorganizations, significant changes in functions and risks, relevant changes to business strategies, the conclusion or modification of major long-term contracts), documentation must be created within six months of the event (contemporaneous documentation).

Careful structuring of transfer price arrangements is particularly important for opti-mizing the effective tax rate of a group and avoiding double taxation as a result of transfer price adjustments. The selection of tried and tested options (such as the resale price method vs. the cost-plus, licensing model or cost allocation method) may help in this respect. It is also possible to structure the organization of the group in terms of the various functions to be performed, or by redistributing the risks and rewards within the group. This may also be achieved, for example, by changing the sales system to a commission basis or by establishing shared administrative service centers.

The conclusion of advance pricing agreements (APA) is possible under German tax laws and should be considered. APAs are possible pursuant to bilateral and multilat-eral mutual agreement procedures.

9.5.3 Transfer pricing principles for the secondment of staff

Inbound investments in Germany often involve transferring employees from a foreign entity to a German entity.

Expenses for seconded employees (salary and additional remuneration) may be borne by either the transferor or the transferee entity. Where there is a wide disparity between the tax rates of the two countries, it is possible to achieve an optimal solution from a tax point of view by entering into contracts that stipulate which party will bear expenses relating to the secondment.

When determining whether the costs of the seconded employees are deductible expenses in Germany, the tax authorities, under their administrative guidance, look to the party whose economic interests are served by the secondment.

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The secondment is assumed to be in the interest of the transferor entity if

− The salary paid to the seconded employee contains elements exceeding the sal-ary levels applicable to the country of residence of the transferee entity;

− The seconded employee performs budgeting, coordination, or control functions for the transferor entity which are not separately remunerated;

− The transferor entity will benefit, after the return of the seconded employee, from the overseas experience gained; or

− The job performed by the seconded employee is permanently carried out by an employee seconded from the transferor entity.

The secondment is assumed to be in the interest of the transferee entity if a director of an independent enterprise would, in a comparable situation, also have hired the particular employee and borne the relevant costs. If the costs incurred for the sec-onded employee exceed the costs of a comparable employee on the German labor market, the transferee entity must have a valid business reason for paying higher remuneration. This should be based on the specific situation in the enterprise, on a comparable arm’s length situation, or on the hypothetical arm’s length expense for seconded employees.

If the secondment is deemed to be in the interest of the transferor entity, the amount by which expenses exceed the cost for comparable employees in Germany is attributed to the transferor entity. If the costs incurred by the transferee entity are not reimbursed or not sufficiently reimbursed by the transferor entity, a profit adjustment will be made for tax purposes at the level of the transferee entity in accordance with the provisions of the German Foreign Transactions Tax Act. If the expatriate is working in the joint interest of the transferor and transferee entities, the secondment costs must be allo-cated fairly according to the input involved between transferor and transferee entity. In agreement with the tax authorities, it is possible to use a uniform allocation scheme for employee secondments within a group.

Where employees are seconded to a German subsidiary, wage tax (Lohnsteuer) must be withheld only if the German subsidiary constitutes an employer for wage tax pur-poses. Normally, the employer under German tax law is regarded as the person/entity for which the employee is required to work and follow instructions or under whose management the employee is (§ 1 para. 2 Wage Tax Procedures Ordinance, Lohn-steuerdurchführungsverordnung – LStDV). In case of doubt, it is possible to obtain a “binding ruling” for wage tax purposes (Anrufungsauskunft) from the tax authorities in order to avoid the risk of a wage tax liability for the German entity.

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9.6 German REITs

After months of lively discussion, the German legislature enacted legislation on 28 May 2007 creating the Real Estate Investment Trust (REIT) as a new asset class. The introduction of the REIT is likely to open up significant opportunities for real estate companies, investors in real estate, and companies with substantial real estate holdings in Germany, in particular by providing the opportunity to transfer assets to the capital market. REITs may help companies to unlock built-in gains and to invest the proceeds in their core business. In all events, REITs should make it easier for for-eign investors to invest in the German real estate market.

REITs are joint stock corporations (Aktiengesellschaft) organized under German law having their registered office and principal place of management in Germany. The shares in a REIT must be registered for trading on a public exchange in a member state of the European Union or the European Economic Area. Their minimum stated capital is Euro 15 million. At least 25 % of the shares in a REIT must be widely held at the time of stock exchange registration as a REIT corporation. At least 15 % of the shares must be widely held at all times. Stock is considered widely held where no one share-holder holds 3 % or more of the shares. No shareholder is allowed to hold directly 10 % or more of the shares in a REIT corporation.

At least 75 % of a REIT’s assets must consist of real estate and at least 75 % of its gross revenues must be derived from the rental, leasing, or sale of real estate. However, the REIT is not permitted to engage in trading in real estate. A REIT is considered to trade in real estate if the REIT’s gross revenues from the sale of real estate within a five year period amount to more than half of the value of its average real estate holdings during the same period. Furthermore, a REIT must distribute at least 90 % of its distributable profits to its shareholders.

Where a REIT meets these requirements, it is exempt from German corporate income tax, trade tax and solidarity surcharge.

The tax exemption at the level of the REIT corresponds to full taxation at the level of the shareholder. This applies both for direct investments in foreign REITs and for indi-rect investments in REITs through investment funds. Dividends paid by a REIT are subject to 25 % withholding tax. For foreign shareholders, the withholding tax of 25 % constitutes final and definitive German taxation. However, many tax treaties provide for a reduction of German withholding tax to 15 %. Foreign investors would thus in many cases be able to derive income from a German REIT with only a 15 % German tax burden (less under certain tax treaties).

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Depending on the relevant tax treaty, capital gains on the sale of REIT stock held by foreign investors may be exempt from German taxation as well.

The distributable profits of a REIT are determined on the basis of year-end financial statements prepared in accordance with German GAAP. Only straight-line deprecia-tion (2 % p.a.) is allowed in determining distributable profits.

Special rules exist to encourage the reorganization of real estate holdings into REITs. A 50 % tax exemption is granted for capital gains on the sale to a REIT (or an invest-ment fund) of certain land and buildings held as business property if the relevant pur-chase agreement is concluded after December 31, 2006 and before January 1, 2010 (so-called exit sale provision).

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10 Acquisition and restructuring of business entities

10.1 Legal aspects of acquisitions

10.1.1 Sales of business entities

In Germany, the acquisition of a business enterprise is governed by the general provi-sions of the German Civil Code (Bürgerliches Gesetzbuch – BGB) pertaining to the sale of objects und rights. A business enterprise (Unternehmen) is regarded neither as an object nor as a right in itself, but rather as an accumulation of the elements (tangible and intangible assets, liabilities, business relationships, market conditions) which make up a specific business organism.

A business entity can be acquired in its entirety either by way of an asset deal or a share deal. Under an asset deal, assets and liabilities of the business enterprise are directly sold and transferred by the seller to the purchaser. As the business enterprise does not constitute an object or right in itself, an asset deal may only be accomplished by an individual transfer of the assets and liabilities of the business enterprise by way of singular succession. By contrast, under a share deal the purchaser acquires the shares in the corporate entity to which the assets and liabilities of the business enter-prise are attributed. The attribution of the assets and liabilities to the respective legal entity as such remains unchanged. A share deal is therefore generally a (legally) less complex way to transfer a business enterprise, as it involves an indirect transfer of the entire entrepreneurial organism by way of the transfer of the shares. In the case of an asset deal, special attention must be paid to the provisions of the BGB dealing with the labor law consequences of the transfer of a business (§ 613a BGB). Under this provi-sion, employment relationships relating to a business or part of a business are trans-ferred by operation of law to the acquirer of a business.

The provisions of the German Civil Code on the law of sales (§§ 433 ff. BGB) cover the purchase of objects and apply mutatis mutandis to the acquisition of rights (§ 453 para. 1 BGB) as well. Therefore the rules of contract law applicable to share deals and asset deals are very similar in practice.

10.1.2 Typical steps of a business entity acquisition

The acquisition of a business entity may take a wide variety of forms, given the differ-ences in nature, size, and organizational structure of the target and the entities involved.

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However, certain typical phases of the acquisition process can be identified: initial contact, confidentiality agreement, letter of intent (LOI), due diligence, sale and pur-chase agreement, and completion.

10.1.2.1 Initial contact

The first contact between a potential vendor and a potential purchaser of a business may take place when the interested buyer notifies the target entity of its interest in acquiring the business. This contact is often established via agents, such as investment brokers, investment banks, or law firms specializing in commercial clients. The initial contact may also be initiated by the potential vendor by sending out a so-called infor-mation memorandum to companies that are seen as prospective buyers.

10.1.2.2 Confidentiality agreement

Once negotiations have been entered into, a confidentiality agreement is often con-cluded between the parties. During the negotiations, the buyer is often provided with sensitive information on the seller’s business. Obviously, the seller wants to avoid dis-closure of such information to outsiders in case the intended acquisition does not mate-rialize. Although the buyer is already under a pre-contractual obligation not to use any information received in the course of the negotiations to the detriment of the seller, a confidentiality agreement is often used to detail and clarify the rights and obligations of the parties with respect to the information disclosed during the negotiations. A con-fidentiality agreement will normally cover the way in which confidential information is to be treated, the legal consequences of a violation of the confidentiality obligation, the persons subject to the confidentiality obligation, the treatment of documents in the event of a violation of the agreement, the duration of the confidentiality agreement, as well as possible contractual penalties.

10.1.2.3 Letter of intent

Letters of intent (LOI) are instruments frequently employed in Anglo-American law that have also become common in German business life. In general terms, they serve to express an intention to reach a particular result in the course of the negotiations. A letter of intent usually outlines the negotiation positions of the parties, records the results of the negotiations made to date, and fixes a schedule for future negotiations.

Whereas a LOI is generally not intended to have binding legal consequences, state-ments made in the LOI or the LOI as such may been seen as a binding legal agreement under certain conditions. It is therefore advisable for the parties to stipulate whether statements made in the LOI have binding effect or not.

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10.1.2.4 Due diligence

10.1.2.4.1 Significance and purpose in Germany

Any acquisition of a business entity should be preceded by an analysis of the target. The scope of this analysis will vary depending on the circumstances. As part of the due diligence process, the target entity will be closely examined by the prospective buyer. The examination may cover all areas of the target entity, especially its legal, financial and tax circumstances, as well as its strategic and technological position.

The vendor will often provide the prospective buyer with information on the target entity that has been systematically prepared and is made available for review in an examination room (data room). Before being given access to the data room, the pro-spective purchaser will usually have to agree to abide by specific data room rules, especially with respect to confidentiality.

The results of the due diligence process will normally be documented in a due dili-gence report. The findings of the due diligence process are important for the drafting of the purchase contract, in particular with respect to the seller’s warranties.

10.1.2.4.2 Legal consequences

Liability for defects may be precluded if the purchaser was aware of the defect in the object or right acquired when the agreement was concluded (§ 442 (1) BGB). As a con-sequence, the protection afforded by general statutory provisions may become less effective where a due diligence process has been carried out and defects have been identified in the course of that process. However, it is possible to waive the application of § 442 BGB, so that the purchaser is entitled to statutory protection even if it has knowledge of defects in the object being purchased.

10.1.2.5 Sale and purchase agreement

10.1.2.5.1 Contents of the purchase agreement

Since a business enterprise does not constitute an object as such, under an asset deal all assets and liabilities pertaining to the business have to be transferred individually. The purchase contract must therefore in principle list all components of the business enterprise to be transferred to the buyer, for which purpose reference is often made to inventories or balance sheets. A “catch-all” clause may also be inserted into the agree-ment, under which all assets and liabilities pertaining to a specific business are to be transferred.


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A share deal, which is a mere acquisition of rights, requires only an exact identification of the shares to be transferred. However, a share purchase agreement will often have a complexity comparable to that of an asset purchase agreement, in particular because of the warranties granted.

10.1.2.5.2 Statutory warranties

The acquisition of a business entity is subject to the provisions on sales contained in the German Civil Code (Bürgerliches Gesetzbuch – BGB). For an asset deal, the provi-sions governing the sale of objects (§§ 433 ff.) apply, under which a vendor is in prin-ciple liable for any material defect in the thing being sold. In case of a sale of a busi-ness enterprise, a defect is assumed if the defect pertains to the enterprise as such (and not merely to an individual asset). In contrast, a share deal is regarded as a transfer of rights (§ 453), under which the seller is in principle responsible only for the existence of the rights as such (and not for the economic value of the enterprise embodied in the shares). However, the acquisition of all or almost all of the shares in an enterprise may be treated as an acquisition of objects and thus of the enterprise itself. As a result the liability provisions for the sale of objects apply.

When the business entity acquired is not free of defects, the purchaser has a variety of remedies. He may demand subsequent performance (Nacherfüllung), which implies the elimination of defects of the object supplied. He may further (alternatively) either rescind the agreement, reduce the purchase price, or claim damages or reimbursement of expenses.

10.1.2.5.3 Contractual warranty clauses

In practice, German statutory liability regulations are often not considered to give the purchaser adequate protection and are therefore replaced by special contractual war-ranty clauses (representations and warranties) which take into account the specific interests of both parties.

Technically, such warranty clauses are often agreed on as independent warranty agree-ments that do not form part of the purchase contract as such. Thus, the vendor assumes, as a separate legal obligation, a guarantee for certain qualities of the object of sale which are of importance to the buyer. The warranty clause will also deal with the legal consequences in case of breach of warranty, such as subsequent performance and com-pensation payments by the seller. In view of the fact that the business entity will be constantly changing in the course of operations, the right to rescind the contract will only be agreed in exceptional cases.

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10.1.2.6 Completion

In practice, a certain period of time will elapse between the signing and the comple-tion of the sale and purchase agreement, i. e. the date at which the rights and obliga-tions attached to the business entity pass from the vendor to the purchaser (also referred to as closing or transfer date). The contract may require a number of transactions to be carried out during this period, such as obtaining the necessary antitrust approval for the acquisition, passing shareholder resolutions, spinning off certain business entities, or implementing IT solutions.

10.1.3 Antitrust law

In the European Union, antitrust rules exist at the level of both the European Union and the member states. Under Regulation No. 4064/89 of the European Council dated December 21, 1989 (Merger Control Regulation), all mergers in the European Union exceeding a certain threshold must be referred for approval to the European level. Merger control regulations are also in place at a national level, such as the German Act Against Restraints on Competition (Gesetz gegen Wettbewerbsbeschränkungen – GWB).

Where European merger control regulations do not apply, a merger of business entities may be subject to German merger control procedures pursuant to § 35 and § 37 GWB. Under § 35 (1) GWB, this is assumed to be the case when the combined world-wide turnover of the parties involved is more than € 500 million and at least one of the par-ties has generated domestic turnover of more than € 25 million during the financial year preceding the merger. The combined turnover is computed using a group approach, which extends to the turnover of all controlling or controlled entities of the parties involved. German merger control procedures are not triggered, however, even if the above-mentioned thresholds are exceeded, if the planned merger does not fall within the definition of § 130 para. 2 GWB, if the requirements of the de minimis clause are met, or if the planned merger only affects an insignificant market.

Under § 37 (1) no. 1– 4 GWB, transactions that involve acquiring assets, obtaining a controlling position, acquiring shares, or establishing a joint venture are subject to merger control procedures when the above-mentioned criteria are met. As far as obtaining a controlling position is concerned, the power to control an entity is not restricted to relationships under corporate law. The power to control may also be con-ferred by way of rights, agreements, and other measures which – together or individu-ally – allow a party to exercise a controlling influence over the business activities of the target company, taking into account the substance and legal consequences of the transaction.


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Any planned merger must be reported to the German Federal Cartel Office (Bundes-kartellamt) before the sale and purchase agreement is implemented. The parties may not complete the merger until the German Federal Cartel Office has issued its approval. De facto measures may also be considered as acts of completion. The German Federal Cartel Office may prohibit completion (Untersagung des Vollzugs), thus barring all measures relating to the completion of the merger. Legal transactions of the parties in contravention of the prohibition of completion are null and void.

Failure to comply with the notification requirement and actions in contravention of a prohibition of completion are administrative offences (Ordnungswidrigkeiten) and subject to penalties.

10.2 Tax considerations for acquisitions

In general a seller’s primary interest is to minimize the tax on the capital gain realized upon a sale or to generate a tax-exempt gain. As the preferential treatment of capital gains only applies to capital gains on the sale of shares in corporations, the seller will generally prefer a share deal over an asset deal.

By contrast, the purchaser will seek to structure the acquisition so as to maximize depreciation and amortization of the purchase price for tax purposes, which is not pos-sible when only shares are acquired.

In general, the tax structuring considerations of the parties center around the following criteria:

Treatment of capital gains resulting from the sale

Depreciation/amortization of acquisition cost

Deductibility of refinancing expenses

Use of tax loss carryforwards of the acquired entity.

10.2.1 Asset deal

Where an acquisition is carried out by way of an asset deal, the book values of the assets transferred are stepped up to acquisition cost in the hands of the purchaser. The seller realizes a capital gain equivalent to the difference between the purchase price and the tax basis of the assets. The obvious advantage of an asset deal is that the pur-chaser may select the assets he wants to acquire. It should be noted, however, that lia-bilities resulting from employment contracts may be transferred to the purchaser by operation of law where the assets transferred qualify as a business (Betrieb) or an inde-

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pendent part of a business (Betriebsteil, see § 613a German Civil Code, Bürgerliches Gesetzbuch – BGB). Liabilities of the seller may also be transferred to the buyer by operation of law if the business is carried on under the former firm name (§ 25 German Commercial Code, Handelsgesetzbuch – HGB), although such liability may be avoided by a disclaimer that must be entered in the commercial register. Furthermore, there may be liability for certain tax obligations (§ 75 Tax Procedure Law, Abgabenordnung – AO), which may not be disclaimed.

