Germany

GERMANY

The German Tax System

SYNOPSIS: The German tax authorities have one of Europe's most restrictive taxation systems. In particular, indigenous or indigenous based companies do not benefit from either the territorial tax system of countries like France or the general flexibility of the United Kingdom or Ireland. Further, the country's anti-avoidance provisions often benefit from a reverse burden of proof and severely limit the use of traditional offshore vehicles. Nevertheless, there is still much scope for German firms involved in international transactions to establish foreign subsidiaries, provided they can show both genuine local management and control and a bona fide commercial reason. Therefore, a country like Ireland will appear very attractive to German firms since: (i) It has no stigma and, (ii) the establishment of a genuine commercial but non-tax, reason will be relatively easy given the existence of a highly skilled workforce and competitive salaries and, (iii) Ireland is a full member of the EU making it difficult for the German fiscal authorities to imply any malfeasance. One reason behind this is that the EU has sanctioned Ireland’s ‘incentives’ as ‘desirable’ and, (iv) the German/Irish tax treaty provides that an Irish subsidiary of a German firm can repatriate dividends back to Germany free from further taxation in Germany, even if the subsidiary was only liable to the Irish 12.5% Corporate Tax Rate.

COUNTRY FACTS

Location: South of Denmark, north-east of France and west of Poland. Landmass, 138,000 sq. miles or 364,320 sq. kilometres Approximately the same size as Italy

Population: The unified Germany has a population of approximately 82,000,000 making it by far the most populated country in Western Europe

Development: Germany is Europe's greatest industrial and exporting power with a total gross national product not far below that of the United Kingdom and Italy combined. On a world level Germany is only behind the United States and Japan. Nevertheless, since unification with East Germany the country has faced considerable economic turmoil, inflationary pressures and spiralling taxes. Combined with, or perhaps because of these factors, there has also been a significant increase in social tension between former East and West Germans and ethnic minorities

Capital city: Berlin

Currency: The Euro (€)

Education level: Highly educated population

 

MAJOR LEGAL ENTITIES

COMPANIES: GmbH and AG's:

In Germany there are two principle corporate vehicles, the Gesellschaft mit beschrSnkter Haftung (a GmbH) and the Aktiengesellschaft (an AG). The former being a private company limited by shares whilst the latter is a public company limited by shares, which can theoretically be listed on a public stock exchange. Unlike France where 'public' companies (societes anonymes) constitute the favoured corporate bodies in Germany GmbH's, or private companies, are far more popular. The governing law in both cases derives from the German Commercial Code.

(i)                  GmbH's: In structure these are very similar to a French societe a responsibility limitee (a Sarl). To register a GmbH there need be only one shareholder and director who may, as in the case of a UK limited company, be the same entity. The minimum capitalisation required to establish a GmbH is €50,000.00 of which 50% must be paid up on registration. For companies requiring more than the minimum capitalization the basic rule is that in no circumstances must the paid up share capital be less than 25% of the total issued share capital. The liability of the shareholder/s is strictly limited to his/their investment, though in the case of partly paid shares creditors on liquidation can demand the balance. The liability of the company director/s (geschaftsfuher/s) is personally restricted save in circumstances where there has been an unauthorised or ultra vires act. If such an act has occurred then an innocent third party can normally enforce the agreement against the company. The company in turn being able to sue or claim damages against the director. Of course, all this becomes academic if the director and shareholder are one of the same. The formation procedure for a GmbH is relatively simple but the company's bylaws must be pre-notarised before being filed with the applicable local court. In most cases share certificates are not issued to the shareholders with equity stakes normally being internally recorded. All GmbH's must maintain full accountancy records and medium to large GmbH's also have to submit annual audits to the fiscal authorities. In the case of companies employing more than 500 people, it is also necessary to appoint a supervisory board (an aufsichtsrat) which is basically responsible to ensure that the company director/s adequately perform their duties