The parties should agree on an allocation of the purchase price to the assets and liabil-ities acquired. Such allocation does not bind the tax authorities, but does provide a useful starting point. Non-competition agreements entered into in the context of an asset deal are generally treated as a part of the goodwill transferred and do not consti-tute separate assets.

Tangible and intangible assets are transferred to the tax accounts of the purchaser at acquisition cost. Any excess amount is capitalized as goodwill, which is amortized for tax purposes over a period of 15 years. Depreciable assets are depreciated over their useful lives (based on the official tax depreciation tables). Land and participations in other companies are not subject to scheduled depreciation.

Step-up structures involving an internal asset deal (i. e. where the business of an acquired corporation is sold within the group by way of an asset deal) may generate tax benefits where the seller corporation has tax loss carryforwards, in particular where such loss carryforwards may be forfeited in the future (see chapter 10.2.5.). The seller will have to recognize hidden reserves, which are fully taxable for corporate income and trade tax purposes and may be offset against tax loss carryforwards. How-ever, due to the implementation of minimum taxation rules in Germany as of January 1, 2004, such transfers may still result in a tax burden, which has to be weighed against the future tax savings resulting from the step-up received on the assets.

10.2.2 Acquisition of shares in a corporation

In the case of share deals, the book values of the assets and liabilities at the level of the target company remain unchanged. In the past, share deals were often followed by a conversion of the acquired corporation into a partnership (so-called “conversion model”), which allowed the purchaser to transform the purchase price into (tax-deduct-ible) depreciable assets and goodwill. However, the 2000 tax reform abolished the conversion model. Thus, the options of stepping up the depreciable asset base by way of a post-acquisition change in entity structure are very limited under current tax law.

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10.2.3 Acquisition of a partnership interest

The acquisition of a partnership interest is, for tax purposes, treated as a pro-rata acquisition of the partnership’s assets. Accordingly, the purchaser steps up the tax basis of the assets of the partnership to the level of its own acquisition cost. Techni-cally, this step-up is carried out at the level of the partnership by way of supplementary balance sheets (Ergänzungsbilanzen). Any portion of the purchase price that cannot be attributed to acquired assets (including self-generated intangibles such as patents or know-how not previously recognized in the partnership balance sheet) forms part of goodwill, which is amortized over 15 years for tax purposes.

10.2.4 Funding an acquisition

A purchaser may fund the acquisition by means of debt or equity. If financed by debt, the buyer wants to ensure that the interest expenses incurred to fund the acquisition may be offset against the target’s future profits in order to reduce the German effective tax rate.

10.2.4.1 Acquisition of a corporation

10.2.4.1.1 Acquisition by a corporation

Since 2004, dividends distributed by a corporation to another corporation are in prin-ciple tax exempt. However, 5% of the dividend income is deemed to constitute non-deductible business expense directly related to the tax-exempt income, in effect reduc-ing the tax exempt portion of the dividend to 95 %. In return, expenses actually incurred related to the income (such as interest expenses) are fully deductible.

The most common techniques to enable a full offset of interest expenses against posi-tive income are:

Tax group (Organschaft) A common way to achieve deductibility of business expenses incurred for the acquisition of a company is to establish a tax group (Organschaft) between the target and the acquiring corporation. In this way, the target company’s positive income may be offset against any negative income at the level of the parent com-pany. The main downside of a tax group is that pre-existing tax loss carryforwards for corporate income and trade tax purposes at the level of the controlled company may not be used for the duration of the tax group (“frozen” loss carry forwards). Furthermore, rules relating to the avoidance of double consideration of losses may apply. Under these rules, tax losses of a controlling corporation are ignored for

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German tax purposes to the extent to which they have already been taken into account in the course of a taxation under a foreign jurisdiction.

Debt pushed down into the subsidiary Another strategy to offset interest expenses against positive income of the target company is to push down the debt incurred into the acquired company itself. This is typically done by a downstream merger of the acquiring company into the target corporation.

10.2.4.1.2 Acquisition by an individual

Since 2004, dividends distributed by a corporation to an individual have been 50 % (2009: 40 %) tax-exempt. Expenses related to the income taxed under the “half-income” (2009: “partial-income”) rule are only 50 % (2009: 60 %) tax deductible.

10.2.4.1.3 Thin capitalization rules

10.2.4.1.3.1 Through 2007

German thin capitalization rules must be considered where an acquisition is debt financed. Under the thin capitalization rules, loan interest paid by an entity to its sub-stantial shareholder (participation of more than 25 %) is deemed to be a constructive dividend where a debt-to-equity ratio of 1.5 to 1 is exceeded or the loan granted bears hybrid interest. Since the revision of the thin capitalization rules in 2004, they also apply to the financing of foreign corporations subject to non-resident tax liability in Germany.

The application of the thin capitalization rules to debt provided by third parties has been particularly controversial. According to the wording of the law, the rules extend to loans granted by third parties where the third party has recourse against the share-holder or a related party. However, the German Federal Ministry of Finance restricted the application of the provision so as to benefit the taxpayer. Under official guidance issued in 2005, the thin capitalization rules do not apply to third party financing if there is no back-to-back financing involving the shareholder or a related party. How-ever, the burden of proof lies with the taxpayer, who has to provide evidence that no detrimental security (such as security in form of interest-bearing funds) has been granted by the shareholder. The evidence may be provided by way of an attestation to be filled in by the third party entitled to the recourse. The German tax authorities have created a sample form for this purpose.

Special rules apply to debt-financed acquisitions of shares within a group. Where a corporation borrows funds for purposes of purchasing shares in another corporation,


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and both the seller of the shares and the lender are substantial shareholders of the financed corporation, any interest on the loan provided will be treated as a construc-tive dividend. The same applies if the seller and the lender are related parties of the shareholders, or are third parties with recourse against such parties. In such case, no safe haven is available and no arm’s length exception applies.

10.2.4.1.3.2 From 2008 onwards

Effective January 1, 2008, new earnings stripping rules replaced the previous thin capitalization rules. Unlike the thin capitalization rules, the new rules apply to all types of debt financing (shareholder and third party debt). They also apply to all legal entities, such as sole entrepreneurships, partnerships, corporations, and consolidated tax groups (Organschaft).

Under the new rules, net interest expense is deductible only up to a percentage of 30% of EBITDA for tax purposes. Interest expense is fully deductible to the extent positive interest income is available. Net interest expense is defined as interest expense less positive interest income. EBITDA for tax purposes is taxable income plus interest expense, less positive interest income, and less depreciation and amortization.

Interest expense may be carried forward where it is not deductible in a particular year.

By way of exception, interest is fully deductible in the following cases:

Net interest expense of the entity is less than € 1 m.

The entity does not form part of a controlled group (Konzern). An entity forms part of controlled group where it is or could be consolidated under IFRS, local GAAP of an EU member state, or U.S. GAAP. Where the entity in question is a corpora-tion, the exception for uncontrolled entities applies only if remuneration on share-holder debt accounts for no more than 10% of the net interest expense.

The entity is part of a controlled group, but proves that the equity ratio of the busi-ness in question is no more than 1 % less than that of the controlled group as a whole (equity ratio pursuant to IFRS, alternatively local GAAP of EU member state or U.S. GAAP). Equity ratio is the respective relation of equity to the balance sheet total. Where the entity in question is a corporation, this exception applies only if remuneration on shareholder debt accounts for no more than 10 % of the net interest expense. Shareholder debt for purposes of this provision only includes debt that is shown in the fully consolidated tax accounts of the relevant corporate group and involves recourse against a shareholder of the controlled group that is not itself

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part of the controlled group. In other words, interest payments on loans inside a consolidated group are not treated as detrimental shareholder financing for pur-poses of this provision.

Interest non-deductible under the earnings stripping provisions may be carried for-ward infinitely and may be used in future tax periods. In the event of termination or transfer of a business, the interest carryforward will be forfeited. Where the entity in question is a partnership, the interest carryforward is forfeited pro rata when a partner withdraws from the partnership.

A corporate tax group (Organschaft) is treated as a single business entity for purposes of the earnings stripping rules. The interest expense of the controlled entity and the controlling entity are aggregated. The de minimis threshold of € 1 m applies to the aggregate interest expense of both entities.

For further details on the German rules limiting interest deduction, please refer to chapter 6.2.1.4.

10.2.4.2 Acquisition of a partnership

Under the German system of partnership taxation, interest incurred on debt used to acquire an interest in a German partnership is tax deductible as special business expenses of the partner (Sonderbetriebsausgaben) at the level of the partnership itself rather than at the level of the acquisition vehicle.

If the acquisition vehicle is a foreign entity, it may be possible to deduct the interest expense both in Germany and in the foreign jurisdiction (double dip). However, it should be noted that the foreign acquisition vehicle may be subject to German thin capitalization rules. Further restrictions may apply where a tax group (Organschaft) is in place. Under the German dual consolidated loss rules, tax losses of the controlling corporation may not be used in Germany to the extent the losses have already been used under foreign tax law in the course of the taxation of the company.

10.2.5 Utilization of pre-acquisition tax losses

Tax losses may be carried forward for trade tax and corporation / income tax purposes. However, since 2004 the offset of losses against future profits has been substantially restricted. Complete offset of losses generated by a company against future profits is only possible with respect to a base amount of € 1 million. Loss carryforwards in excess of this amount may be offset against the profits of the current or future periods only up to 60 % of the income of the respective assessment period. Tax losses may also be carried backwards to the previous tax year, up to a maximum of € 511,500.


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In addition, the utilization of pre-acquisition losses is subject to further restrictions.

10.2.5.1 Acquisition of a partnership interest

Where a partnership interest has been (directly) acquired, trade tax loss carryforwards are forfeited in proportion to the partnership interest transferred. However, such forfei-ture may be avoided by indirect acquisition of the partnership interest.

Loss carryforwards for income tax purposes may not be used since the partnership is regarded as transparent for taxation purposes and loss carryforwards are directly attributed to the partners.

10.2.5.2 Acquisition of corporations

Loss limitation rules may bar the use of losses of a corporation acquired (change-of-control rules).

Until 2008, pre-acquisition losses were forfeited if a corporation’s economic identity changed. A change of economic identity was presumed if more than 50 % of the shares in the corporation were transferred and the corporation resumed or continued its trade or business with predominantly new assets. These rules continue to apply where more than 50 % of the shares in a corporation are transferred within a five-year period begin-ning prior to 1 January 2008 and predominantly new business assets are injected prior to 1 January 2013.

New statutory rules have considerably tightened the requirements for the use of pre-acquisition losses. Under the new rules in force from 2008 onwards, a direct or indirect transfer of more than 25 % of a corporation’s shares or voting rights within a five year period triggers a pro rata forfeiture of existing loss carryforwards. Loss carryforwards are forfeited in their entirety where more than 50 % of the shares or voting rights are transferred. The rules also apply where shares are transferred to a group of purchasers with convergent interests.

10.3 Legal aspects of reorganizations

10.3.1 Introduction

The reorganization and restructuring of business entities in Germany is governed prin-cipally by the German Reorganization Act (Umwandlungsgesetz – UmwG), which pro-vides a cohesive set of rules that enable German business entities to change their legal structure efficiently to suit their needs in a changing economic environment.

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The law’s main benefit is that it permits the process of reorganization to take place by way of universal succession (Gesamtrechtsnachfolge), and thus avoids an individual transfer of assets from entity to entity. It also aims at safeguarding the rights of share-holders (in particular minority shareholders) by mechanisms of information and approval. The law also seeks to protect legitimate interests of creditors of an entity.

The scope of the Reorganization Act has so far been limited to reorganizations of domestic entities. However, recent developments on the European level have put pres-sure on European member states to open their regimes on corporate reorganizations to other EU resident entities. These developments include the adoption of the EU direc-tive on cross-border mergers (2005/56/EU) that grants corporations resident in one EU member state the right to participate in a merger with another EU resident entity, and the decision of the European Court of Justice in the SEVIC case (C-411/03), in which the court held that mergers between corporate entities are protected by the freedom of establishment (Art. 43 of the EC Treaty).

To comply with the requirements set by European Cross-Border Merger Directive, Germany enacted legislation in 2006 that permits German corporations to take part in cross-border mergers within the European Union. Cross-border mergers are permissi-ble for corporations that have been (i) formed in accordance with the laws of a member state and (ii) have their statutory seat or headquarters in an EU member state. The rules applicable to domestic mergers apply mutatis mutandis, unless otherwise expli-citly provided for in the law. In any case, a cross-border merger has to satisfy the requirements of the legal systems of both member states involved.

However, it is unclear whether the new rules enacted fully satisfy the requirements of the European fundamental freedoms as interpreted in the SEVIC decision. The new rules cover only cross-border mergers of corporations, not mergers of other legal enti-ties (such as partnerships). Furthermore, the rules relate only to mergers (Verschmel-zungen), which is just one type of corporate reorganization. They do not cover other types of corporate reorganizations such as spin-offs (Abspaltungen) or split-ups (Auf-spaltungen). Given the broad language employed by the ECJ in its SEVIC decision, there is ample reason to believe that the rules on cross-border mergers should include all legal entities and all types of business reorganizations.

In addition to the internationalization of the national reorganization regimes triggered by these developments, the EU itself has adopted an EU regulation creating the Soci-etas Europea (SE) as a truly supranational business association (Regulation of October 8, 2001, 2157/2001/EC). An SE can be established by two or more stock corporations from at least two different EU member states and may operate throughout the EU on the basis of a single set of rules and a unified management and reporting system.

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10.3.2 Reorganizations under the German Reorganization Act

The German Reorganization Act provides for four different forms of reorganizations:

Merger (Verschmelzung)

Division (Spaltung)

Transfer of assets (Vermögensübertragung)

Change of legal form (Formwechsel)

For these forms of transformations, the Reorganization Act provides a cohesive set of rules, the variation of which is possible only where explicitly permitted by law. Trans-fers of assets (Vermögensübertragung) apply only to reorganizations involving a pub-lic entity, and are therefore not further discussed.

10.3.2.1 Merger

10.3.2.1.1 Types of mergers

A merger is a transaction by which the entire assets and liabilities of a transferring entity (übertragender Rechtsträger) are transferred by operation of law to an absorb-ing entity (übernehmender Rechtsträger) without liquidation. The transferring entity ceases to exist.

With regard to the absorbing entity, a merger may be carried out in two different ways: It may either be carried out as a merger by absorption (Verschmelzung durch Auf-nahme), where the transferring entity is merged into a pre-existing entity. Alterna-tively, the absorbing entity may only come into existence by the merger transaction itself (Verschmelzung zur Neugründung), where two or more transferring entities are involved in the merger.

In either case, the shareholders of the transferring entity receive shares of equal value in the absorbing entity in exchange for their cancelled interest in the transferring entity. The shares received may be shares the absorbing entity holds in itself, or may result from an increase of its share capital (issuance of new shares). However, the share capi-tal of the absorbing entity may not be increased to the extent it holds shares in the transferring entity. Thus, no new shares are issued where the absorbing entity owns 100 % of the shares in the transferring company (upstream merger).

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10.3.2.1.2 Legal entities subject to merger

The provisions of the German Reorganization Act apply to partnerships (OHGs, KGs, and GmbH & Co. KGs), corporations (GmbHs, AGs, and KGaAs), registered coopera-tives (eingetragene Genossenschaften), registered associations (eingetragene Vereine) under § 21 German Civil Code (Bürgerliches Gesetzbuch – BGB), cooperative audit-ing associations (genossenschaftliche Prüfungsverbände), and mutual insurance com-panies (Versicherungsvereine auf Gegenseitigkeit). Each of these entities may either serve as a transferring or an absorbing entity. Economic associations (wirtschaftliche Vereine) within the meaning of § 22 BGB may only participate in a merger as a trans-ferring entity.

10.3.2.1.3 The merger process

The principal steps of a merger process are as follows:

A merger agreement is concluded between the entities involved. The agreement is exe-cuted by the relevant representative bodies of the entities in notarized form. The agree-ment must contain, among other things, specific information on the share exchange ratio and the amount of additional cash contributions.

The draft merger agreement is forwarded to the works councils (Betriebsrat) (if any) of the entities involved no later than one month prior to the relevant shareholder meet-ings of each of the entities. The shareholders must approve the merger agreement by resolution.

A merger report (Verschmelzungsbericht) is prepared by the representative bodies of the entities involved in the merger. Its objective is to provide the shareholders with suf-ficient information to make a well-informed decision with regard to the merger. The report must set out the legal and economic reasons for the contemplated merger, describe the specific provisions of the merger agreement, and explain the reasons for the share exchange ratio and any cash compensation. The requirement of a merger report may be waived by unanimous resolution of the shareholders of the entities involved or where a wholly owned subsidiary is being merged into its parent entity.

The merger agreement is examined by one or more external auditors, who are required to submit a report as to the adequacy of the proposed share exchange ratio and cash compensation offered. This requirement may be waived under the same conditions as the draft of a merger report.

To approve the merger, the interest holders of the merging entities pass a merger reso-lution to be recorded by a public notary.


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The merger must be registered in the commercial register. A final balance sheet (Schlussbilanz) of the transferring entity must be submitted together with the registra-tion documents. The merger is legally effective only after registration with the com-mercial register.

10.3.2.1.4 Preparation of balance sheet at date of merger

The transferring entity has to prepare a final balance sheet according to German GAAP as of the merger date. This balance sheet must be filed with the commercial register together with the application documents. The period between the merger date and the date of application for registration with the commercial register must not exceed eight months.

Opening accounts are prepared if two entities are merged into a newly created entity (Verschmelzung zur Neugründung). Opening accounts are not required if an entity is merged into a pre-existing entity (Verschmelzung zur Aufnahme).

10.3.2.2 Division

10.3.2.2.1 Types of divisions

A division is often referred to as a “de-merger”, as it is a transaction inverse to a merger. Whereas a merger brings two entities together into a single entity, a division separates one entity into two (or more) entities. The German Reorganization Act provides for three types of business divisions, namely a split-up (Aufspaltung), a spin-off (Abspal-tung), and a drop-down (Ausgliederung).

A split-up (Aufspaltung) is a transfer of the assets and liabilities of a transferring entity to two or more absorbing entities by way of universal succession, whereby the transfer-ring entity ceases to exist. The assets and liabilities may be transferred to pre-existing entities (Aufspaltung zur Aufnahme), or may be transferred to entities newly created by the split-up itself (Aufspaltung zur Neugründung). The interest holders of the transfer-ring entity are granted interests in the absorbing entities in exchange for their interest in the transferring entity.

In contrast, under a spin-off (Abspaltung) the transferring entity does not transfer its entire assets and liabilities to the absorbing entity, and therefore does not cease to exist as such. The assets and liabilities may be transferred to pre-existing entities (Abspal-tung zur Aufnahme) or to entities newly created by the spin-off itself (Abspaltung zur Neugründung). The assets and liabilities not transferred remain with the transferring entity. Again, the interest holders of the transferring entity are granted interests in the absorbing entities in exchange for their interest in the transferring entity.

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The difference between a spin-off and a drop-down (Ausgliederung) is that in a drop-down the interest in the absorbing entity is not granted to the interest holders in the transferring entity, but to the transferring entity itself. The transferring entity does not cease to exist. The assets and liabilities may be transferred to a pre-existing entity (Ausgliederung zur Aufnahme) or to an entity formed by the drop-down itself (Aus-gliederung zur Neugründung). In the latter case, a parent-subsidiary relationship is established.

10.3.2.2.2 Legal entities subject to division

All of the entities enumerated in 10.3.2.1.2 above (legal entities subject to merger) can also be divided. Stock corporations (Aktiengesellschaften – AGs) and limited partner-ships with share capital (Kommanditgesellschaften auf Aktien – KGaAs) may not be divided unless they have been registered in the commercial register for a period of at least two years.

10.3.2.2.3 The division process

The above comments on the merger process (under 10.3.2.1.3) apply analogously to the division process, although some differences should be noted. Since a division involves the allocation of assets and liabilities between different entities, the assets and liabili-ties to be transferred to the respective entities have to be specified by the division agreement (Spaltungsvertrag). If the assets and liabilities are transferred to an entity established by virtue of the division itself, a division plan (Spaltungsplan) has to be set up by the representative body of the transferring entity.

10.3.2.2.4 Preparation of a balance sheet at the date of the division

The transferring entity has to prepare final accounts according to German GAAP as of the division date. The final accounts have to be filed with the commercial register together with the application documents. The period between the division date and the date of application for registration with the commercial register must not exceed eight months.

Opening accounts have to be prepared if an entity is divided into two newly created entities. Opening accounts are not required if an entity is divided and assets and liabil-ities are transferred to an already existing entity.


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10.3.2.3 Change of legal form

10.3.2.3.1 Definition

A change of legal form involves the conversion of an entity into a different type of business association. The identity of the entity as such remains unchanged. The change of legal form does not involve a transfer of assets and liabilities. After the change of legal form, the provisions relevant to the new legal form apply to the entity as such and to its interest holders.

10.3.2.3.2 Legal entities subject to conversion

Entities may change their legal form to that of a civil law partnership (Gesellschaft bürgerlichen Rechts), a commercial partnership (Personengesellschaft), a non-com-mercial partnership (Partnerschaftsgesellschaft), a corporation or a registered coop-erative (eingetragene Genossenschaft).

10.3.2.3.3 The conversion process

The representative body of the entity changing its legal form has to prepare a conver-sion report (Umwandlungsbericht), which serves to provide information on the change of legal form to the shareholder. The report has to describe the change of legal form and the shareholders’ interest in the new entity with regard to legal and economic aspects. The report has to be supplemented by a list of all assets and liabilities pre-sented with their fair market values (and not with their accounting values).

The interest holders of the entity have to approve the change of legal form by resolu-tion adopted at a meeting of interest holders. The resolution must be certified by a public notary. A draft of the resolution must be submitted to the entity’s works council (if any) no later than one month prior to the meeting of interest holders.

The change of form of the legal entity must be entered in the commercial register. Only after registration with the commercial register does the the change of legal form have legal effect.

10.3.3 European Company (SE)

The regulation on the Statute on the European company (Societas Europea – SE) entered into force on October 8, 2004 and provides a legal framework for the SE as a supranational legal entity. The SE is in particular designed for companies having busi-ness operations in different member states. Furthermore, it facilitates cross-border mergers and permits the transfer of the company’s registered office.

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The SE is a limited liability company with a minimum share capital of € 120,000 and separate legal existence. The SE has to be incorporated in one of the member states, so that one may speak of a “French” SE or a “German” SE, depending on the place of incorporation. The SE Regulation does not constitute a comprehensive framework covering all matters of corporate law, but leaves a wide range of subjects to be addressed by national law. In as much, the SE is governed by different layers of law, including the SE Regulation, SE-specific national legislation, national legislation pertaining to all public limited liability companies, and the SE charter.

It is furthermore possible to transfer the registered office of an SE from one member state to another. Under national law, such “migration” of a corporate entity is often regarded as an event of dissolution from the perspective of the country of emigration. By contrast, an SE is free to transfer its registered office to another member state. However, the registered office and the place of management must always be located in the same member state.

With regard to corporate governance, an SE is free to choose the so called dual system (or “two-tier” system) followed in Germany (and various other European countries) or the monistic system (or “one-tier” system) followed in Anglo-Saxon countries. Under the two-tier system, the company has a management board (Vorstand) responsible for the day-to-day management of the company and a supervisory board (Aufsichtsrat), responsible for the supervision of the management board. By contrast, under the monistic system, the company only has a board of directors as a single administrative body. The board of directors consists of managing and non-managing directors, who are responsible for both managing and supervising the company’s activities.

Worker’s codetermination in the context of the formation of an SE is governed by a separate directive (Council Directive 2001/86/EC), the intention of which is to ensure that the codetermination rights of the labor force of the SE are not weaker than those applying to the companies participating in the formation of the SE. The law provides for negotiations between the SE’s governing bodies and a special employee negotiating committee to agree on the terms of co-determination within the SE.

An SE may be established only in a limited number of ways: by merger, as a holding SE, as a subsidiary SE, and by conversion of an existing public company into an SE. In all cases, a transnational element is required.

10.3.3.1 SEs by merger

The formation of a SE by merger requires two or more corporations, at least two of which are governed by the laws of different EU member states. As under the German


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Reorganization Act, this may be accomplished by a merger of one participating corpo-ration into the other or by the merger of both corporations into a corporation estab-lished by virtue of the merger. The management and administrative bodies of the cor-porations involved have to draw up draft terms of the merger and a merger report. The merger report is reviewed by the merger auditors. The merger plans must be disclosed and filed with the commercial register. The employees’ representative bodies have to be informed and given the opportunity to form a special negotiating committee. After the general meeting of shareholders has approved of the merger plans and the creditors have been provided with any necessary security, the SE may apply for registration with the commercial register. Upon registration, the merger takes effect and the SE acquires legal status.

10.3.3.2 Holding SEs

In the formation of a holding SE, the shareholders of the participating corporations contribute their shares in these corporations to the newly formed holding SE. Private limited liability companies (such as GmbHs) as well as stock corporations may act as participating companies. At least two of the participating entities have to be governed by the laws of different member states or must have had for at least two years a subsid-iary company governed by the law of another member state or a branch situated in another member state.

The representative bodies of the companies must draw up draft terms of incorporation of the holding SE. These must, among other things, fix the minimum proportion of the shares in each of the participating companies to be contributed into the SE.

The draft terms of formation must then be disclosed and examined by independent experts. Finally, the general meeting of shareholders of each company promoting the operation has to approve the draft terms of formation of the holding SE.

10.3.3.3 Subsidiary SEs

Two or more companies may form a subsidiary SE, provided at least two of them are governed by the law of different member states, or have for at least two years had a subsidiary company governed by the law of another member state or a branch situated in another member state. All companies within the meaning of Article 48 of the EC Treaty and other legal bodies governed by private law may participate in the formation of a subsidiary SE. The formation of a subsidiary SE is accomplished by the subscrip-tion of the shares in the subsidiary SE. If the subsidiary SE has its registered office in Germany, this process is governed by §§ 23 ff. Stock Corporation Act (Aktiengesetz – AktG).

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10.3.3.4 SE by conversion

A stock corporation may be converted into an SE if it for at least two years has had a subsidiary company governed by the law of another member state. The conversion is accomplished without changing the entity’s legal identity and involves neither the dis-solution of the old corporation nor the formation of a new legal entity. Draft terms of conversion and a conversion report have to be prepared. After approval of the conver-sion by the general meeting of shareholders, the application for the conversion is filed with the commercial register. The conversion is legally effective upon entry in the commercial register.

10.4 Tax issues arising from corporate restructuring

The German Reorganization Tax Act (Umwandlungssteuergesetz – UmwStG) was recently amended to cover cross-border reorganizations (Gesetz über steuerliche Begleitmaßnahmen zur Einführung der Europäischen Gesellschaft und zur Änderung weiterer steuerlicher Vorschriften – SEStEG). The amendments were made in the con-text of recent developments in primary and secondary European law which have led to a certain opening of the corporate regimes of the European member states to foreign entities (see above 10.3.1.).

Under the new rules, non-recognition treatment has been extended to cross-border mergers involving EU or European Economic Area (EEA) entities. Whereas reorgani-zations in principle are carried out at fair market value, a tax-neutral transfer of assets and liabilities at book value (or any intermediate value) is now possible provided Ger-many’s right of taxation with respect to the assets transferred is not restricted. On the other hand, taxpayers not wishing to reorganize at book value may also do so at fair market value. The transferring entity is no longer bound to German generally accepted accounting principles in its closing accounts, which strictly prescribe accounting at acquisition cost. Thus, a reorganization profit may be generated at the level of the transferring entity, which can – within the limits of the minimum taxation rules – be offset against a potential tax loss carryforward.

The rules governing corporate contributions were also revised in connection with the corporate reorganization amendments. Contributions may be made to or by an entity resident in another EU/EEA state without recognition of capital gain. Furthermore, the regime on “tainted shares” has been fundamentally redesigned.

The tax consequences of a specific reorganization depend both on the general princi-ples applying to all reorganizations and on those applying to the legal form of the enti-ties involved. In principle, a corporate reorganization may have tax consequences at

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the level of all entities involved in the reorganization, such as the transferring entity, the absorbing entity, and the shareholders.

10.4.1 Mergers and contributions

10.4.1.1 Mergers of corporations

A corporate merger is, in principle, carried out at fair market value. On application, a tax-neutral transfer at book value or at any value intermediate between fair market value and book value is possible where Germany’s right to tax any built-in gains of the assets transferred is preserved and no cash consideration is granted. A reorganization gain resulting from a value above acquisition cost in the closing tax accounts is fully subject to corporate income tax and trade tax on income (unless an offset against exist-ing tax loss carryforwards is available).

The closing accounts have to be prepared by the transferring corporation with effect as of the transfer date of the reorganization for taxation purposes (steuerlicher Übertra-gungsstichtag), which precedes the transfer date for corporate law purposes (Umwand-lungsstichtag). The transfer date may be set at up to eight months prior to the filing of the merger in the commercial register. The income earned by the transferring corpora-tion between the transfer date for tax purposes and the registration of the reorganiza-tion with the commercial register is attributed to the absorbing corporation with retro-active effect.

The absorbing corporation takes the assets and liabilities of the transferring corpora-tion at the unchanged book values as shown in the closing accounts of the transferring corporation. Profits arising from the merger at the level of the absorbing corporation are in principle tax exempt under the general participation exemption. Loss carryfor-wards at the level of the transferring corporations are not transferred to the absorbing corporation.

The absorbing corporation steps into the legal position of the transferring corporation, in particular with regard to the book values of the assets transferred, depreciation, and untaxed reserves. Corporate income tax credits, untaxed reserves, and the contribution account for tax purposes of the transferring corporation are added to the respective amounts of the absorbing corporation.

By the merger, the shareholders of the transferring corporation are deemed to have sold their shares in the transferring corporation and to have acquired the newly issued shares of the absorbing corporation at fair market value. If Germany is entitled to tax capital gains on the sale of the shares in the absorbing corporation, the transaction is deemed to be carried out at book value.

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10.4.1.2 Merger of a corporation into a partnership

A merger of a corporation into a partnership is, in principle, carried out at fair market value. On application, a tax-neutral transfer at book value or any value intermediate between fair market value and book value is possible where Germany’s right to tax any built-in gains of the assets transferred is preserved and no cash consideration is granted. The corporate income tax liability of the transferring corporation for the assessment period of the merger is increased or decreased by the tax refund which would result from a full distribution of the corporation’s reserves on the transfer date (notional dis-tribution for tax purposes).

At the level of the absorbing entity, a reorganization result (profit or loss) arises in the amount the difference amount between the value of the absorbed assets in the closing tax accounts of the transferring corporation and the tax book value of the shares in the transforming corporation. The reorganization result is established separately for each member of the partnership (being either a corporation or an individual). A reorganiza-tion profit is in principle tax-exempt to the extent the reorganization result is attributed to a corporation as a partner, except for 5 % of the reorganization profit, which is treated as non-deductible business expense. The reorganization profit is 50 % tax exempt to the extent that the reorganization result is attributed to an individual. A reorganization loss is not tax deductible for corporate partners and 50 % tax deductible for individuals (subject to certain limitations).

The new rules provide for a “split” computation of the reorganization result at the level of the absorbing entity. Open reserves existing at the transferring corporation no lon-ger form part of the reorganization result and are instead treated as deemed dividends distributed to the shareholders; they are thus subject to German withholding tax. This is of particular relevance for non-German resident shareholders, who are subject to German taxation by way of withholding at source (unless the shares are held in a Ger-man permanent establishment), and for whom withholding tax is definitive.

The absorbing entity steps into the legal position of the transferring corporation, in particular with regard to the book values of the assets transferred, depreciation, and untaxed reserves. As for the merger among corporations, an existing loss carryforward of the transferring corporation may not be carried over to the partnership or its part-ners.

10.4.1.3 Contributions to corporations

Unlike mergers, which generally involve the disappearance of the transferring entity and the grant of shares in the absorbing entity to the shareholders of the disappearing


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entity, contributions are transactions in which the transferor takes shares in the absorb-ing entity in exchange for the contribution.

10.4.1.3.1 Contribution of assets

Contributions of business assets (entire businesses, branches of activity, and interests in trading partnerships) to a corporation must in principle be made at fair market value. The contributing entity transfers and the absorbing entity takes the assets at fair mar-ket value. A contribution gain is triggered at the level of the contributing entity.

However, a contribution may be accomplished on a non-recognition basis where the assets are contributed to an EU/EEA resident entity, Germany’s right of taxation with respect to the assets is not restricted, and the assets have a positive accounting value for tax purposes. The absorbing corporation may grant consideration other than shares (boot) up to the book value of the assets contributed without jeopardizing the tax-neu-trality of the contribution. Non-recognition treatment is therefore available for domes-tic as well as cross-border contributions. However, non-recognition treatment is not extended to entities not resident in the EU/EEA. An exception exists for contributions by which Germany’s right of taxation with respect to the granted shares is not restricted (this applies above all where the granted shares are held in a German permanent estab-lishment).

Capital gains resulting from a disposal of shares taken in return for a tax-neutral con-tribution of assets (“tainted shares”) are not fully tax exempt where the shares are sold within a period of seven years after the contribution. Formerly, capital gains resulting from the sale of tainted shares were fully taxable. Under the new rules (established by the SEStEG), the unrealized gains existing at the time of the contribution and those built up between the contribution and the share disposal are treated differently. Full taxation pertains only to the unrealized gains existent at the time of the contribution, whereas those built up after the disposal qualify for the capital gains exemption. Fur-thermore, the taxable portion of the unrealized gains declines pro rata temporis over a period of seven years. To the extent that a capital gain from a share disposal within the seven year period is fully taxable, the absorbing corporation can step up the basis of the assets contributed.

10.4.1.3.2 Contribution of shares (share-for-share exchange)

Contributions of shares to a corporation must in principle be made at fair market value. The contributing entity transfers and the absorbing entity takes the shares at fair mar-ket value. A contribution gain is triggered at the level of the contributing entity.

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However, a contribution may be accomplished on a non-recognition basis if the contri-bution causes the absorbing corporation to acquire a majority of the voting rights in the corporation whose shares are transferred (qualified share-for-share exchange). The absorbing corporation may grant consideration other than shares (boot) up to the book value of the assets contributed without jeopardizing the tax-neutrality of the contribu-tion.

Under current law, a contribution gain is triggered at the level of the contributing entity where Germany’s right of taxation with respect to the shares given or taken in the con-tribution is restricted. This in particular applies where shares are contributed to a for-eign entity or where the shares taken in exchange for the contribution are issued to a foreign shareholder. However, non-recognition treatment is still available if a qualified share-for-share exchange occurs and Germany’s right of taxation with respect to the shares received from the share-for-share exchange is not restricted. Thus, contribu-tions to a foreign corporation may be accomplished on a non-recognition basis if the contributing entity is resident in Germany for tax purposes or if the shares received are held in a German permanent establishment. However, non-recognition treatment always requires the acquiring corporation to be a EU/EEA resident.