(ii)                AG^’s: Like a GmbH, an AG only requires a sole subscriber but is generally subject to greater disclosure and bureaucracy. The minimum capitalisation required is €80,000.00 with at least 25% being fully paid up at the time of registration. Unlike most GmbH's it is not only necessary to have a board of directors (which in the case of an AG is called the vorstan which, despite it's name may only have one member) but also a supervisory board (an aufsichtsrat) having at least 3 members. The purpose of the vorstan is to perform all normal management and control functions whilst the aufsichtsrat is effectively a representative body acting on behalf of the subscribers. The modis operandi of the aufsichtsrat being to monitor and assist the board in carrying out it's functions and in particular to prevent any ultra vires activities. Where ultra vires activities are found, the aufsichtsrat has the authority to dismiss the board of directors. In respect to the shareholders of an AG it is normal that bearer shares are issued and that any dispositions are notarised to confirm the veracity of the process. All AG's must maintain full accountancy records and submit to an annual audit. The process of initial registration is basically the same as for a GmbH save that before the submission of the notarised by-laws the initial shareholder/s must appoint the directors and the supervisory board. These boards confining to the court that all capitalization requirements have been satisfied       

COMPANIES: GmbH & Co. KG (FISCALLY TRANSPARENT)

AG GmbH & Co. KG (a Gesellschaft mit beschrSnkter Hafhmg und Kommanditgesellschaf) is a cross between a company and limited partnership. In effect, the GmbH is appointed the general Partner with the other partners enjoying limited Partner status. However, as the limited partners are mostly the owners of the general partner, GmbH full limited liability is normally secured. The reason this structure is generally employed is that it is fiscally transparent and need not submit annual audited accounts. Both these factors producing potential and often substantial savings. Of course, the GmbH part of the entity is subject to all the normal rules appertaining thereto as is the kommanditgesellschaf

PARTNERSHIPS: OHG's & KG's

German partnerships adhere to the European norm and can be divided into unlimited partnerships (offene handelgesellschaft or OHG's) and limited partnerships (kommanditgesellschaft or KG's). In respect to the OHG's, all partners are equally liable for partnership debts and will or should have two or more active participants. In respect to KG's this is a classic limited partnership with only the general or managing partner being liable beyond his or initial investment (for a full explanation see 'Basic Legal Entities' pages 4 to 6). The formation process OHG's and KG's is relatively straightforward and only requires the registration of the applicable partnership agreement with the local court. OHG and KG partnerships must keep accurate records but are fiscally transparent and subject to little bureaucracy.

BRANCH OF A FOREIGN COMPANY:

The registration procedure for a branch of a foreign company in Germany (a zweignniederlassung) is very similar to that required for a succursale in France. In both cases, there can be negative tax consequences for a registered permanent establishment unless there exists a suitable double taxation treaty. In the case of Germany, such a branch can be established by merely supplying a certified translation of the mother company's by-laws and certificate of incorporation together with a notarised application by the it's directors (confirmed by the applicable German consulate) together with confirmation of it's manager/representative in Germany to the local court. The benefits of a branch include low registration costs, no or minimal separate capitalisation and no annual auditing requirements

TAXATION OF GERMAN COMPANIES

The German corporate tax system is relatively complicated and makes a distinction between both the types of legal structure being employed and, distributed and undistributed profits. Therefore, advice is always recommended before establishing an entity in Germany. In addition, it should be noted that whilst the ostensible German corporate tax burden is reasonable, the real level will often be considerably higher and will include, net asset tax (vermogensteuer) and municipal trade tax (gewerbesteuer) plus the new continuing solidarity tax of 7.5% to assist in the re-integration of the former East Germany.

CORPORATE TAX (KORPERSCHAFTSTEUER)

BASIC FACTS: In synopsis, the corporate tax structure in Germany is as follows:

(i) INDIGENOUS NON-FISCALLY TRANSPARENT COMPANIES. All AG's and GmblTs (apart from a GmbH & CoKG) are liable to split-rate corporate taxes depending on whether profits have been distributed or not as dividends. The applicable rates being:

Retained Profits =    45%

Distributed Profits =    30%

The reason for the distinction is that Germany operates a tax credit system whereby domestic dividend recipients will receive the aforementioned after the company has deduced both the 30% corporation tax and a dividend withholding tax of 25%. Both these sums are then available as a tax credit against the recipients personal tax liability. In effect for German residents, there is a similar system to the French avoir fiscal whereby individuals who have a personal tax liability of less than 55% will be entitled to a refund of the difference between this rate and their individual tax rate liability. Therefore, if there was not a distinction between retained and distributed profits, companies would have to retain 70% of dividend distributions (45% plus 25%) leading to unnecessary bureaucracy and almost automatic refunds. In the case of foreign shareholders there is no tax credit available and (if there is no double taxation treaty) a further 25% withholding tax. Nevertheless, this situation is very unlikely given Germany's large treaty network and it's membership of the European Union. In respect to non-EU countries, the standard treaty withholding tax rate, where participation exemption criteria have not been met is 15% or if they have a participation exemption 5%. In other words, foreign non-EU shareholders will normally be faced with a total (including corporation tax) tax burden of between 35% and 45%. In the case of shareholders within the EU and able to satisfy the demands of Directive 90/435 there will be no withholding taxes whilst non-participating small investors will be subject to the normal 15% rate.

(ii) BRANCHES OF FOREIGN COMPANIES REGISTERED IN GERMANY:

Branches of foreign companies having a permanent establishment in Germany are subject to a fiat-rate tax of 42% on their German profits. The reason for the different rate is that a branch of a foreign company cannot be distinguished from it's mother in regards to share distributions. In other words, it is not possible to extrapolate the normal German tax system to such undertakings and hence, make a distinction between retained and distributed profits. Further, such entities will not be able to benefit from the normal German tax credits and for this reason are not subject to any withholding taxes. The question therefore becomes whether it is fiscally advantageous for a foreign investor to establish a branch or a separate German AG or GmbH. On the one hand, a branch operation allows for the integration of mother/branch accounts without requiring any additional (accepting that such is needed in the mother jurisdiction) audit requirements. On the other hand, there is a significant spread between the normal distributed profits rate of 30% and the 42% rate demanded from branches. Therefore, if the full withholding tax rate of 25% were applicable, a branch would be far more desirable than a German GmbH/AG since the branch would only have to pay it's normal 42% whilst the GmbH/AG would be liable to 30% plus the 25% withholding tax (total tax liability being 55%). However, such a situation is quite unlikely given the extensive German double taxation treaty network. In general terms, the following should be noted before making an election:

EU & Non-EU Investors (No participation exemption)

In such circumstances, a branch would normally be favoured since the standard German treaty withholding tax rate for portfolio/small investors is 15%. Therefore, on distribution, the tax liability would be, for a GmbH/AG, 30% plus 15% = 45%. For a branch it would be 42%.

Non-EU Investors (with a participation exemption)

Where a company meets the participation exemption criteria (normally requiring an equity holding of 10% to 25% in the German company) the withholding tax is normally reduced to 5% giving an effective 35% tax burden. Therefore, the creation of a local German company will be preferable.

EU Investors (with a participation exemption)

EU investors with a major participation will normally either satisfy EU Directive 90/435, which requires a 25% stake or, if the treaty definition of a major participation is lower, the treaty rate. In the first case, there would be no withholding taxes whilst in the second, generally a 5% withholding tax. Where there is a conflict, Directive 90/435 will take precedence

CAPITAL GAINS TAX

In Germany there is no distinction between capital gains and ordinary income. Therefore, the rates already mentioned for corporation tax will be equally applicable as, if appropriate, will be the other potential taxes. Nevertheless, it should be noted that in certain circumstances it is possible to benefit from rollover relief

VALUE ADDED TAX

As with all other EU members, Germany employs a value added tax system. Since the 1st of April 1998 the mainstream rate has been 16% but there is a lower 7% rate for certain "essentials" and price sensitive goods and/or services together with certain exempt or zero rated items

 

OTHER TAXES

The other main taxes currently applicable in Germany are as follows:

Insurance Tax: General insurance contracts are subject to a 15% surcharge on the before tax premium. However, certain exemptions are made for life and other specified insurances

Property Acquisition Tax: On the purchase of land or property an individual or company is liable to pay a 2% duty on the actual acquisition price. It will be noted that German property acquisition taxes are lower than in many other European countries

Land Tax: This is a sort of municipal ground rent charge against all land and properties. In most cases, the rates are negligible.

 

GERMAN GOVERNMENT INCENTIVES

In general the German government does not offer specific incentives, tax or otherwise, to those wishing to invest what was Western Germany. In addition, previous incentives available for investment in territories constituting the former German Democratic Republic (East Germany) are no longer available. Previously there were a number of concessions and/or incentives including exemption from the municipal trade tax on capital and accelerated depreciation concessions against fixed assets up to 50%.

EXAMPLE BENEFICIAL STRUCTURES

In Germany the anti-avoidance provisions are well developed and certainly cause difficulties for individuals (see below). Nevertheless, in general foreign and fiscally beneficial companies can be used provided they come from a 'respectable' jurisdiction and genuine management and control are established. For inward investment many tax treaties make it possible to avoid capital gains tax and the ubiquitous legitima portia principle. However, the main use for such companies is to transfer activities to more fiscally beneficial pastures.

USING A FOREIGN COMPANY TO CIRCUMVENT CORPORATION TAX LEVIED ON A CAPITAL GAIN

The most important point to note is that Germany does not have specific legislation, as do both France and Spain, against the use of a foreign company to acquire local property. Nevertheless, such a company must be protected by a suitable double taxation treaty whereby capital gains* can be exempted on the disposition of 'movable' property (i.e. the shares) in the foreign holding company. Of course, such a company must be careful not to be deemed to have a 'permanent establishment' in Germany or local taxation will apply in the normal manner. In respect to the choice of jurisdiction, either the United Kingdom or the Republic of Ireland (both having the necessary treaty provisions) would seem ideal candidates although other possibilities could include Luxembourg and the Netherlands The benefits of using an offshore company, at least for a non-German national/resident, could include:

(i) Circumvention of indigenous inheritance taxes.

(ii) Circumvention of Property Acquisition Tax on a future resale.

(iii) Avoidance of German taxes and, possibly, those of the 'holding' company jurisdiction.

(iv)  Avoidance of Net Asset Tax

 

CONCEPT OF RESIDENCE

In Germany residents pay income tax on their world-wide income (subject to any treaty exemption) whereas those deemed not to be resident are only liable to pay taxes on their German source income. Residence in Germany will normally exist if an individual has been in the country for more than 6 months (which may fell in two calendar years unless the purpose of the stay relates to an extended 'holiday' or convalescence, in which case the period will be extended to 12 months). Apart from straightforward physical residence, taxation can also be extended to one's world-wide income if it can be shown that one has a habitual place of abode' in Germany. This second test is to prevent foreign consultants, and other such people from performing ongoing work in Germany but nevertheless circumventing the normal definition and responsibilities of residence. The exact factors that would be considered in respect to residence and one's habitual place of abode would include:

(i) PHYSICAL RESIDENCE

In ascribing residence the German authorities would consider the objective facts relating to an individual such as the type of accommodation being enjoyed and the location of any family members. Therefore, if an individual had rented a flat for an eight-month period and had brought furniture from abroad it is quite possible that residence would be ascribed even if there were a genuine intention only to stay in Germany for 4 months (see S.8 abgabenordnung)

(ii) INFERRED RESIDENCE

An individual will be deemed to have a habitual place of abode (as indicated above) if for example, he habitually goes to Germany to carry out his work. The feet that the time physically spent in Germany could be well below 6 months is not the issue rather the ongoing nature of the transactions. Of course, it is possible to have treaty exemptions but this will depend on the nationality/residence of the person in question. It, of course, being possible to be legally resident in more than one country at a time (see S.9 abgabenordnung)

TAXABLE INCOME

Tax is charged on the annual disposable income from all sources (e.g. salary income, rental income). The tax year is the same as the calendar year. Employers pay salary after the deduction of social costs and income tax. All deductions are liable to be audited.