Where shares are contributed by individuals to a corporation, capital gains from the disposal of the shares do not fully qualify for the capital gains exemption. Where the contributed shares are disposed of within a period of seven years, the disposition trig-gers retroactive taxation of the built-in gains existing at the time of the contribution at the shareholder level. The taxable built-in gains are phased out pro rata temporis over the seven-year holding period. The historical cost of the contributed shares is stepped up accordingly in the event of a disposal by the absorbing corporation during the hold-ing period.

10.4.1.4 Contribution to a partnership

A contribution to a partnership must in principle be carried out at fair market value. A contribution at book value is possible if Germany’s right of taxation with respect to the contributed assets is not restricted. The contributing entity is deemed to have trans-ferred the assets to the absorbing partnership at a sales price equal to the value of contributed assets in the tax accounts of the absorbing partnership. Thus, a contribu-tion gain is triggered where the assets are contributed at fair market value.

10.4.2 Divisions

A division in the form of a split-up or a spin-off is often referred to as a de-merger because part of a legal entity is transferred to another entity by way of universal suc-


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cession (Universalsukzession). Therefore, the rules for mergers apply mutatis mutan-dis to divisive reorganizations.

In addition, there are special requirements that must be met to ensure non-recognition treatment of a de-merger.

10.4.2.1 Split-up of a corporation

A split-up of a corporation (Aufspaltung) may only be carried out at book value where the assets transferred qualify as a branch of activity (Teilbetrieb). Under the case law of the German Federal Tax Court (Bundesfinanzhof – BFH), a business division is an organically self-contained part of an enterprise enjoying a certain degree of indepen-dence which, when viewed separately, has all (or almost all) of the characteristics of a business unit and is viable as such. Interests in partnerships and 100% holdings in corporations are deemed, in principle, to be business divisions.

Equity components which are fiscally unencumbered and the contribution account for tax purposes should be apportioned to the entities involved in the de-merger based on the ratio of the transferred assets to the assets of the transferor corporation prior to the de-merger.

Far-reaching anti-avoidance clauses exist to combat abuse of the rules allowing for non-recognition treatment of a de-merger. Non-recognition treatment is for instance denied where the de-merger results in a sale to third parties or it serves to prepare such a sale. The de-merger is deemed to serve to prepare such a sale where shares of a com-pany involved in the split-up are sold within five years of the transfer date for tax pur-poses, provided these shares amount to more than 20 % of the shares in the de-merging entity before the split-up took effect. If the prerequisites for the anti-avoidance clause are met the, assets are transferred to the absorbing corporation at their fair market value. The other legal consequences of the de-merger are not affected.

If a split-up does not enjoy non-recognition treatment, it is taxed as a liquidation of the transferor entity according to general rules. The assets of the transferring corporation are distributed in kind at fair market value to the shareholders of the transferring cor-poration, who are deemed to contribute them into the absorbing corporation.

10.4.2.2 Spin-off of a corporation

The requirements for non-recognition treatment of a split-up (Aufspaltung) apply mutatis mutandis to a spin-off (Abspaltung). A spin-off may only be carried out at book values where the assets transferred qualify as a separate business division (Teil-

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betrieb). As a further prerequisite, the assets remaining at the level of the transferring entity must also qualify as a separate business division.

10.4.3 Change in legal form

Conversion of a corporation into another type of corporation or conversion of a part-nership into another type of partnership does not trigger adverse tax consequences.

The conversion of a corporation into a partnership is treated the same way as a merger of a corporation into a partnership. Please see the comments on mergers in chap-ter 10.4.1.2.

The conversion of a partnership into a corporation is treated as a contribution to the corporation. Please see the comments on the merger of a partnership into a corporation in chapter 10.4.1.3.

10.5 Tax due diligence review

A tax due diligence exercise is often carried out prior to a transaction . The scope and depth of a tax due diligence will vary according to the size and complexity of the transaction.

A tax due diligence may include:

Establishment of the tax status of the target

Identification of tax risks

Establishment of the effective tax rate of the target

Support of cash-modelling

Analysis of tax policy

The findings of the due diligence may have an effect on the warranties granted under the sale and purchase agreement or on the purchase price itself. They also serve to establish the factual basis for the optimization of the transaction structure.

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11 Taxation of individuals

11.1 Overview

The taxation of individuals in Germany is based on the principle of the taxpayer’s abil-ity to pay taxes. The German constitution (Grundgesetz – GG) only permits the state to tax the income of individuals if, after taxation, that individual has adequate eco-nomic means to maintain a minimum livelihood.

An individual’s income is subject to income tax (Einkommensteuer) plus a solidarity surcharge (Solidaritätszuschlag) (see chapter 11.7 below). Church tax (Kirchensteuer) is collected if the individual belongs to one of the “recognized” churches (see chap-ter 11.8 below). Income generated by an individual from a trade or business is also subject to trade tax (Gewerbesteuer) (see chapter 6.2.2).

Increases in wealth from inheritance or gifts are not classified as “income”; proceeds from theses sources are, however, subject to inheritance tax (Erbschaftsteuer) and gift tax (Schenkungsteuer) (see chapter 11.9 below).

Value added tax (Umsatzsteuer) regulations apply if individuals operate a business (see chapter 7.1.1). Individuals are also affected by real estate transfer tax (Grund-erwerbsteuer), which arises whenever real property is transferred for consideration.

While several other European countries still have taxes on capital, Germany’s net worth tax (Vermögensteuer) has not been levied since January 1, 1997. The Federal Constitutional Court (Bundesverfassungsgericht – BVerfG) held in 1995 that certain aspects of the net worth tax were unconstitutional and that collection of the tax must cease at the end of 1996 if the defects were not remedied. The legislature has, however, intentionally failed to act. Accordingly, there is at present no legal basis to levy net worth tax in Germany.

Municipalities continue to levy a tax on real estate (real estate tax, Grundsteuer).

11.2 Basic principles of an individual’s liability to tax

11.2.1 Distinction between unlimited and limited tax liability

As in most other European countries, the German income tax system is based on the criterion of residency (Ansässigkeit). Citizenship is not a relevant factor. According to the concept of unlimited tax liability (unbeschränkte Steuerpflicht), individuals resi-

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Taxation of individuals



dent in Germany are subject to income tax on their worldwide income. The status of unlimited tax liability is also relevant for various tax allowances and filing options (e. g. joint returns for married people, child benefit payments, and child allowances).

For the purpose of income tax, an individual’s residence is presumed to be the place where an individual is domiciled or has his customary place of abode (gewöhnlicher Aufenthalt). The term “domicile” (Wohnsitz) involves more than having a dwelling place (Wohnung) in Germany. In order to be liable for tax as a resident, the taxpayer must actually use the dwelling place or, at a minimum, it must be evident from the specific circumstances that there is an intention to use it on a long-term basis. If the individual does not have a dwelling place or if the intention to use it on a long-term basis is not evident, then resident tax status applies if the individual does in fact reside in Germany. However, the facts and circumstances must indicate that the physical presence is other than of a temporary nature. Physical presence for more than six months will result in deemed residence. Short interruptions, such as holidays in for-eign countries, are not relevant and therefore count towards the six month period.

Non-residents are subject to taxation only on certain income from German sources. This is known as the concept of a limited tax liability (beschränkte Steuerpflicht). If an individual has no German-source income, no taxes are levied. Consequently, unlim-ited tax liability (resident tax status) is based more on the individual, whereas limited tax liability (non-resident tax status) is based more on the source of the income.

11.2.2 Special forms of tax liability

Besides the standard categories of unlimited and limited tax liability, there are a num-ber of specific cases where individuals not resident in Germany may also be subject to unlimited tax liability:

German citizens working for German “governmental” organizations abroad, to the extent such persons only have limited tax liability in the other country.

Individuals who are not resident in Germany, but who earn the vast majority of their income in Germany and elect to be taxed on their German income only on a resident basis. For further information, see chapter 11.3.11 below.

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11.3 Taxation of income

11.3.1 Taxation of resident individuals

Resident individuals are subject to income tax on their aggregated worldwide income falling into one or more of the following seven categories of income:

Income from agriculture and forestry;

Income from a trade or business;

Income from self-employment;

Income from employment;

Income from capital investment;

Rental income from real estate and certain other tangible property and royalties;

Other income (of specific types).

“Other income” includes annuities, certain capital gains, and certain non-recurring income. Income, which does not fall into one of the seven categories is not taxable.

11.3.2 Computation of taxable income

The tax year for income tax purposes is the calendar year.

In order to determine the total amount of taxable income, the amounts of income from the different categories must be calculated separately. For the first two categories of income (income from agriculture and forestry, and income from a trade or business), the normal method of computing the gross income relevant for income taxation is the “net worth comparison method,” under which the relevant gross income is the differ-ence between the net worth of the assets pertaining to each category of income at the end of the preceding assessment period compared to the current assessment period. The “net worth comparison method” is mandatory for income from agriculture and forestry or trade or business where the annual profits exceed € 30,000 and sales reve-nue exceeds € 500,000. Where income is below these thresholds, the “net income method” may be used. Under this method, taxable income is computed by reducing gross income by income-related expenses in accordance with cash receipts and dis-bursements. Business-related expenses are generally deductible under both methods. In the case of income from self-employment, the taxpayer can choose between the “net worth comparison method” and the “net income method”.

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Net income from employment, investment income (for further details see also chap-ter 11.5.1 below), rental income, and certain other income is determined by deducting any expenses incurred to produce, maintain, and safeguard that income (income-related expenses, Werbungskosten) from gross receipts. For employees, these expenses include commuting expenses, tools, work clothes, certain membership dues, and cer-tain away-from-home expenses. In the case of rental income, interest expenses, depre-ciation, and other related expenses can be deducted.

From 2009 on, there will be a flat tax for income from capital and capital gains. Income from those categories will be taxed at a fixed rate of 25 % and will not be included in the calculation of the gross income (for further information, see chapter 5.1.1.7 and chapter 11.4 and 11.5 below).

The basic level of tax-exempt income (Grundfreibetrag) is € 7,664 from 2004 onwards. For married taxpayers (joint return, Zusammenveranlagung), the basic level of tax-exempt income is doubled.

11.3.3 Standard deductions for income-related expenses

The following standard annual deductions for income-related expenses are allowed unless higher expenses can be itemized:

For employment income: € 920

For investment income, for individuals: € 51

For married individuals filing jointly: € 102

For annuities: € 102

An additional allowance of € 750 (€ 1,500 for married individuals filing jointly) can be deducted from investment income (Sparerfreibetrag). Due to the introduction of the flat tax for income from capital and capital gains in 2009, the standard deductions for investment income will be abolished. Moreover, the Sparerfreibetrag will be replaced by an overall allowance (Sparer-Pauschbetrag) of € 801 for single taxpayers and € 1,602 for married taxpayers who file a joint income tax return. Higher expenses will no longer be deductible (see also chapter 5.2.1.7, with regard to exemption option, see chapter 5.2.3.4).

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11.3.4 Itemized deductions

The following itemized deductions are applicable:

Foreign income taxes that do not qualify for foreign tax credit treatment or where a deduction is elected instead of tax credit.

Special expenses (Sonderausgaben), which are private expenses rather than income-related expenses: They include certain alimony and maintenance pay-ments; premiums for life insurance and accident insurance, and compulsory social security payments, subject to limitations; expenses for vocational education, sub-ject to limitations; and certain expenses for professional tax advice. Taxpayers who do not itemize and earn employment income, can alternatively claim a provisional lump sum of the employment income (Vorsorgepauschale) as a deduction. Follow-ing revisions of the treatment of retirement income beginning as of January 1, 2005, which will apply the concept of deferred taxation to the public pension insur-ance system as well, the provisional lump sum is to be calculated as follows:

(a) An amount, which, when measured against wage income, is equal to 50 % of the contribution to the public pension insurance system, and

(b) 11 % of wage income, capped at € 1,500.

The efforts to completely take into account employee pension contributions as described in (a), above, will not be fully effective until 2025 due to the phased introduction of the deferred taxation model.

A provisional minimum lump sum deduction of € 36 is always deductible.

For joint returns, the amounts mentioned above are doubled (i. e. € 3,000 and € 72 respectively).

Individuals who are not subject to the public pension system (e. g. general manag-ers) may only deduct special expenses of 11 % of employment income, limited to a maximum amount of € 1,500 (doubled in case of married individuals filing jointly).

Extraordinary expenses (außergewöhnliche Belastungen): Where a taxpayer incurs unusually high, unavoidable expenses due to extraordinary circumstances or hard-ship, relief may be granted by allowing as a deduction the excess of such expenses over a “reasonable burden”. The definition of a reasonable burden is based on the net income before special expenses and on the number of children, and ranges from 1 % to 7 % of net income before special expenses. Certain expenses may be allowed subject to an absolute rather than a percentage-of-income limitation.

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Finally, other allowances may apply under the following circumstances: old age (Altersentlastungsbetrag; 65 and older: 36.8 % of total income but not more than € 1,748 in 2007 (in 2008: 35.2 % and € 1,672); to be reduced by 1.6 % annually until 2020 and thereafter by 0.8 % after 2021 with corresponding reductions in the total allowable amount); and allowance for single parents (Entlastungsbetrag für Alleinerziehende; € 1,308).

Retirement benefits from an earlier employment relationship will remain tax free as a tax-exempt retirement plan (Versorgungsfreibetrag), 36.8 % of retirement ben-efits but not more than € 2,760 in 2007 (2008: 35.2 % and € 2,640). Until the com-plete abolition of the tax relief in 2040, the total allowable amount will be phased out corresponding to the allowance for old age (see previous bullet point above).

11.3.5 Child benefit payments, child allowances

The deductibility of expenses incurred by parents for their children is subject to spe-cial rules. In order to maintain a minimum livelihood for children (who themselves have unlimited tax liability), a system is in place which differentiates between child benefit payments and child allowances. Tax-exempt child benefits are paid upon filing an application with the family welfare office (Familienkasse). This comprises a monthly amount of € 154 for the first, second, and third child, and € 179 for the fourth and each further child. The child allowance, on the other hand, amounts to € 1,824 (€ 3,648 jointly filing) p.a. for each child (as a deduction against taxable income), plus an additional allowance of € 1,080 (€ 2,160 jointly filing) p.a. for each child for care, education, and training expenses. In most cases, however, the child allowances are not applied, because the payment of child benefits is more advantageous for most taxpay-ers. The tax office automatically applies the more favorable alternative. Furthermore, foreign employees working in Germany may take advantage of the child benefit if they are subject to social insurance contributions. However, they are entitled to the child allowance if they have unlimited tax liability.

Since 2006 certain expenses for child care (Kinderbetreuungskosten) due to employ-ment of the parents are deductible. Additionally, expenses for child care due to the age of the child (3 to 5 years old) or to vocational training or illness of the parents are deductible as special expenses. Limitations apply in both cases.

11.3.6 Private pension savings

Since 2002, the German Income Tax Act (Einkommensteuergesetz – EStG) has included provisions that are intended to encourage individuals to save more for their retirement. Tax benefits for additional private pension savings are granted by payment

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of a retirement savings subsidy (Altersvorsorgezulage) to the individual. In order to qualify for this subsidy, the taxpayer must conclude a certified retirement pension con-tract and contribute an amount, the minimum level of which is specified in detailed regulations. The retirement savings subsidy initially comprises an annual fixed amount of € 114 in 2007 and € 154 in 2008 and thereafter. For married couples filing jointly, these amounts are doubled. If the taxpayer entitled to this subsidy has children and also draws child benefits for them, a subsidy amount is also paid for each child (2007: € 138; from 2008 onwards: € 185).

Alternatively, a taxpayer entitled to the subsidy can apply for an additional deduction of special expenses (2007: € 1,575; from 2008 onwards: € 2,100). The tax office auto-matically applies the more favorable alternative.

11.3.7 Homeowner subsidies

Since 1996, taxpayers acquiring or constructing a new house or apartment used by themselves for residential purposes were granted homeowner subsidies (Eigenheimzu-lagen) upon application.

After lengthy political discussions, the homeowner subsidy was repealed as of January 1, 2006. The repeal applies, however, only to new cases. For taxpayers currently receiv-ing benefits under the old subsidy, payments will continue to be made as scheduled.

11.3.8 Utilization of losses

Complicated rules concerning loss offset between the various income categories were repealed as of the 2004 tax assessment period. Income and losses from different income categories can be fully offset against each other without limitations during any given tax assessment period. Certain exceptions continue to exist for special types of income such as losses from livestock breeding businesses or losses from private sales transactions, however.

If, after offset between the various income categories, a net loss results for an assess-ment period, it can be used to offset income in other assessment periods.

The first option is to carry the losses back to the preceding year. There is a ceiling of € 511,500 (€ 1,023,000 for married couples filing jointly).

If a loss still remains after the carryback, it can be carried forward to future assess-ment periods indefinitely. Since 2004, however, there are so-called minimum taxa-tion rules, under which loss carryforwards may be fully offset against net income only up to a maximum of € 1 million. Loss carryforwards in excess of this amount

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may be offset against only 60 % of the total net income exceeding that € 1 million threshold.

In addition to the general rules relating to the utilization of tax losses, income tax leg-islation also contains specific provisions on cross-border transactions. Losses not deductible under certain circumstances include without limitation the following: losses from a foreign permanent establishment; losses arising from the lease of property or relating to agricultural or forestry activities based outside Germany; losses arising in connection with income which is tax-exempt in Germany.

11.3.9 Determination of tax liability

Individual income tax is imposed at progressive tax rates as summarized in the follow-ing tables for 2007/2008:

Table 18: Single individuals

Annual taxable income Marginal tax rate Tax due

up to € 7,664 0 % € 0 € 7,665 – € 12,739 15.00 % – 23.97 % € 1 – € 988€ 12,740 – € 52,151 23.97 % – 42.00 % € 989 – € 13,989

€ 52,152 – € 250,000 42.00 % € 13,990 – € 97,086over € 250,000 45.00% at least € 97,086

Table 19: Married couples filing jointly

Annual taxable income Marginal tax rate Tax due

up to € 15,328 0 % € 0€ 15,329 – € 25,479 15.00 % – 23.97 % € 2 – € 1,977€ 25,480 – € 104,303 23.97 % – 42.00 % € 1,978 – € 27,978€ 104,304 – € 500,000 42.00 % € 27,980 – € 194,172

over € 500,000 45.00 % at least € 194,173

The rates and amounts outlined above are calculated according to the formula defined by the German Income Tax Act for 2007 and onwards.

The tax liability for married taxpayers filing jointly is determined by doubling the tax taken from the basic tax table that would have been due on one half of the taxable joint income. Taxes withheld at the source, such as on employment income, on dividends, and on interest paid by a domestic bank can be credited against the income tax liabil-ity.

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In addition to the income tax itself, a solidarity surcharge of 5.5 % is also levied on the income tax amount assessed.

11.3.10 Relief from double taxation

11.3.10.1 Unilateral relief

Foreign income taxes that are substantially similar to German income tax may be credited against the German tax liability, limited to the amount of income tax actually paid (equivalent to German income tax) in the other country. Per country limitations also apply. Alternatively, foreign income tax can be deducted from the taxable income.

11.3.10.2 Tax treaty relief

Tax treaties are agreements under international law between two countries. The pur-pose of such agreements is to avoid double taxation. Tax treaties are generally based on one of two systems: either (i) the country of the taxpayer’s residence does not levy taxes on income having its source in the other treaty country (exemption system); or (ii) the country of residence taxes such income, but credits the taxes paid in the source country against its own income tax liability (credit system). Under credit systems, per country limitations normally apply. Germany may also credit notional foreign with-holding taxes if so provided for in the relevant tax treaties. Provisions of this nature are included in a few tax treaties with industrially less developed countries, normally as an incentive for German companies to invest in those countries.

The treaty relief described above generally applies to resident individuals as well as to corporations. If income is exempt from tax under a treaty, Germany retains the right to take account of this income for purposes of determining the applicable average tax rate on other taxable income in Germany (progression clause, Progressionsvorbehalt). In addition to the treatment under tax treaties outlined above, the following principles generally apply to income from employment and self-employment:

Remuneration paid to a resident of Germany for employment exercised in the other treaty country is normally taxed in that other country, unless (i) the recipient is present in the other country for not more than 183 days during the year, (ii) the sal-ary is paid by an employer who is not a resident of the other country, and (iii) the salary is not borne by a permanent establishment of the employer in the other country. The tax treaties between Germany and a number of neighboring countries contain specific regulations for cross-border commuters. Under these regulations, the country of residence retains the right to tax the employment income of the

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cross-border commuter under certain circumstances, even if the 183 day threshold is exceeded.

Income from self-employment is usually taxable in the country of residence unless the individual has a fixed base regularly available to him in the other country for the purpose of performing his activities. Some treaties, however, apply the provi-sions for income from employment rather than the “fixed base” criterion.

11.3.11 Non-resident individuals

Non-residents are subject to income tax on certain categories of income from German sources. To trigger German income tax, the income of the non-resident must have a specific connection with Germany. This includes:

Income from agriculture and forestry activities in Germany;

Business income derived through a permanent establishment or a permanent repre-sentative in Germany;

Capital gains from the sale of shares in a resident corporation, provided the non-resident’s investment is more than 1 %;

Income from self-employment or employment (to the extent that the work is per-formed or used in Germany);

Dividend income where the entity paying the dividend is resident in Germany; interest on mortgages and bonds issued by German borrowers;

Rental income, where the real estate or other tangible or intangible property is located or registered in Germany;

Certain other income, including gains on the sale of German real estate.

Non-resident individuals are in some respects treated differently from residents. As outlined above, non-residents are subject to German income tax only with regard to certain categories of income from German sources. Depending on the type of income, the German source income of non-residents may be subject to tax either through with-holding at the source (at graduated rates in the case of amounts deducted from wages and salaries by the employer, or at a flat rate on gross income such as dividends), or by direct assessment upon filing of an income tax return. Business expenses or other income-related expenses are only deductible to the extent that they are economically related to the relevant income. Losses from one category of income may only be offset against income from another if both categories are subject to tax through direct assess-ment rather than the withholding tax procedure.

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The tax withheld on investment income is deemed to fully discharge the tax liability on that income unless it is derived through a permanent establishment in Germany, in which case the withholding tax is credited against the income tax payable upon direct assessment.

These rules generally place taxpayers with limited tax liability in Germany at a disad-vantage compared to taxpayers with unlimited tax liability in Germany. Therefore, such rules may not withstand scrutiny in light of the underlying European rights. As a reaction to various rulings by the European Court of Justice, the German legislature has already eliminated a number of inconsistencies in the treatment of non-residents in Germany. One example of this is the introduction of a “notional” elective unlimited tax liability for non-residents, including the ability to claim allowances or deduct expenses incurred for family members living in the EU and who are not subject to unlimited tax liability in Germany.

11.4 Capital gains

11.4.1 Sales of business assets

Gains on the sale of business assets are generally included in taxable income and taxed at ordinary rates. However, gains on the sale or disposal by an individual of his entire business, or an autonomous part thereof, or his partnership interest, are treated as “income from a trade or business”. An allowance of up to € 45,000 (under certain cir-cumstances) is granted if the seller is 55 years of age or older. The amount remaining after this deduction is subject to a reduced tax rate (applicable to extraordinary income, außerordentliche Einkünfte). The rationale for this is that it avoids the disadvantages of the progressive tax rate system, e. g. when a one-time gain is generated in return for assets which have been earned over a long period. The reduced tax rate is based on notional spreading of the capital gain over a period of five years (called the 1/5 rule). If the capital gain does not exceed the ceiling of € 5 million, older taxpayers (55 and older) may alternatively apply for a reduced tax rate. The reduced tax rate is 56 % of the average tax rate. The minimum tax rate is 15 %.

11.4.2 Sales of investments held as private assets

Capital gains on the sale of investments in a corporation held as private assets are sub-ject to tax if the individual is deemed to own a certain ownership percentage in the corporation. A certain ownership percentage is assumed if the individual has owned a minimum interest of 1 % within the preceding five years.

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The capital gain is subject to tax if it exceeds an allowance of up to € 9,060 (pro-rated according to the interest held in the corporation).

The “half-income” rule (from 2009 on: “part-income rule”) applies to the remainder of the gain; in other words one half (from 2009 on: 40 %) of the capital gain (less allow-ance) is tax-exempt. It should be noted, however, that expenses cannot be deducted for the portion of the gain which is tax-exempt.

11.4.3 Other private capital gains

Gains derived by an individual from the disposal of capital assets not used in a trade or business (private Veräußerungsgeschäfte) are not subject to taxation, except in the fol-lowing two cases:

A sale is taxable if the holding period is

Less than ten years in the case of real estate, or

Less than one year in case of other property e. g., securities, or if the sale occurs before the acquisition (short sale). Gains on the sale of investments in corporations are also taxable under these provisions. The law on “private disposal transactions” has priority over the taxation of capital gains described under chapter 11.4.2. From 2009 on, the non-taxation of gains from the disposal of other property beyond the one year holding period will be abolished. As a result, every such gain will be taxed irrespective of any holding period. Prior law will remain applicable to prop-erty purchased before January 1, 2009.

The total net gain from a “disposal of capital assets not used in a trade or business” is subject to income tax at ordinary rates if it exceeds an allowance of € 512 (from 2009 on: € 600) per calendar year. The “half-income” rule applies. Losses from the “dis-posal of capital assets not used in a trade or business” can only be offset against gains from such transactions within the same year. Losses on such gains, which cannot be offset with capital gains in the same calendar year can be carried back and forward in accordance with the general rules for loss carrybacks and carryforwards (see 11.3.8 above).

11.5 Special issues relating to investment income

With respect to the taxation of investment income, some of the procedures differ from the general principles described above.

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11.5.1 Half-income rule

The “half-income” rule applies not only to capital gains (see chapter 11.4.2 and 11.4.3 above), but also – as a general rule – to dividends paid to individuals. In this situation, however, only one half of the income-related expenses can be claimed as a deduction. Upon introduction of the flat tax for income from capital and capital gains in 2009, the modified “part-income” rule will be no longer a general rule. It will apply only to busi-ness-related capital gains.

11.5.2 Withholding tax on investment income

Investment income, in particular interest and dividend income, is subject to a with-holding tax (Kapitalertragsteuer) at a rate between 20 % and 30 %; other rates apply in special cases. The withholding tax is levied on the gross amount of investment income, i. e. before any deduction of income or business-related expenses, special expenses, or taxes, and must be withheld by the payor. As a result of specific tax directives, with-holding tax is also levied where only one half of the investment income is subject to tax or where the investment income is tax-exempt or where, under tax treaty provi-sions, the ultimate taxation will be reduced or even eliminated entirely. Under certain circumstances, it is possible to claim a refund of the income tax withheld on tax-exempt income.

In the case of interest paid by a domestic bank, the interest withholding tax (Zinsab-schlagsteuer) is normally 30 %. However, this withholding tax on interest is not levied, if:

The creditor of the interest is a domestic bank (inter-bank privilege).

The interest is paid to an individual not resident in Germany.

If an individual cashes in an interest certificate with a domestic bank (so-called “over-the-counter transactions”), i. e. delivers a certificate embodying an interest claim to a domestic bank in return for a cash payment, the interest withholding tax is increased from 30 % to 35 %.

The 30 % withholding tax need not be deducted at the source (i. e. the gross interest can be paid out) if:

The total interest on an annual basis does not exceed the allowance of € 750 plus the € 51 standard deduction (€ 1,500 plus € 102 for married couples filing jointly). (For changes in 2009 see also chapter 11.3.3);

Special issues relating to investment income

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Circumstances indicate that the recipient of the interest is not required to file a German tax return;

The bank holds written instructions from the customer directing it to take account of the allowances of € 750/€ 1,500 (certificate of exemption, Freistellungs-bescheinigung), or (in case of the second alternative) the bank holds a certificate from the tax authorities certifying that the recipient is not required to file a Ger-man tax return (Nichtveranlagungsbescheinigung).

The introduction of the flat tax for income from capital and capital gains in 2009 also has technical effects in the area of withholding tax. In most cases, the withholding tax rate will be 25%. Where income from capital is subject to withholding tax, the income tax liability is deemed to be satisfied by the tax withheld. The flat rate tax is not levied in addition.

11.6 Filing requirements and payment of tax

In general, income tax, church tax, and (since 1995) a solidarity surcharge are assessed upon filing of an income tax return (Einkommensteuererklärung).

Domestic taxpayers are required to file an income tax return if income for a particular assessment period exceeds € 7,664 and the income has not been subject to tax with-holding. Specific provisions apply to income tax returns filed jointly by married cou-ples. With regard to income from employment, there is often no requirement to file an income tax return since the withholding of wage tax will already have ensured that the income has been subject to taxation. In such cases, a special annual wage tax adjust-ment (Lohnsteuerjahresausgleich) is performed by the employer. Hence the amount of taxes for the year is settled as soon as possible. A non-resident individual must file an income tax return whenever he/she has German-source income unless the tax liability is deemed to be satisfied by withholding at the source.

Returns must be filed with the local tax office by May 31st for the preceding calendar year. An extension until December 31st may be granted if the return is prepared by a professional tax advisor. Further extensions may be available upon request.

The tax is not payable with the return. Rather, the tax authorities will issue a final assessment notice after receipt of the return. Any balance due is payable within 30 days after receipt of the assessment notice.

The tax office will assess quarterly prepayments based on the prior year’s tax or on estimates on income not subject to withholding taxes. These prepayments are due on March 10th, June 10th, September 10th, and December 10th.

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The tax authorities are entitled to impose interest for late payment of tax, which applies to income, corporation, trade and value added tax claims. The interest rate is 6.0 % p. a. or 0.5 % per month.

Any taxpayer subject to unlimited tax liability who is not specifically required to file an income tax return may nevertheless do so in order to be assessed for income tax. This can be useful, for instance, where high income-related or business-related expenses are incurred or if income is earned for only a part of the assessment period. The deadline for filing an income tax return is the end of the second year following the assessment period e. g., for 2006 it is December 31, 2008.

11.7 Solidarity surcharge

The solidarity surcharge (Solidaritätszuschlag) is levied as a supplement to income and corporate income tax and currently is at a rate of 5.5 % of the assessed amount of income and corporate income tax (see chapter 6.2.1.13). It applies to taxpayers with unlimited tax liability and to the German-source income of taxpayers with limited tax liability.

11.8 Basic principles of church tax

Church tax (Kirchensteuer) is levied by “recognized” churches in Germany that have been granted the right to impose a tax on their members. Recognized churches are inter alia the Roman Catholic Church (römisch-katholische Kirche), the German Pro-testant-Lutheran Church (evangelisch-lutherische Kirche), the Reformed Church (reformierte Kirche), and Jewish parishes ( jüdische Kultusgemeinden). It does not apply to foreign churches. Depending on the German state of residence, the tax amounts to 8 % or 9 % of the wage tax withheld and is remitted by the employer to the local tax office or the church tax office. For income not subject to wage tax withhold-ing, quarterly prepayments and final payments are made along with the relevant income tax payments. In this case, the church tax is calculated on the assessed income tax (or on the prepayments). Church tax is a deductible (special) expense for income tax pur-poses. Foreign employees working in Germany are subject to church tax if they are members of the Roman Catholic Church since this church defines itself as a worldwide church.

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11.9 Basic principles of inheritance and gift tax

Inheritance and gift tax (Erbschaft- und Schenkungsteuer) is levied on transfers of property by reason of death (inheritance tax), gifts during lifetime and transfers for certain specified purposes (gift tax), as well as on the net worth of certain family foun-dations or trusts (at intervals of 30 years).

The transfer of domestic property valued according to the provisions of the German Valuation Act (Bewertungsgesetz) is subject to inheritance and gift tax, regardless of whether the transferor and/or the transferee are residents of Germany. The transfer of foreign property is subject to inheritance and gift tax only if the decedent or donor is a resident of Germany at the time of death or at the time when the gift is made, respec-tively, or if the beneficiary or donee is a resident at the time when the tax liability arises, or if either the decedent/donor or the beneficiary/donee is a German citizen and emigrated within a five-year period preceding the taxable event.

The tax is generally assessed on the net worth (gross values less liabilities) of the prop-erty transferred after deducting certain exemptions (e. g. an exemption allowance for business assets of € 225,000 plus a 35 %-exemption of the net value of the business assets after allowance). In the case of a resident transferor or of a resident transferee, personal exemptions depend on the family relationship of the respective individuals. The three classes of relationships and the respective personal exemptions for inheri-tance and gift tax purposes are:

Table 20: Classes of relationship

Class Relationship Exemption

I Spouse € 307,000(Step-) Children and Grand (step-) children of deceased (step-) children € 205,000Grand (step-) children and (Grand-) Parents (in the event of transfers at death) € 51,200

II (Grand-) Parents (for gifts), siblings and their children (first degree), step-parents, children-in-law, parents-in-law, and divorced spouse € 10,300

III All others € 5,200

If neither the transferor nor the transferee is a resident, an allowance of € 1,100 applies throughout. In addition, there is a surviving-spouse exemption of € 256,000 less any survivors’ benefits not subject to inheritance tax, and special exemptions for children ranging from € 10,300 to € 52,000 depending on their age. Other exemptions from tax may be allowed under certain circumstances.

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Taxable transfers of property are subject to inheritance tax at graduated rates, depend-ing on the value of the property and the classes of family relationship mentioned above. The tax rates can be illustrated as follows:

Table 21: Inheritance and gift tax classes

Net worth of inheritance/gift I II III

up to € 52,000 7 % 12 % 17 %€ 256,000 11 % 17 % 23 %€ 512,000 15 % 22 % 29 %

€ 5,113,000 19 % 27 % 35 %€ 12,783,000 23 % 32 % 41 %€ 25,565,000 27 % 37 % 47 %

over € 25,565,000 30 % 40 % 50 %

For purposes of determining the applicable tax rate, transfers within a period of ten years are accumulated, and any inheritance tax which should have been previously levied on the transfers is credited against the resulting entire tax liability. Accordingly, the personal exemptions are available every ten years.

Further major reform of the German inheritance and gift tax system is expected in the near future due to the Federal Constitutional Court decision of November 7, 2006. In this decision, the court held that the current rules by which property is valued for inheritance and gift tax purposes violate the principle of equality before the law and are therefore unconstitutional. The court allowed the legislature until December 31, 2008 to remedy the constitutional defects. After considerable political debate, draft legislation was approved by the government on December 12, 2007 that would reduce taxation in situations involving family members. Relief would be granted in particular for transfers of business property between family members (see Chapter 5.3.3 above). The bill is expected to be enacted in the end of 2008.

Basic principles of inheritance and gift tax

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12 Opportunities for international investors

Many regional, federal and European Union programs exist to promote investment in Germany. In particular, programs are designed to promote states in eastern Germany and investments by small and medium-sized businesses (especially within the frame-work of the so called Mittelstandsinitiative). The aim of the various promotional pro-grams is to attract investments to Germany. The level of grants available depends prin-cipally on the size of the enterprise and the number of new jobs created. It should be remembered that the programs are subject to change.

12.1 European investment grants

For the 2003 – 2005 grant period, Germany had approx. € 4.7 billion available in EU funding for purposes of promoting companies’ investments and € 2.8 billion for infra-structure investments. The Financial Framework for 2007 – 2013 provides Germany with approx. € 26 billion for structural actions.