CALCULATION OF INCOME TAX: Progressive rates of tax ranging from 19% to 53% are applied to the total taxable income, the rate being dependent on which band of income the total taxable income falls in a given fiscal year

SELF-EMPLOYED TAX PAYERS - SPECIAL RULES: Self-employed individuals are subject to the same tax rates as for general employees. However, it should be noted that partnerships, despite being fiscally transparent, are liable to Trade Tax

DIVIDENDS: Dividends are received net of a deduction for tax. The applicable taxes from domestic sources will be corporate tax at 30% plus the standard withholding tax of 25%. Both these sums will then be available as a tax credit against an individual's personal tax responsibilities. If the corporate and withholding taxes are greater than the aforementioned a refund will be granted. In respect to foreign dividend distributions the same system operates save that certain prescribed jurisdictions, normally those with significantly lower income tax levels than Germany, will not be afforded a credit against foreign tax payments

CHURCH TAX: Members of recognized churches are subject to a 'Church Tax payable to the local State at rates varying between 8% and 9%. As stated these are tax deductible

SOCIAL CHARGES: German social security charges are compulsory deductions against gross salary for all employees/employers. The only exceptions are for sickness insurance for those earning high salaries. However, generally the owners of small companies and the self-employed are exempt. The benefits include the provision of unemployment benefit and; 'old age¹ pensions and; health insurance and; invalidity insurance.

CAPITAL GAINS TAX: In most cases a short-term capital gain will be added to the income of an individual and taxed in the normal manner. Long-term gains are generally tax-free. For land and fixed structure buildings, ownership must be established for at least two years prior to realizing the gain whilst for other assets, including stocks and shares, the period is only six months.

INHERITANCE & GIFT TAXES: In Germany, the standard civil law forced heirship principles apply, with tax levels increasing the more remote the relationship. However, it may be possible for non-residents with German assets to circumvent the above by having a foreign company own the said assets with any future sale being realised by a disposition of that company's shares. Shares in a foreign company generally being treated as 'movable' property under international law. Therefore, if the company emanates from a common law jurisdiction, where forced heirship is rare, an individual should be free to dispose of his assets as he or she pleases. For those physically resident in Germany there may be tax treaty concessions on foreign dispositions. It should be noted that there could be different tax consequences in respect of an inherited sum, which is received after the grantors death, and a gift, which is received during his or her life.

 

ANTI-AVOIDANCE PROVISIONS

In Germany, anti-avoidance provisions can be divided into two sub-divisions. The first seeks to prevent the use of foreign/offshore mechanisms for tax avoidance purposes in respect to German commercial activities whilst the second seeks to prevent wealthy individuals from changing their residence/nationality for the same reason. Nevertheless, German law like it's British counterpart specifically allows resident companies and individuals to arrange their affairs in such a manner that would be most fiscally beneficial (see the decision of the Federal Tax Court - the Bundesgerichtshof - 17/04/74). Therefore, provided no specific German legislation is breached there are no de jure restrictions. However, in general terms traditional and normally non-treaty partner tax haven countries should be avoided, as they are very likely to be investigated and subject to a reverse burden of proof. For individuals, there must also be careful planning with perhaps the use of relatively high tax jurisdictions, such as the United Kingdom and Ireland, offering the best 'legitimate¹ advantage.

SPECIFIC TAX PROVISIONS

♦ GERMAN RELATED TRANSACTIONS: In general, German law seeks either to set-aside any transaction which could be deemed an intentional abuse of the tax system (see S.42 of the General Tax Act or Abgabenordnung below) as if such transaction has never existed or, where passive income is redirected to a favourable tax jurisdiction*, to ascribe such income to the German resident (see Aussensteuergesetz S.7 -S.14 08/09/72 below). In respect to S.42 it should be noted that this provision is universal in application and is not merely restricted to either passive activities or to German residents. However, it is clear that /^k there must always be an intention to abuse the German tax system. In respect to the Aussensteuergesetz sections the main protection seems to be afforded by being able to establish genuine foreign management and control. Where there is an overlap between the two possibilities, Le. that either S.42 or Aussensteuergesetz sections could apply, it will normally be the latter which takes precedence since it is specific to a certain type of situation

♦ THIN CAPITALISATION: Since 1 January 1994, Germany has thin capitalisation rules that deny interest deductions on shareholder loans that are deemed to be equity. However, the rules for deductibility are reasonably clearly defined providing operating companies with a so called 'safe haven¹ within a 3-1 debt-equity ratio (so long as less than 20% of its shares are held by a holding company) whilst holding companies have a more generous 9-1 debt-equity ratio. Holding companies for this purpose must have at least two investment in resident or non-resident corporations that exceeds 20% of the subsidiaries' nominal capital and either i) more than 75% of the holding company's gross income is dividends and interest from subsidiaries (based on a 3 year average) or ii) more than 75% of its assets (excluding its assets (excluding receivables) as equity holdings in other corporations. Debt covers all loans from foreign shareholders (or parties related to them) owning more than 25% of a corporation and includes debt with unrelated third parties (e.g. banks) if that third party has any recourse against a foreign 25% shareholder (or party related to that shareholder). The advantageous treatment for holding companies has led to many multinational corporations reorganizing their corporate structures to benefit from the 9-1 debt-equity ratios…

THE APPLICATION OF THE GENERAL TAX ACT

S. 41(2) - This section allows a tax inspector to disregard any 'sham' transactions for tax purposes. However, the definition of the word 'sham' is very literal, allowing the section to be ignored if there is any veracity to the disputed transaction. For example, if a German firm claimed to have sent DM 10,000.00 to a Bahamian IBC and actually did so forward the sum to a real Bahamian company this section could not be implemented. In fact, only if there was no such company could it be relied upon with any degree of confidence. The point being that whether malfeasance exists or not does not matter only that some kind of legitimate structure has been established. For obvious reasons, therefore, this provision is hardly employed. S.42: Section 42 is far more commonly employed than S. 41(2) since it concentrates on the intention to evade German taxes and is not fettered by the mere veracity of the structure. Under this section the intention to evade taxes will normally be satisfied if it can be shown that the transaction has no commercial reason other than the saving of tax. The factors that will normally be considered in deciding whether there is a bona fide commercial reason and the requisite intention would include:

 (a) Would the format and structure of the transaction be in keeping with what would normally be expected of a like business. For example, a car manufacturer purchasing components from a West Indian intermediary would be a prima facie cause for concern and,

(b) are the fees/charges being invoiced consistent with the nature of the goods/services provided. Again, using the example in (a), are the costs of the components 'reasonable' by industry standards and,

(c) are the jurisdictions involved deemed 'low tax' by German standards i.e. subject to a 30% or less tax liability and,    -

(d) would it have been possible to purchase similar goods and/or services in Germany or another high tax-area on similar terms and conditions and,

(e) is there evidence of any control or influence over the other transacting party(ies) and,

(f) is there evidence that the other transacting party(ies) were not genuine and did not have bona fide management and control in the applicable jurisdiction. It should be noted that the use of serviced office address facilities and/or passive local administrators, managers or directors would not suffice as a defence. Of course, other variations on the above could be developed but the simple crux of the matter is that the transactions must be real and carried out in the normal course of business. If not, there is a strong possibility that the transactions could be open to an attack under S.42

THE APPLICATION OF S.42 TO NON-RESIDENTS

One of the most important benefits of this section, at least from the point-of-view of the tax authorities, is that it does not appear to discriminate between residents and non-residents of Germany. Therefore, non-residents investing or receiving income from Germany could be subject to S.42 if they try and insert some sort of intermediary vehicle to mitigate their German tax obligations. However, on a practical level 'attacks' on non-residents are relatively rare especially if sensible precautionary measures are taken. For example, if the tax benefiting jurisdiction was located in the European Union, such as Ireland, or if the ostensible local tax was over 30% (as in Malta) the proverbial 'red flag¹ is unlikely to be raised and even if so raised such jurisdictions will normally afford genuine defences.