In principle, there are a number of ways to obtain grants from EU institutions. How-ever, support for enterprises is usually given indirectly through the provision of federal and regional grants funded by EU capital.

Sometimes, it is possible to apply directly to international institutions for funding. Public invitations to apply for this type of funding may be found in the Official Journal of the European Union. Assistance from European funds may be given in the form of subsidies, loans at concessionary rates of interest, equity investments, or the provision of venture capital.

Especially for small and medium-sized enterprises (SMEs) from Member States, the EU provides assistance in different forms such as grants, loans and, in some cases, guarantees. Support is available either directly or indirectly through the EU’s Struc-tural Funds, which are managed at the national level (see also chapter 12.3 below). SMEs can also benefit from a series of non-financial assistance measures in the form of programs and business support services.

12.2 Investment subsidy

The investment subsidy (Investitionszulage) may be claimed in certain cases for initial investment in states in eastern Germany (Brandenburg, Mecklenburg-Western Pomer-

European investment grants

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Opportunities for international investors



ania, Saxony, Saxony-Anhalt, and Thuringia as well as special areas of Berlin). These investment grants are available for the acquisition or manufacture of new depreciable movable fixed assets or for the purchase or construction of buildings, provided the investment is made

a) To found a business,

b) To extend an existing business,

c) To implement fundamentally new production methods,

d) To diversify the production for additional products,

e) On or after the purchase by an outside investor of a business that was closed or would otherwise have been closed.

For movable fixed assets, an investment subsidy of up to 12.5 % (or 15 % in certain border territories) of the acquisition or manufacturing cost is granted. The rate appli-cable for small and medium-sized companies increases to 25 % (or 27.5 % in certain border territories). Special rates apply for investments in Berlin. The purchase or con-struction of new buildings attracts a standard grant rate of up to 15 % of the purchase or building cost. These tax incentives do not apply to acquisitions of low-value assets (where the unit costs do not exceed € 410) or to aircraft or motorcars. Should the max-imum amount of public grants (including other subsidies) be exceeded, the investment grant is reduced.

The movable assets must belong to the fixed assets of the business applying for the subsidy and must remain in this business for at least five years. For SMEs this period is shortened to at least two years. Private use of the assets, especially where this results in constructive dividends, must not exceed 10 %. Assets for which an investment sub-sidy is claimed must be used during the five-year period to engage in manufacturing processes or to provide production-related services. In the event the subsidized asset is withdrawn from the business or factory prior to the expiration of the five-year period, the subsidy may nevertheless be retained if a comparable substitute asset is procured. If the useful life of the asset is less than five years, then the asset must remain in the business or factory only for this period of time.

The investment subsidy should be applied for through the relevant tax office and is exempt from income tax, corporate income tax, and trade tax.

The 2005 Investment Subsidy Act (Investitionszulagengesetz – InvZulG 2005) ceased to apply at the end of 2006. However, the 2007 Investment Subsidy Act (InvZulG 2007) – legislation which continues these tax incentives for certain investments made

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between January 1, 2006 and December 31, 2010 – entered into force on July 20, 2006. The 2007 legislation made only slight changes in the subsidy requirements. Except for some areas of the state of Berlin, the rates of investment subsidies remained unchanged.

12.3 Federal and regional investment grants

12.3.1 Measures to promote investment

Financial assistance from the German federal government and regional governments is usually provided in the following ways:

Subsidies (some of which are repayable under certain conditions),

Loans at concessionary interest rates,

Guarantees.

The most important federal and regional measures to promote investment are detailed below.

12.3.1.1 Subsidies

Subsidies may be irrecoverable, i. e. non-repayable, or repayable under certain condi-tions. Subsidies which are repayable under certain conditions may lead to repayment claims being made by the provider of the subsidy if the investment is successfully completed.

Investment subsidies are provided within the framework of the “Improvement of Regional Economic Structures” joint initiative. In principle, an investment project may qualify for a subsidy if it contributes directly and permanently to the creation of addi-tional income in that particular region.

The conditions and the amount of the grant are approved each year in a strategic plan. The current 36th strategic plan applies to the period from 2007 to 2010.

A condition attached to the granting of investment subsidies is that the created perma-nent jobs have to be maintained over a period of at least five years after the completion of the investment project.

Investments, which may qualify for subsidies, include:

The setting up, expansion, reorganization, or fundamental rationalization / mod-ernization of a manufacturing facility,

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The acquisition, by an external investor at market conditions, of a manufacturing facility which has been closed down or is threatened with closure, and

The creation of telecommuting jobs.

The investor is required to provide an appropriate portion of the equity (at least 25 %) to qualify for the grant. Investment subsidies are generally granted only if the project will be completed within 36 months.

Those entitled to apply may choose between subsidies for capital equipment or for labor costs.

In the case of subsidies for capital equipment, the relevant costs include:

The purchase cost or manufacturing cost of the fixed assets acquired,

The acquisition cost of intangible assets, to the extent that these have been acquired for consideration (excluding the purchase of affiliated companies), provided these assets are used exclusively in the business obtaining the subsidy,

The cost of leased assets, if capitalized in the books of the lessee.

All assets attracting subsidies must remain in the manufacturing facility claiming the grant for at least five years.

Investment projects not qualifying for subsidies include:

Replacement investments,

Financing costs entered as an asset,

The purchase or manufacture of various types of vehicles, or

The purchase of second-hand assets, unless these arise from the acquisition of manufacturing facilities which have been closed down or are threatened with clo-sure.

The maximum level of costs that are capable of attracting subsidies is currently € 500,000 for the creation of new jobs and € 250,000 for the protection of existing jobs. Under their own regulatory authority, most of the states (Länder) have had to further reduce this maximum subsidy level because of their poor fiscal condition.

In the case of subsidies for labor costs, the relevant costs include payroll costs (includ-ing social insurance contributions) incurred over a two-year period. The jobs subsi-dized must generate real net output and last for at least five years. The predominant part of the jobs subsidized must fulfill the following criteria:

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Jobs requiring superior qualifications,

Jobs creating notable added value,

Jobs in a department of superior innovational potential.

The level of the subsidy depends on the investment location. The regional development areas were revised on the basis of the Guidelines for Subsidies with Regional Scope 2007 – 2013 of the European Commission (Regional Guidelines). The joint initiative now distinguishes between four different grades of development areas. The former B Development Areas were classified as A or C Development Areas.

The A Development Areas comprise all states in eastern Germany except Berlin (i. e. Brandenburg, Mecklenburg-Western Pomerania, Saxony, Saxony-Anhalt, and Thuringia) as well as certain areas in Lower Saxony (Uelzen, Lüchow-Dannenberg).

The C and D Development Areas include Berlin as well as regions in western Ger-many with poor infrastructure, e. g. Passau, Bad Kissingen (Bavaria), Bremerhaven, Bremen (Bremen), Werra-Meißner, Kassel (Hesse), Emden, Braunschweig (Lower Saxony), Dortmund, Moenchengladbach (North Rhine-Westphalia), Kaiserslautern, Bad Kreuznach (Rhineland-Palatinate), Saarbruecken (Saarland), Flensburg, Kiel (Schleswig-Holstein). The area ranked first belongs to the C, the one mentioned second (if there is one) to the D Development areas.

In addition, E Development Areas were implemented as of January 1, 2004 in order to relieve tensions between the areas with high promotional preference and the areas with low or even no promotional preference, such as Schwandorf (Bavaria), Fulda (Hesse), Wolfenbüttel (Lower Saxony), Herzogtum Lauenburg (Schleswig-Holstein).

A general map of the Development Areas is included in Appendix 14.2. It shows the different Development Areas in Germany distinguished between Areas A to E. The following table summarizes the maximum rates of subsidy for these Development Areas.

Table 22: Summary of maximum subsidy rates

Development Areas Small enter-prises

Medium-sized enterprises

Other

A 50 % 40 % 30 %C 35 %* 25 %* 15 %*D 15 % 7.5 % 7.5 %;

€ 200,000 maximum over three years

* local variances possible


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Medium-sized enterprises are defined as enterprises

with fewer than 250 employees, and

with either turnover not exceeding € 50 million or a balance sheet total not exceed-ing € 43 million, and

in which less than 25 % of the enterprise is legally or beneficially owned by one or more enterprises that do not comply with this definition.

Small enterprises are defined as enterprises

with fewer than 50 employees, and

with turnover or a balance sheet total not exceeding € 10 million, and

in which less than 25 % of the enterprise is legally or beneficially owned by one or more enterprises that do not comply with this definition.

The above conditions must be cumulatively met in order to qualify for the investment subsidy.

The applications for subsidies have to be addressed to the appropriate office before the commencement of the project. Even if all requirements are met the investment subsidy cannot be enforced at law as a legal right. Once the investment project has been com-pleted, a statement showing how the funds have been applied should be prepared. If there has been improper use of the funds provided, the subsidies may be recaptured.

12.3.1.2 Loans at concessionary interest rates

Loans at concessionary interest rates are granted by various public credit institutions, such as the Kreditanstalt für Wiederaufbau – KfW (i e. KfW-Mittelstandsbank, KfW-Förderbank). The application for funds must be made by a private credit institution. The loans generally have maturities of between ten and twenty years. The maximum amount of the loan is between € 500,000 and € 10 million, depending on the subsidy program. Loans are granted, for example, for the following purposes:

Projects relating to permanent employment for unemployed individuals,

Investments by SMEs,

Cash assistance to deal with immediate liquidity problems in SMEs,

Leasing of industrial property,

Investments in environmental protection,

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Construction or expansion of photovoltaic plants,

Investments in renewable energy sources (biomass, biogas, geothermal, and hydro-electric power plants),

Development and launch of innovations,

Capital Resources Aid (under various conditions).

Loans are also available for business start-ups. Interest-subsidized loans are currently available for amounts between € 25,000 and € 2.0 million.

12.3.1.3 Guarantees

Guarantees may be provided for investments in projects and equity interests if the required loan financing cannot be guaranteed using the enterprise’s own customary bank surety and if the project would otherwise not materialize due to insufficient surety.

Some of the guarantees are extended by public credit institutions and some by private guarantee banks. The extent of the guarantees or surety arrangements varies. In many cases, up to 80 % of the loan amount is guaranteed. All applications for guarantees should be made through a private credit institution to the guarantee bank concerned.

12.3.2 Key areas for grants

12.3.2.1 Research and development

R&D grants are available in selected fields of technology through specialized pro-grams run by the German Federal Ministry for Education and Research. Support is given in this way for projects which are of considerable interest and are associated with a high level of technical and economic risk. Currently, the grants apply to six fields of research:

Research in natural sciences including climate and environmental research and energy research,

New technologies,

Information and communications technology,

Biotechnology, health research, job organization, and design,

Transport, space travel, construction,

Innovations in states in eastern Germany.


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Those entitled to apply are industrial enterprises, research institutes, and higher educa-tion establishments. The R&D grants are targeted particularly at small and medium-sized businesses that have the personnel and resources needed to carry out correspond-ing research and development work.

Grants (which are project-linked and non-repayable) of up to 50 % of the eligible costs require expert approval prior to the commencement of the project.

12.3.2.2 Human resource development

Investment in human resource development is subsidized by the European Social Fund (ESF) and is reflected in a number of federal and regional development programs.

Grants are given to programs that develop the professional skills of individuals, par-ticularly those of individuals who have difficulty finding or keeping a job or are return-ing to work after a career break. Moreover, the European Social Fund supports Mem-ber States in their efforts to develop and introduce new, active policies and strategies to combat the causes of unemployment and to improve professional qualifications.

12.3.2.3 Environmental protection

Loans at concessionary rates of interest are granted to most development programs where the main purpose is to promote investment in environmental protection on a large scale. Such assistance is given for programs in the following areas:

Air pollution control,

Noise abatement,

Water pollution control / Sewage water treatment,

Waste disposal / Reclamation of contaminated industrial sites,

Energy conservation / Renewable energy sources.

Some investment in the field of innovative environmental technology is subsidized directly. Interest subsidies may also be given to reduce the cost of loans.

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13 Labor Law

13.1 Residence and work permits

A foreign national who intends to work in Germany for a resident or a non-resident employer generally requires a residence permit and a work permit (see chapter 1.6.1). He or she also needs a tax card (Lohnsteuerkarte) and a social security number (Sozial-versicherungsnummer).

13.2 Employment

13.2.1 Employment contract

Employment contracts should be entered into, or confirmed by the employer, in writing (Nachweisgesetz). However, a lack of written form does not render the contract void or unenforceable. An employment contract can be concluded for an indefinite period or a limited period (fixed-term contracts). A clause limiting the term of an employment contract (fixed-term contract) is enforceable if an acceptable justification for the time limitation exists, e. g. work on a temporary project. In addition, fixed-term contracts are also valid without objective justification in three primary cases, provided the dura-tion of the contract is fixed according to the calendar. (i) Fixed-term employment for periods of up to two years is permissible if the employee did not previously work for the same employer. (ii) Fixed-term employment is permissible in the first four years after the formation of a company (start-up period). (iii) Fixed-term employment is per-missible for periods of up to five years for employees who are 52 years of age or older at the time of hiring and have been unemployed for at least four months immediately prior to commencement of the fixed-term contract. This exception also applies to employees who meet the age requirement, but were not technically unemployed because they were drawing certain transitional benefits or held a publicly subsidized job. Time limitations are unenforceable unless in writing. Employees wishing to chal-lenge a time limitation in their employment agreement must file an action in the labor court for declaratory judgement that the employment relationship continues despite expiration of the specified deadline. The filing deadline is three weeks from the date of termination according to the contract.

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Labor Law



13.2.2 Terms of employment

The employer and the employee are generally free to agree on the terms of the employ-ment contract. However, this right is limited by mandatory provisions of the law and by collective bargaining agreements (Tarifverträge) and works council agreements (Betriebsvereinbarungen).

13.2.2.1 Working hours

Generally, the German work week is between 35 and 40 hours. The maximum work week allowed by law is 48 hours (Arbeitszeitgesetz).

13.2.2.2 Paid vacation

The statutory minimum vacation entitlement is 20 days per calendar year, based on a normal five day working week (at least four weeks of paid vacation annually).

13.2.2.3 Continued payment of salary in the event of illness

The law requires employers to continue to pay employees during the first six weeks of absence from work due to illness (see chapter 13.4.2.1).

13.2.2.4 Discrimination

In 2006, the German parliament enacted general anti-discrimination legislation (Allge-meines Gleichbehandlungsgesetz – AGG). This new legislation is based on EU equal treatment and anti-discrimination directives and is commonly referred to as the anti-discrimination law. The new bill prohibits discrimination based on race or ethnic ori-gin, gender, religion, disability, age, or sexual identity. The AGG enables employees to sue their employers for “punitive damages” if the employers fail to protect them against discrimination in the workplace.

13.2.2.5 Requests to work part-time

Any full-time employee who has been employed for more than six months by the same employer may request that he or she be employed on a part-time basis instead, pro-vided the employer employs more than 15 persons. The employer must grant this request unless it is unfeasible for operational reasons, e. g. because the reduction of working time would have a negative impact on the organization, work flow, or safety, or would lead to excessive costs. Other acceptable reasons for refusal may be specified by collective bargaining agreements.

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13.2.2.6 Maternity and parental leave

For the last six weeks of pregnancy and the first eight weeks after giving birth, moth-ers are not permitted to work (maternity leave, Mutterschaftsurlaub). The law requires employers to continue to pay mothers during their maternity leave. Furthermore, the mother or the father may elect up to three years’ special postnatal leave to care for and raise the new-born child (parental leave, Elternzeit). For a period of 12 months, the parent who stays at home receives a monthly tax-free allowance amounting to 67 per-cent of his or her last net take-home pay or € 1,800, whichever is less. The allowance is paid by the federal government. The contractual relationship between the employer and the employee is suspended during parental leave. Once parental leave has ended, the parent has the right to resume his or her former job or a similar position with the same employer.

13.2.3 Termination of employment

Employment contracts can be terminated by either party by giving notice of termina-tion (Kündigung) to the other contracting party. The notice of termination must be in writing in order to be effective. German labor law distinguishes between “ordinary termination” (discretionary dismissal without cause effective at the end of a notice period) and “extraordinary termination” (dismissal for cause with immediate effect). Minimum periods of notice are stipulated by the law (Bürgerliches Gesetzbuch). Gen-erally, a statutory notice period of four weeks applies. The statutory notice period for termination by the employer increases with the length of the employment (for instance, employment of five years extends the notice period to two months). Statutory notice periods are minimum notice periods and can be shortened only by collective bargain-ing agreements. When concluding an employment contract, the parties often agree on a probationary period (Probezeit) of up to six months. During this period, the employer and the employee can terminate the employment on only two weeks’ notice.

Extraordinary dismissal is permissible if there is reasonable cause (wichtiger Grund) for immediate termination. In order to constitute reasonable cause, the circumstances must be such that continuing the employment until the end of the regular notice period (or, for fixed-term contracts, until the contractual expiration date) would be unreason-ably burdensome (unzumutbar) for the employer. Criminal acts against the employer or colleagues are examples of reasonable cause. Extraordinary dismissal is only pos-sible within two weeks of the time the employer learns the facts on which the termina-tion is based.

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Labor Law



Fixed-term contracts terminate automatically at the end of their agreed term. They are subject to termination without cause (“ordinary termination”) only if this has been agreed in the individual agreement or the applicable collective bargaining agreement.

Employees wishing to challenge the validity of their dismissal must file a complaint before a labor court within three weeks of the date on which they have received the notice of dismissal.

Certain groups of employees, such as works council members, disabled employees, pregnant women, and employees on parental leave, have special protection against dismissal.