SECTIONS 7-14 OF AUSSENSTEUERGESETZ

The principal distinction (as already inferred) between S.42 and the aforementioned is that they apply only to passive income being paid to a foreign undertaking in which a German resident holds an equity stake of 10% or more. It is not necessary, though often the case, that such a person has an intention to mitigate his or her tax position. The reason behind this is that it may not be possible for a minority equity holder to 'force' the other interested parties, who may not be German residents, to use an alternative structure. Nevertheless, where benefits do accrue to a German resident the modis operandi of these Sections is to place such a person in a position as if full German tax obligations were met They do not, however, seek to set-aside the veracity of the whole undertaking only to balance the German equity holders tax position. Notwithstanding the provisions contained in the said Sections, it is important to realise that they will only apply where the structure in question cannot demonstrate genuine foreign management and control and/or that there are no applicable tax treaty protections. Therefore, once more, the legitimate tax mitigator will not be denied the right to manage his or her affairs in a fiscally advantageous manner. In regards to the criteria considered in the application of the Sections there is considerable overlap between S.42 (see above) but in particular the following will be given special emphasis:

(a) Whether genuine foreign management and control can be established. As with S.42 serviced office facilities or foreign 'nominee' officers will not be sufficient. (b) That the basic requirements of 10% ownership and passivity exist. (c) That no specific tax treaty provisions apply. (d) That the recipient jurisdiction has taxes below 30%. If this cannot be satisfied it may not be possible to rely on Sections 7-14

(e) Whether the German resident, or residents, can or may be able to exercise control over the operations of the foreign company from Germany, creating a 'boomerang' effect for tax purposes. If the answer to this is yes then, even if there may also be legitimate foreign management and control, difficulties could arise. S.42 may also apply in these circumstances since the activities may no longer be 'passive^’

SPECIFIC TAX PROVISIONS

♦ EXTRATERRITORIAL POWERS: In order to prevent the departure of long-term German residents and citizens to more fiscally beneficial territories, the authorities have introduced legislation penalizing wealthy individuals leaving Germany for solely tax reasons. Of course, the effectiveness will be fettered by the choice of alternative residence and if any, the provisions of the applicable tax treaties. In general terms, significant benefits can be achieved by moving to countries like the United Kingdom and Ireland given their distinction between domicile and residence and the existence of favourable tax treaties than, for example, to traditional havens such as Monaco The principle extraterritorial provisions are S.2 and S.6 Aussensteuergesetz ( Foreign Tax Act) 08/09/72 and S.16 Einkommensteuergesetz 19/02/90 (Income Tax Act):

S.2 FOREIGN TAX ACT:

S.2 of the Foreign Tax Act, 1972, is by far the most powerful piece of extraterritorial legislation and basically applies to German citizens who have been 'resident' in Germany. Importantly, the term resident for the purposes of this act is substantially broader than normally applicable. In fact, a German citizen will be potentially liable to this legislation if he or she has been resident for 5 out of the 10 years preceding migration. Once liable, subject to the qualifying criteria, the said individual could face special German taxation, basically seeking to equalise for a further 10 years. The qualifying criteria, both of which must be satisfied, are as follows:

(a) That the individual has migrated to a tax haven jurisdiction. This for the purposes of S.2, subject to tax treaties, equates with the aforementioned receiving a taxable income of over DM 150,000.00 and being taxed on that income at a level amounting to less than two thirds of the then prevailing German income tax rate or that special schemes or dispensations are available which could result in a lower tax liability than prima facie may seem the case.

An example being Cyprus, which will often tax non-nationals at half the rate of indigenous citizens (approximately 20%). Alternatively, if the tax haven rules cannot be satisfied and the German citizen has not established any new jurisdiction of residence, he or she will probably fall foul the 'perpetual traveller* caveats and be treated in the same manner as if he or she had taken up residence in a tax haven with zero taxation.

(b) That there exist, after the departure, significant economic interests in Germany. This second qualifying criteria being necessary to ensure the jurisdiction of the German fiscal authorities. Under the Foreign Tax Act, an individual will have a significant economic interest if:

(i) He or she plays an active managerial role in a German undertaking, including a partnership or,

(ii) where no such active role exists, that he or she holds at least, a 25% equity interest in a German   undertaking   or   receives   a   distributed   income   which   equivalent   to   the aforementioned or,

(iii) the former German resident receives foreign source income constituting either 30% of his or her total income or €60,000.00 in a given financial year (whichever applies first) which, if he had remained resident, would have been subject to German taxation or,

(iv) the former German resident receives income from net assets which, if he had remained resident in a given financial year, would have been subject to German taxation, such income constituting 30% of his or her total income or €150,000.00 (whichever applies first).

S.6 FOREIGN TAX ACT:

The principle objective of S.6 of the Foreign Tax Act is to automatically infer a capital gain on residents* leaving Germany who have, at least, a 25% equity interest in a German company. If this is the case, the fiscal authorities will charge 50% of the normal taxes applicable to a capital gain

S.16 INCOME TAX ACT:

The modis operandi behind S.16 of the Income Tax Act and S.6 of the Foreign Tax Act is very similar save that the former applies to previously resident sole proprietors leaving Germany whilst the latter applies to investments held in German companies. However, unlike S.6 a sole proprietor will be subject to tax on all of the imputed capital gain. This is logical since, by definition, if such a person leaves his or her business must have ceased if not sold. The fact that the business in continued elsewhere is irrelevant.

 

COUNTRY	DIVIDEND WITHOLDING TAXES			INTEREST (FROM)		ROYALTIES (FROM)
Argentina	15/25%	15% 25%		10/15 25%	10/15%	15/25%
Australia	15%	15%	"	10%	10%	10%
Austria	5%	15%	"	25%	N/A	N/A
Belgium	5%	15%	"	(11)0//15%	0/15%	N/A
Brazil	15%	15%	"	15%	15%	15/25%
Bulgaria	(12)15/25	15/25%	"	(12)0/25%	N/A	5%
Canada	(13)15/25%	15/25%	"	(12)15/25%	15%	10%
China	(14)10/25%	10% 25	"	(14)10/25%	10%	10%
Cyprus	10%	15%	"	10%	10%	(16)0/15%
Czech Rep.	5%	15%	"	N/A	N/A	5%
Denmark	10%	15%	"	N/A	N/A	N/A
Ecuador	15%	15%	"	15%	15%	15%
Egypt	15%	15%	"	25%	46%	(17)15/25%
Finland	10%	15/25%	"	N/A	N/A	(18)0/5%
France	(19)5%	15/25%	"	N/A	N/A	N/A
Greece	25%	5%	"	10%	10%	N/A
Hungary	5%	15%	"	N/A	N/A	N/A
Iceland	5%	15%	"	N/A	N/A	N/A
India	(20)15/25%	15/25%	"	(21)10/15/25%	10/15%	20%
Ireland	15%	5%	"	N/A	N/A	(22) N/A
Israel	25%	25 %	"	15%	15%	5%
Italy	15%	15%	"	10%	10%	10%
Japan	15%	15%	"	10%	10%	10%
Kuwait	(24)15/25%	15/25%	"	(24)0/25%	N/A	10%
Luxembourg	10%	15/4%	"	N/A	N/A	5%
Malaysia	5%	15%	"	15%	15%	10/5%
Malta	5%	15%	"	10%	10%	(26)0/10%
Morocco	5%	15%	"	10%	10%	10%
Netherlands	5%	15%	"	(27)10/25%	N/A	N/A
New Zealand	15/25%	15/25%	"	10/25%	10%	N/A
Norway	25%	15%	"	N/A	46%	N/A
Poland	(28)5/25%	15%	"	(28)0/25%	N/A	N/A
Portugal	(29)15/25%	15/25%	"	(30)10/15/25%	10/15%	N/A
Singapore	10%	15%	"	10%	10%	(31)0/25%
Slovakia	5%	15%	"	N/A	N/A	5%
South Africa	7.5%	15%	"	10%	10%	N/A
Spain	15%	15%	"	10%	10%	5%
South Korea	10%	15%	"	(23)10/15%	10/15%	10/15%
Sweden	15/25%	15/25%	"	N/A	N/A	10%
Switzerland	5/25%	10%	"	N/A	N/A	N/A
Thailand	15%	20%	"	(34)10/25%	10/25%	5/15%
Tunisia	10%	15%	"	10%	10%	10/15%
Turkey	(35)15/25%	20%	"	(35)15/25%	15%	10%
U.S.S.R.(former)	(36)15/25%	15/25%	"	(36)5/25%	5/46%	N/A
United Kingdom	15%	5%	"	N/A	N/A	N/A
United States	(37)5/10/25%	15%	"	(37)0/25%	N/A	N/A
Yugoslavia	(38)15/25%		"	(38)0/25%	N/A	N/A