If a works council (Betriebsrat) exists, the employer is obliged to consult it in every case before dismissing an employee, even though the council’s response does not bind the employer. Termination without proper hearing of the works council is ineffective.

13.2.4 Job security legislation

The right of the employer to terminate employment contracts without cause (“ordinary termination”) is severely restricted by the Employment Protection Act (1951 Kündigungsschutzgesetz – KSchG, last amended in 2006). In general, it applies to all employees who have worked for the employer for more than six months, provided the employer has more than ten employees (five employees for persons who have held their job since December 31, 2003). Discretionary termination of an employment contract with an employee covered by the Act is ineffective unless the employer can prove that the termination is “socially justified.” As a rule, “social justification” is deemed to exist only if the termination is occasioned by reasons relating to the person or the behavior of the employee or by urgent business reasons that prevent the continuation of the employment. For terminations based on business reasons, the employer has to take social factors into consideration in selecting the employees to be discharged (Sozial-auswahl). These social factors include the duration of employment, the employee’s age, spousal and child support obligations, and disabilities.

13.3 Labor regulations

13.3.1 Collective bargaining agreements

In Germany, there are numerous legal provisions which establish a general framework for wages and salaries, as well as for other terms and conditions of employment. The detailed terms and conditions (e. g. the amount wages and salaries and their constituent elements, working hours, notice periods, holidays, and non-mandatory social insur-

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ance payments made on the employees’ behalf) are generally agreed in the course of collective negotiations between the trade unions (Gewerkschaften) and the employer associations (Arbeitgeberverbände). The individual trade union enters into collective bargaining agreements (Tarifverträge) through collective bargaining with the employer or employer association either at the national, regional or local level, or at the company or industry sector level. Each collective agreement consists of two parts: The first part deals with the rights and duties of the contractual partners. The parties’ two main obli-gations are to maintain the industrial peace and to use all available means to ensure that their members abide by the agreement. The second part sets forth rules related to labor contracts, to operational questions, and to the works constitution within the meaning of the Works Constitution Act. Only members of the trade union and mem-bers of the employer association are actually bound by the agreements. In practice, there is rarely any discrimination against employees who are not trade union members because the employers wish to avoid further organization of employees in trade unions. The German Federal Ministry of Labor and Social Affairs (Bundesministerium für Arbeit und Soziales) may, at the request of one of the negotiating parties, declare a col-lective bargaining agreement to be universally binding. If such a declaration is made, the agreement applies to all employees in the industry sector and geographic region, even if their employer is not a member of the respective employer association.

In principle, the terms and conditions of employment for executive staff (leitende Ange-stellte) are not covered by collective bargaining agreements, but are subject to indi-vidual agreements instead. Executive staff is defined under the German Works Consti-tution Act (Betriebsverfassungsgesetz – BetrVG, see below) as those employees who are entitled independently to hire and dismiss employees in the company, have full power of attorney or procuration (Prokura), or regularly make management decisions.

The Confederation of German Employer Associations (BDA) is a national umbrella organization, consisting principally of employer associations classified by industry sector. The BDA formulates and represents the interests of employers at the national and international level, for example by developing financial, employment, social and training policies.

The German Trade Union Federation (DGB) is an umbrella organization which coor-dinates the positions of eight trade unions from all fields of industry in their dealings with the political decision-makers. The DGB defends the interests of the employees who are members of its member trade unions.

Labor regulations

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13.3.2 Co-determination and works councils

Employee participation, i. e. the ability and right of employees to influence company decision-making processes, takes place in Germany mainly through the works council (Betriebsrat) (at the operational level) and the supervisory board (Aufsichtsrat) (at the company level).

At the company level, the Coal, Steel, and Iron Industry Co-Determination Act (Mon-tanMitbestG 1951, last amended in 2004) requires stock corporations (AGs) and lim-ited liability companies (GmbHs) in the coal, steel, and iron industry with more than 1,000 employees to grant employees equal representation in the Supervisory Board, meaning that the Supervisory Board consists of an equal number of shareholder and employee representatives. To avoid stalemates, the Supervisory Board also has a neu-tral member who has no allegiance to either the employees or the shareholders. Fur-thermore, a human resource director, who may not be elected without a majority of the votes cast by the employee representatives, is appointed to the management board and is ranked equally with other board members.

The Act on the Co-Determination of Employees (MitbestG 1976, last amended in 2005) requires stock corporations (AGs), limited partnerships with share capital (KGaAs), and limited liability companies (GmbHs) with more than 2,000 employees to have equal representation for the employees and the owners of the company. In stale-mate situations, the Chairman of the Supervisory Board, who generally represents the interests of the owners, has a double vote. The human resource director is appointed to the management board and is ranked equally with other members of that board. In contrast to the rules set out in the Coal, Steel, and Iron Industry Co-Determination Act (MontanMitbestG) referred to above, this appointment can be made without a majority vote from the employee representatives.

The One-Third Participation Act (DrittelbG 2004, replacing identical provisions in the BetrVG) requires one third of the members of the Supervisory Board to be employee representatives in the case of all AGs, KGaAs, and GmbHs with more than 500 employees, and in the case of all AGs and KGaAs which were entered in the com-mercial register prior to August 10, 1994 but are not family-owned companies.

Co-determination at the operational level is governed principally by the German Works Constitution Act of 1972 (Betriebsverfassungsgesetz – BetrVG 1972, last amended in 2004). This law applies irrespective of the legal form of the company. In all enterprises with more than five permanent employees who are entitled to vote, an elected works council (Betriebsrat) must be established at the employees’ request. The main function of the works council is to monitor all laws, regulations, collective bar-

187



gaining agreements, and works council agreements (Betriebsvereinbarungen) appli-cable to the employees. Works council agreements are agreements between the works council and the employer which are binding on the enterprise’s workforce and consist of detailed regulations governing the terms and conditions of employment (e. g., work-ing hours, the timing of breaks, and safety issues). However, wages and other working conditions which are regulated or normally regulated by collective bargaining agree-ments are not permitted to be the subject of a works council agreement. The works council may also play a role in training, perform consultation and advisory duties, and have nomination rights, participation rights and co-determination rights in personnel, organizational, and economic matters. The number of works council members within an enterprise increases with the number of its permanent employees.

A central works council (Gesamtbetriebsrat) must be established in companies with multiple works councils at different business locations (Betriebsstätten). The local works councils are not subordinate to the central works council. Rather, the central works council is responsible for dealing with matters which relate to the company as a whole or to several business locations and which cannot be settled by the local works councils or which require uniform resolution throughout the entire company.

In a consolidated group (Konzern) in which there are works councils in more than one company, a group works council (Konzernbetriebsrat) can be established in order to represent the interests of all employees of the company group. The group works coun-cil is responsible for dealing with matters which relate to the group or to several group companies and cannot be settled by the individual works councils (e. g. welfare ser-vices with group-wide effect) or which require uniform resolution throughout the entire group.

In the case of enterprises operating throughout the European Union, the European Works Councils Act (Gesetz über Europäische Betriebsräte – EBRG 1996, last amended in 2000 – transposing the European Works Councils Directive of September 22, 1994 into German law) requires a European Works Council to be set up by means of an agreement if the employees so request. If no agreement can be reached, the Euro-pean Works Council is established by law. An enterprise operating throughout the European Union is defined as an enterprise which has at least 1,000 employees in the member states of the European Union and has at least 150 employees in each of at least two different member states. The European Works Council consists of employees of the enterprise operating throughout the European Union, i. e. one representative from each member state in which the enterprise operates. Once every calendar year, the European Works Council should be informed and consulted by the management of the enterprise operating throughout the European Union about business developments and

Labor regulations

188

Labor Law



future prospects of the enterprise, and should be provided with the necessary docu-ments relating to these topics on a timely basis. Furthermore, the European Works Council has to be informed and – on demand – consulted regarding extraordinary mat-ters, e. g. cross-border production outsourcing.

The Societas Europaea Act (SEEG – Gesetz zur Einführung der Europäischen Gesell-schaft, 2004) enables companies to merge into a so-called Societas Europaea (SE). The SE is the first corporate entity to be uniformly available in all EU member states. The details of the co-determination system applicable to the employees of an SE are basically subject to negotiation between a special committee acting on behalf of the employees of the merging companies and the management of those companies. If a consensus cannot be achieved, an SE-works council is established by law. Further-more, if a German corporation is involved, the German co-determination rules apply. The number of employee representatives in the SE’s Supervisory Board or Board of Administration (Verwaltungsrat) is equal to the highest number of employee represen-tatives in any of the merging companies. Since the German co-determination rules provide for equal representation or one-third representation for employees (depending on the number of employees of the company), the German co-determination rules typ-ically determine the number of employee representatives in an SE where a German corporation is involved.

New rules for cross-border mergers are set out in the Employee Participation Act (MgVG – Gesetz über die Mitbestimmung der Arbeitnehmer bei einer grenzüberschrei-tenden Verschmelzung, 2006). The system of employee participation is very similar to that which applies when establishing an SE by way of a merger. However, there are some important differences. Unlike the rules governing employee participation in an SE, the Employee Participation Act provides for employee participation only at the board level, not at the operational level.

13.4 Labor costs

13.4.1 Wage regulation

Employment contracts normally provide for salary or wages payable on a monthly basis. When employment contracts are subject to universally binding collective bar-gaining agreements (allgemeinverbindliche Tarifverträge) specifying a particular minimum payment, the salary or wages must equal or exceed the minimum amount for the relevant job.

In the past, Germany was one of only five European Union countries without a statu-tory minimum wage. In autumn 2007, the introduction of a statutory minimum wage

189



became the subject of political controversy. As an initial result, minimum wage legis-lation was enacted for Germany’s postal sector effective January 1, 2008.

13.4.2 Social insurance system

The German public social insurance system provides for pension insurance, health insurance, nursing care insurance, unemployment insurance, and accident insurance. In general, social insurance coverage is mandatory for all employees working in Ger-many, regardless of their citizenship or the residence of their employer. Employees temporarily transferred by a foreign employer to a German branch of the same enter-prise are generally exempt from German social insurance contributions. In order to qualify for the exemption, employees must be able to prove their intention to return to their home country, and the foreign employer must retain the essential functions of an employer, such as decisions about salaries, promotion, transfers, etc. The critical factor for the German authorities is whether the employee remains on the non-German pay-roll.

The employer and the employee in general pay equal contributions to the insurance system, except for statutory accident insurance, which is borne entirely by the employer. The employer’s portion of social insurance contributions does not constitute taxable income for the employee. The employer is liable for remitting its contributions as well as those of the employee and generally deducts the employee’s portion from wages or salaries.

13.4.2.1 Health insurance and nursing care insurance systems

Health and nursing care insurance is mandatory for employees. Contributions are computed as a percentage of earnings and are generally shared equally by the employer and employee. The current rates for health insurance are around 14 % (shared equally by the employer and employee), with a 0.9 % supplement paid solely by the employee. The current rate for nursing care insurance is 1.95 %. A childless employee must pay an additional contribution of 0.25 % to the nursing care insurance system.

The wage and salary amount that is subject to insurance contributions is capped. In 2008, the applicable ceilings for health and nursing care insurance contributions are € 43,200 per year or € 3,600 per month. Wages and salaries in excess of these amounts are not counted when calculating health and nursing care insurance contributions. Employees may opt for private health insurance instead of public insurance if they can show that their gross annual salary in 2008 exceeds € 48,150 and that their gross annual salary exceeded the respective upper income limit in the last three years as well. Employees who opt for private health insurance are usually legally entitled to a

Labor costs

190

Labor Law



tax-free reimbursement from the employer of 50 % of the respective premiums, up to one half of the maximum contribution payable under the public system.

In general, the public health insurance system covers the employee and his or her fam-ily and provides benefits that include medical and dental treatment, prescription medi-cines, and under certain conditions, glasses (i. e. for children under 18 years), preven-tive examinations, maternity care, hospitalization, and surgery. However, some restric-tions do apply. The nursing care insurance system provides long-term care benefits.

If an employee is ill, the employer is required to continue paying the employee 100 % of his or her normal income for a period of six weeks. Once the six-week period has elapsed, the employee receives payments from the health insurance system. The gov-ernment scheme will pay a percentage of one’s income up to a maximum of approxi-mately € 2,520 per month as statutory sick pay. This sick pay is generally not subject to a time limit, although it cannot exceed 78 weeks in the case of one and the same illness within a period of three years.

13.4.2.2 Public pension insurance system

Combined employer and employee pension contributions currently amount to 19.9 % of the employee’s gross monthly earnings. For 2008, pension insurance contributions are calculated on the basis of monthly earnings up to € 5,300 (€ 4,500 in the East Ger-man states).

The annual ceiling amount for the calculation of pension insurance contributions is € 63,600 (€ 54,000 in the East German states). The ceiling amounts are generally increased annually.

The public pension system provides for old age, disability, survivors’, and orphans’ pensions, and some rehabilitation treatments. Old-age benefits are normally available from age 65. However, in March 2007 the Bundestag increased the statutory retire-ment age from 65 to 67. The statutory retirement age will be raised incrementally starting in 2012 and reach age 67 in 2029 for those born in 1964 or later. The mini-mum vesting period for old age, disability, and survivors’ pensions is five years. Pen-sions are computed on the basis of a formula which takes account of factors such as the insured’s gross income, the average income of all the persons insured by the system, and the recognized period of coverage. Pensions are generally adjusted annually depending on the development of the general earnings level. In 2005, the ratio of the number of retired persons to the number of contributors was added as a supplementary pension adjustment factor (Nachhaltigkeitsfaktor). Since then, pensions have not risen as fast as wages and salaries as a consequence.

191



The taxation of public pensions was radically changed in 2005. Until 2004, beneficia-ries paid tax only on the “income portion” of their pension payments. The taxable por-tion varied depending on the age of the recipient at the time of the first pension pay-ment (e. g. 27 % for persons retiring at age 65). Starting in 2005, the taxable portion of the pension depends solely on the calendar year in which the first payment occurs; the beneficiary’s age is irrelevant. Under the new regime, full taxability of pension pay-ments is phased in over a transition period that begins in 2005 and ends in 2040. For pensions first drawn in the years 2005 ff., a tax-exempt amount is determined by apply-ing a percentage – the so-called exemption quota – to the monthly pension in the initial year. The amount so determined remains fixed for the duration of the pension; hence subsequent increases in the pension amount do not alter the amount of the exemption. For pensions commencing in 2005, the exemption quota is 50 %. For pensions com-mencing in subsequent years, the exemption quota decreases in steps of 2 % annually through 2020, then 1 % from 2021 to 2040, so that pensions commencing in 2040 or thereafter are fully taxable.

13.4.2.3 Unemployment insurance system

As of January 1, 2008, unemployment insurance contributions are calculated as 3.3 % of an earnings base that is capped at € 63,600 annually or € 5,300 monthly. For the East German states, the ceiling is € 54,000 annually or € 4,500 monthly. The employer and the employee each pay half of the contribution. Unemployment insurance provides benefits in the event of termination of employment, layoffs due to weather conditions (e. g. in the construction industry), and temporary layoffs due to reduced production levels.

In addition, this type of insurance is used to fund a broad range of vocational training courses designed to help former employees find alternative employment.

13.4.2.4 Statutory accident insurance

Contributions to the cooperative associations for statutory accident insurance and accident prevention (Berufsgenossenschaften) are determined on the basis of a rating of the risks applicable to each individual enterprise. This rating depends, in turn, on the industry sector in which the enterprise operates. The contribution will typically range from 0.5 % to 4 % of the total payroll amount. The cost is borne solely by employ-ers, who are mandatory members of the cooperative associations for their particular industry.

The cooperative associations provide benefits in case of occupational diseases, as well as for injuries suffered at work or on the way to or from work. The benefits include

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Labor Law



medical and hospital treatment, rehabilitation therapy, sick pay, as well as disability, survivors’, and orphans’ pensions.

13.4.2.5 International agreements

The European Union has established regulations on social insurance which provide for reciprocal coverage among the member states of the EU and the European Economic Area (EEA). With the eastward expansion of the EU, the European regulations regard-ing social insurance have also been applicable to the following countries since May 1, 2004: the Czech Republic, Cyprus (Greek part), Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Romania, Slovak Republic, Slovenia; and since January 1, 2007 to Romania and Bulgaria. Additionally, Germany has entered into social insurance agree-ments with Australia (on pension insurance only), Bosnia and Herzegovina, Bulgaria, Canada (on pension insurance only), Chile (on pension insurance only), China (on pen-sion insurance only), Croatia, Israel, Japan (on pension insurance only), Korea (on pen-sion insurance only), Macedonia, Morocco, Serbia and Montenegro, Switzerland, Tunisia, Turkey, and the United States (on pension insurance only). In general, these agreements provide that an expatriate continues to contribute only to the social insur-ance plan in his or her home country if the stay in the other country does not exceed 12 to 24 months. In most cases, an extension can be applied for. Generally, people can choose between the social security systems of the two countries. According to the agreements, past work credits from both countries are combined for the purpose of determining eligibility for social security benefits under one of the two systems.

Under German domestic law, in principle no pension payments are made to non-resi-dent aliens. However, an expatriate leaving Germany may apply for a refund of the employee portion of the contributions made to the German pension system at any time once two years have passed since the last contributions were payable.

The social insurance agreements that Germany has concluded generally allow pension payments to foreigners living abroad. Most agreements provide for a voluntary con-tinuation of contributions once a foreigner lives abroad, but do not permit a one-time refund.

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14 Appendix I

14.1 Table of withholding tax ratesCountry Dividends Interest Royalties

Individuals, companies

(%)

Qualifying companies 1

(%) (%) (%)

Argentina 15 15 10/15 15Armenia 15 15 5 0Australia 15 15 10 10Austria 15 5 2 0 3 0 3

Azerbaijan 15 5 10 5/10Bangladesh 15 15 10 10Belarus 15 5 5 3/5Belgium 15 15 2 0/15 3 0 3

Bolivia 10 10 15 15Bosnia-Herzegovina 15 15 0 10Bulgaria 15 15 2 0 6 5 6

Canada 15 5 0/10 0/10China (People’s Rep.) 10 10 10 7/10Croatia 15 5 0 0Cyprus 15 10 2 10 3 0/5 3

Czech Republic 15 5 2 0 3, 4 5 3

Denmark 15 5 2 0 3 0 3

Ecuador 15 15 10/15 15Egypt 15 15 15 15/25Estonia 15 5 2 10 3 5/10 3

Finland 15 10 2 0 3 0/5 3

France 15 5 2 0 3 0 3

Georgia 15 15 5 0Greece 25 25 2 10 3 0 3

Hungary 15 5 2 0 3 0 3

Iceland 15 5 0 0India 10 10 10 10Indonesia 15 10 10 7.5/10/15Iran 20 15 15 10Ireland 10 10 2 0 3 0 3

Israel 25 25 15 0/5Italy 15 10 2 0/10 3 0/5Ivory Coast 15 15 15 10Jamaica 15 10 10/12.5 10Japan 15 15 10 10Kazakhstan 15 5 10 10

Table of withholding tax rates

194

Appendix I



Country Dividends Interest RoyaltiesIndividuals, companies

(%)


(%) (%) (%)

Kenya 15 15 15 15Korea (Rep.) 15 5 0/10 2/10Kuwait 15 5 0 10Kyrgyzstan 15 5 5 10Latvia 15 5 2 0/10 3, 4 5/10 3, 4

Liberia 15 10 0/10/20 10/20Lithuania 15 5 2 0/10 3, 4 5/10 3, 4

Luxembourg 15 10 2 0 3 5 3

Macedonia 15 15 0 10Malaysia 15 5 15 10Malta 15 5 2 0 3 0 3

Mauritius 15 50/unlim-

ited 15Mexico 15 5 0/10/15 10Moldova 15 15 0/5 0Mongolia 10 5 10 10Morocco 15 5 10 10Namibia 15 10 0 10Netherlands 15 10 2 0 3 0 3

New Zealand 15 15 10 10Norway 15 0 0 0Pakistan 15 10 10/20 10Philippines 15 10 0/10/15 10/15Poland 15 5 2 0/5 3 5 3, 4

Portugal 15 15 2 10/15 3 10 3

Romania 15 5 2 0/3 7 3 7

Russia 15 5 0 0Serbia 15 15 0 10Singapore 15 5 0/8 8Slovak Republic 15 5 2 0 3, 4 5 3

Slovenia 15 5 2 0/5 3 5 3

South Africa 15 7.5 10 0Spain 15 10 2 10 3 5 3

Sri Lanka 15 15 10 10Sweden 15 0 2 0 3 0 3

Switzerland 0/5/15/30 0 0 0Tajikistan 15 5 0 5Thailand 20 15 0/10/25 5/15Trinidad and Tobago 20 10 10/15 0/10Tunisia 15 10 10 10/15Turkey 20 15 15 10Turkmenistan 15 15 5 0

195



Country Dividends Interest RoyaltiesIndividuals, companies

(%)


(%) (%) (%)

Ukraine 10 5 2/5 0/5United Arab Emirates 15 5 0 0United Kingdom 15 15 2 0 3 0 3

United States of America 15 5 8 0 0Uruguay 15 15 15 10/15Uzbekistan 15 5 5 3/5Venezuela 15 5 5 5Vietnam 15 5 5/10 0/10 7.5/10Zambia 15 5 10 10Zimbabwe 20 10 10 7.5

1 The rates in this column apply if the holding is at least 25 % of the German company’s capital or voting power (Austria, Canada, Denmark, France, Kuwait, Malta, Mexico, Mongolia, Namibia, Poland, Romania, Russia, Sweden, Tajikistan, Turkey, USA, United Arab Emirates: 10 %, Morocco, Pakistan, Switzerland, Ukraine: 20 %).

2 Upon request dividend payments to qualifying EU companies are exempt from withholding tax (see chap-ter 6.2.1.8.1). Notwithstanding the foregoing, dividends are allowed to be taxed at the source in Estonia until Dec. 31, 2008 if there is no taxation when profits are retained.

3 Upon request interest and royalty payments to qualifying EU companies are exempt form withholding tax (see chapter 6.2.1.8.3).

4 For these countries there is a transitional period of up to 6 years (May 1, 2010) for royalties or interest or both.

5 The lower rate applies if the holding is at least 70 % of the share capital in the German company.6 For Bulgaria there is a transitional period up to 9 years (December 31, 2014) for royalties or interest or

both.7 For Romania there is a transitional period up to 4 years (December 31, 2010) for royalties or interest or

both.8 Complete elimination of taxation at the source on cross border dividend distributions, provided the recipient

company holds at least 80 % of the voting rights in the distributing company and meets one of the require-ments listed in Article 28 Tax Treaty between Germany and the United States.

Table of withholding tax rates

196

Appendix I



14.2 Map of development areas in Germany

Liège

Praha

Zürich

Szczecin

Innsbruck

Amsterdam

Strasbourg

Luxembourg

GRW-Fördergebiete

© B

BR

Bon

n 20

06

100 km

Gemeinden, Stand 31.12.2003Datenbasis: Beschluss Bund-Länder-Planungsausschuss der GA vom20.02.2006

A - Fördergebiet

C - Fördergebiet

C - Fördergebiet (davon Städte/Gemeinden teilweise)

Teilweise C -, teilweise D - Fördergebiet

D - Fördergebiet

D - Fördergebiet (davon Städte/Gemeinden teilweise)

E-Gebiet (Schutzklausel/Einvernehmensregel)

keine Förderung

Fördergebiete der Gemeinschaftsaufgabe “Verbesserungder regionalen Wirtschaftsstruktur” 2007 - 2013in gemeindescharfer Abgrenzung

Teilweise C - Fördergebiet (keine Förderung von Großunternehmen/Großinvestitionen)

Teilweise C - Fördergebiet, teilweise E - Gebiet

Kreisgrenzen

Vorschlag: Karte deutscher Regionalfördergebiete 2007 - 2013(Beschluss Bund-Länder-Planungsausschuss der GA vom 20.02.2006,vorbehaltlich der Notifizierung durch die EU-Kommission)

Annotation to legend: Fördergebiete = development areas.

The above map of German regional development areas for the years 2007 – 2013 is based on a resolution adopted on February 20, 2006 by the German Federal-State Planning Committee (Bund-Länder-Planungsausschuss) for the Joint Task “Improving the Regional Economic Structure” (Gemeinschaftsaufgabe “Verbesserung der region-alen Wirtschaftsstruktur” – GA). The map was approved by the European Commission on November 8, 2006.

197



15 Appendix II

15.1 KPMG Deutsche Treuhand-Gesellschaft Aktien-gesellschaft Wirtschaftsprüfungsgesellschaft

National Office Post Box 303453Klingelhöferstrasse 18 10728 Berlin10785 Berlin T +49 30 2068-0 F +49 30 2068-2000

15.2 KPMG’s regional tax offices in Germany

Region North

Regional officeBremen Michaelis QuartierHamburg Ludwig-Erhard-Strasse 11–17Hanover 20459 Hamburg Post Box 111285 20412 Hamburg T +49 40 32015-0 F +49 40 32015-5000

Frank W. Grube T +49 40 32015-5610 F +49 40 32015-5608 [email protected]

Region West

Regional officeBielefeld Tersteegenstrasse 19–31Cologne 40474 DüsseldorfDortmund Post Box 300564Düsseldorf 40405 DüsseldorfEssen T +49 211 475-7000 F +49 211 475-6000

KPMG

198

Appendix II



Klemens Möller T +49 211 475-7318 F +49 211 475-6000 [email protected]

Region East

Regional officeBerlin Klingelhöferstrasse 18Dresden 10785 BerlinJena Post Box 303453Leipzig 10728 Berlin T +49 30 2068-0 F +49 30 2068-2000

Stefan Kiesewalter T +49 30 2068-4460 F +49 30 2068-2000 [email protected]

Region Central

Regional officeBad Homburg Marie-Curie-Strasse 30Frankfurt 60439 FrankfurtMainz Post Box 500520Saarbrücken 60394 Frankfurt T +49 69 9587-0 F +49 69 9587-1050

Dr. Helmut Rehm T +49 69 9587-4900 F +49 69 9587-1050 [email protected]

199



Region Southwest

Regional officeFreiburg i.Br Heßbrühlstrasse 21Mannheim 70565 StuttgartStuttgart Post Box 800625 70506 Stuttgart T +49 711 9060-0 F +49 711 9060-199

Dr. Frank Wiesmann T +49 711 9060-442 F +49 711 9060-199 [email protected]

Region South

Regional officeAugsburg Ganghoferstrasse 29Munich 80339 MunichNuremberg Post Box 201144Regensburg 80011 Munich T +49 89 9282-00 F +49 89 9282-2000

Wilfried Arbes T +49 89 9282-1040 F +49 89 9282-2000 [email protected]

KPMG’s regional tax offices in Germany

200

Appendix II



15.3 KPMG tax services in Germany

KPMG offers a wide range of tax services. From locations throughout Germany pro-fessionals provide tax services in the following service lines:

Corporate Tax Services

Providing tax advice to businesses is our primary area of focus. We offer our clients a broad range of services, from tax compliance services, the preparation of tax returns and global tax outsourcing services, to support and advice during corporate tax audits, to offering tax advice during legal proceedings. Corporate Tax Services also include support to develop and implement tax strategies for your business. We offer support integrating the tax strategies you have selected into your overall business strategy.

Ernst Gröbl (Member of the Board) T +49 89 9282-1464Ganghoferstrasse 29 F +49 89 9282-200080339 Munich [email protected]

Contact for Corporate Tax Compliance Services

Hans-Gerd Steenweg T +49 69 9587-2159Marie-Curie-Strasse 30 F +49 69 9587-223360439 Frankfurt [email protected]

Financial Services Tax

The Financial Services Tax Team specializes in providing tax advice to financial insti-tutions – particularly in the banking, insurance and investment management area.

Hans-Jürgen A. Feyerabend T +49 69 9587-2348Marie-Curie-Strasse 30 F +49 69 9587-215460439 Frankfurt [email protected]

Global Transfer Pricing Services

The Global Transfer Pricing Services Team develops concepts for the implementation of tax-optimized intra-group transfer pricing systems. When foreign subsidiaries and foreign permanent establishments are formed, the resulting intra-group flow of prod-ucts and services needs to be properly structured and documented. For this purpose, we conduct margin analyses, make royalty computations, and provide assistance parti-cularly in the creation of transfer pricing documentation systems.

201



Christian Looks T +49 69 9587-2259Marie-Curie-Strasse 30 F +49 69 9587-105060439 Frankfurt [email protected]

Indirect Tax Services

Our team of specialists supports you in the diverse areas of VAT and Customs & Trade. Complicated VAT and customs questions are increasingly common even for companies without a high level of international operations. Our specialists advise you how to minimize VAT and customs risks, optimize national and international flows of goods and services, and identify excise tax savings opportunities.

Wilfried Arbes T +49 89 9282-1040Ganghoferstrasse 29 F +49 89 9282-200080339 Munich [email protected]

International Corporate Tax Services

The International Corporate Tax Services team provides the global tax planning required by global companies. From in-bound and out-bound investment to hybrid financing strategies and post-merger integration, our professionals have the technical knowledge and practical experience needed to assist multinational clients at every stage of global growth to achieve tax efficiency in their international operations.

Dr. Martin Lenz T +49 211 475-7385Tersteegenstrasse 19–31 F +49 211 475-638440474 Düsseldorf [email protected]

International Executive Services

The International Executive Services Team provides you with comprehensive advice regarding the international placement of employees (expatriates) – particularly with respect to questions of taxation, social security, and international personnel issues.

Karl-Wilhelm Hofmann T +49 69 9587-2237Marie-Curie-Strasse 30 F +49 69 9587-105060439 Frankfurt [email protected]

KPMG tax services in Germany

202

Appendix II



People Services, Pensions

The Pensions team combines actuarial and legal skills to provide commercially focused and pragmatic advice on all aspects of pension plan design in the context of total rewards, funding, governance and risk management in Germany and abroad. Our fast growing team includes senior well known German industry players as well as actuaries from other European countries.

Roger Diener T +49 621 4267-410Theodor-Heuss-Anlage 12 F +49 621 4267-44468165 Mannheim [email protected]

Mergers & Acquisitions Tax Services

The purchase or sale of any business gives rise to complicated tax issues. Our advisors lead you through this process and accompany you during the integration of the target business. In addition to advice on the most tax efficient structure for the transaction, we also provide support when conducting due diligence. To enable us to provide inte-grated advice for every form of transaction, we work closely with our colleagues from Corporate Finance and Transaction Services.

Christian Jänisch T +49 69 9587-2293Marie-Curie-Strasse 30 F +49 69 9587-258460439 Frankfurt [email protected]

Tax Management Services

Increasing internal and external tax reporting requirements including the financial statements according to IFRS and US GAAP as well as good relationships with the fiscal authorities besides the compliance with corporate governance rules have become key indicators to the measurement of the performance of the tax function. Our core offerings are helping to manage and monitor tax as a business issue with a focus on tax process consulting, audit and accounting related tax services, tax settlements and tax technology.

Christoph Kromer T +49 69 9587-2587Marie-Curie-Strasse 30 F +49 69 9587-105060439 Frankfurt [email protected]

Frank W. Grube T +49 40 32015-5610Ludwig-Erhard-Strasse 11–17 F +49 40 32015-560820459 Hamburg [email protected]

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15.4 KPMG’s Country Specialists

Brazil Thorsten Amann Klingelhöferstrasse 18 10785 Berlin T +49 30 2068-1144 F +49 30 2068-4479 [email protected]

China Thorsten Amann Klingelhöferstrasse 18 10785 Berlin T +49 30 2068-1144 F +49 30 2068-4479 [email protected]

France Dr. Dagmar Weier Tersteegenstrasse 19–31 40474 Düsseldorf T +49 211 475-8362 F +49 211 475-6000 [email protected] Ralf Zender Tersteegenstrasse 19–31 40474 Düsseldorf T +49 211 475-7440 F +49 211 475-6000 [email protected]

India Amitabh Thakur Marie-Curie-Strasse 30 60439 Frankfurt T +49 69 9587-3323 F +49 69 9587-1050 [email protected]

KPMG’s Country Specialists

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Appendix II



Italy Brigitte Romani Marie-Curie-Strasse 30 60439 Frankfurt Tel. 49 69 95 87-2221 Fax 49 69 95 87-1050 [email protected]

Japan Andreas Glunz Tersteegenstrasse 19–31 40474 Düsseldorf T +49 211 475-7127

Korea Bernhard Schraut Marie-Curie-Strasse 30 60439 Frankfurt T +49 69 9587-2022 F +49 69 9587-2386 [email protected]

Brian Yoo Marie-Curie-Strasse 30 60439 Frankfurt T +49 69 9587-3228 F +49 69 9587-1050 [email protected]

Mexico Alexander Eichstaedt Osterstrasse 40 30159 Hannover T +49 511 8509-5268 F +49 511 8509-5180 [email protected]

Netherlands Ton te Dorsthorst Tersteegenstrasse 19–31 40474 Düsseldorf T +49 211 475-7296 F +49 211 475-6000 [email protected]

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Russia Lars Erik Bertram Marie-Curie-Strasse 30 60439 Frankfurt T +49 69 9587-2731 F +49 69 9587-1050 [email protected]

South Africa Thorsten Amann Klingelhöferstrasse 18 10785 Berlin T +49 30 2068-1144 F +49 30 2068-4479 [email protected]

German Tax Center of Excellence Switzerland Christopher E. Steckel

c/o KPMG Zurich Badenerstrasse 172 8026 Zurich Switzerland T +41 44 249-2270 F +41 44 249-2754 [email protected]

Turkey Ergün Kis Tersteegenstrasse 19–31 40474 Düsseldorf T +49 211 475-7857 F +49 211 475-6000 [email protected]

USA Bruno Wallraf Tersteegenstrasse 19–31 40474 Düsseldorf T +49 211 475-7246 F +49 211 475-6000 [email protected]

KPMG’s Country Specialists

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Appendix II



German Tax Center of Excellence in New York Eckart Nuernberger c/o KPMG New York

345 Park Avenue New York, NY 10154–0102 USA T +1 212 954-7950 F +1 212 954-5126 [email protected]

Vietnam Thorsten Amann Klingelhöferstrasse 18 10785 Berlin T +49 30 2068-1144 F +49 30 2068-4479 [email protected]

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KPMG is a global network of legally independent professional firms with about 123,000 employees in 145 countries.

In Germany too, KPMG is one of the leading auditing and advisory firms and has about 8,000 employees at over 20 locations. Our services are divided into the follow-ing functions: Audit, Tax and Advisory. Our Audit services are focused on the auditing of consolidated and annual financial statements. The Tax function incorporates the tax advisory services provided by KPMG. Our high level of specialist know-how on busi-ness, regulatory and transaction-related issues is brought together within our Advisory function.

We have established teams of interdisciplinary industry specialists for key sectors of the economy. These pool the experience of our specialists around the world and fur-ther enhance the quality of our advisory services.

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© 2008 KPMG Deutsche Treuhand-Gesellschaft Aktiengesellschaft Wirtschaftsprüfungsgesellschaft, a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in Germany.

KPMG and the KPMG logo are registered trademarks of KPMG International.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

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