<?page no="0"?> German Profit Taxes 6 th Edition Christoph Freichel, Gernot Brähler, Christian Lösel, Andreas Krenzin <?page no="2"?> Christoph Freichel, Gernot Brähler, Christian Lösel, Andreas Krenzin German Profit Taxes 6 th Edition UVK Verlag · München <?page no="3"?> Bibliografische Information der Deutschen Nationalbibliothek Die Deutsche Nationalbibliothek verzeichnet diese Publikation in der Deutschen Nationalbibliografie; detaillierte bibliografische Daten sind im Internet über <http: / / dnb.dnb.de> abrufbar. Das Werk einschließlich aller seiner Teile ist urheberrechtlich geschützt. Jede Verwertung außerhalb der engen Grenzen des Urheberrechtsgesetzes ist ohne Zustimmung des Verlages unzulässig und strafbar. Das gilt insbesondere für Vervielfältigungen, Übersetzungen, Mikroverfilmungen und die Einspeicherung und Verarbeitung in elektronischen Systemen. © UVK Verlag 2021 - ein Unternehmen der Narr Francke Attempto Verlag GmbH + Co. KG Dischingerweg 5 · 72070 Tübingen Einbandgestaltung: Atelier Reichert, Stuttgart Cover-Illustration: © iStock MicroStockHub Druck und Bindung: CPI books GmbH, Leck Internet: www.narr.de eMail: info@narr.de 978-3-7398-3024-7 (Print) 978-3-7398-8024-2 (ePDF) 978-3-7398-0535-1 (ePub) <?page no="4"?> Preface The German income tax law is subject to permanent changes and due to the high pace of reform, the legislator often makes manual mistakes or that regulations are particularly complex. The textbook, which has already been published in its sixth German edition, has now been translated into English language. This textbook provides beginners with a comprehensive overview of fundamental aspects of income tax law. After an introduction to income tax law, income tax (Chapter 2) is analysed as a focal point. This includes the characterisation, meaning and principles of income tax, personal and impersonal tax liability as well as the temporal allocation of income. This chapter focuses on the explanations relating to the determination of taxable income and the income tax to be determined. Subsequently, the principles of corporate income tax (Chapter 3) and trade tax (Chapter 4) are presented. However, the explanations are not limited to the respective basic principles, but also relate to questions of tax liability, the determination of taxable income or the business profit. Finally, numerous examples are also used to illustrate how these types of taxes are actually assessed. Chapter 5 is devoted to the approaches of the legislator for the implementation of a legal form neutrality of taxation in Germany. The explanations in this textbook on income tax, corporate income tax and trade tax are supplemented by a so-called comprehensive case study in which the interrelationships of the determination of taxable income or business profit, the respective provisions that may be necessary and the calculation of the relevant tax liabilities are shown, taking into account the special features mentioned in the case. For the sixth edition, the entire book was revised and updated in order to adapt it to the current state of knowledge and legal status. In order to meet the didactic requirements, the book contains numerous practical examples as well as illustrative figures and tables. At the end of each chapter there is a summary in the form of core statements on key findings, questions and individual references to literature, which are suitable for in-depth, topic-specific literature study. The comprehensive index helps you to search for concrete content. The book is the ideal companion for the targeted preparation for examinations in the Bachelor's and Master's programmes at universities that are oriented towards business taxation or tax law. It is also ideally suited for selfstudy. Target groups are therefore students, lecturers in the field of business taxation and tax law. The book is also suitable for English-speaking practi- <?page no="5"?> 6 Preface tioners (including those from abroad) who wish to develop basic knowledge of German Profit taxes useful for everyday professional life. Assistants in tax consulting, tax clerks as well as landlords specializing in tax and not least also tax advisers are addressed here. We would like to thank especially Christoph Freichel’s partners Mr. WP StB Dr Matthias Ritzi and Mr. WP StB Matthias Rohr from Moore Treuhand Kurpfalz GmbH Wirtschaftsprüfungsgesellschaft, Steuerberatungsgesellschaft, Mannheim, for the financial support of this book and Mr. Dr Jürgen Schechler from UKV Verlag for the pleasant cooperation. We would like to express our gratitude to our academic staff and student assistants, who have supported us tirelessly and conscientiously in the preparation of the manuscript. In alphabetical order: Ms. Sophie Marie Lorinser, B.A., Ms. RA Dipl.-Finw. Katrin Michels, Mr. Felix Schmitt, B.A. and Ms. Lena-Marie Waller, B.A. We are grateful for any suggestions for improvement, spelling mistakes or suggestions and would like to refer you to the following e-mail addresses: christoph.freichel@htwsaar.de, gernot.braehler@gmx.de, christian.loesel@ingolstadt.de info@kastl-krenzin.de. The book is based on the legal status 01.01.2018 Christoph Freichel Gernot Brähler Christian Lösel Andreas Krenzin In addition to this textbook, a web service is available for download on the title page of the book at www.uvk.digital/ 9783739830247 1. A clearly structured presentation of the illustrations of the book. 2. Additional examples and understanding questions, which support the didactical usability of the presentation by the lecturer in instruction and for the student in the self-study are very useful. <?page no="6"?> Table of contents Preface .............................................................................................................................. 5 List of abbreviations ....................................................................................................11 Introduction to German profit tax law ...................................... 13 The importance of taxes ..............................................................................13 Tax burden and tax justice ..........................................................................13 The three tax disciplines ..............................................................................15 The tax system ...............................................................................................16 1.4.1 Earnings of the state .....................................................................................16 Taxes .................................................................................................................17 Fees....................................................................................................................18 Contributions..................................................................................................18 Special levies...................................................................................................19 1.4.2 Classification of the tax types ....................................................................19 1.4.3 Taxation terminology ...................................................................................21 Taxpayer and/ or taxable subject ................................................................21 Subject of taxation and/ or taxable object ................................................21 Tax base ...........................................................................................................21 Tax threshold, tax allowance, deductible amount .................................21 Tax rate and tax scale ...................................................................................22 1.4.4 Tax sovereignty..............................................................................................24 Personal income tax....................................................................... 27 Basic principles of personal income tax .......................................................27 2.1.1 Characterization, importance and principles of personal income tax ......................................................................................................................27 basis .......................................................................................................27 and demarcation of the personal income tax ............28 and economic importance................................................................29 of income taxation .....................................................................29 two forms of income tax assement ...................................................31 2.1.2 Personal and impersonal liability for personal income tax.................33 2.1.3 Personal liability for personal income tax...............................................33 Types of unlimited tax liability ..................................................................34 <?page no="7"?> 8 Table of contents Types of limited tax liability....................................................................... 39 of double taxation ......................................................................... 41 2.1.4 Impersonal liability for personal income tax.......................................... 41 The types of income ..................................................................................... 41 of the personal income tax ............................................. 48 of earnings and expenses .................................................. 49 2.1.5 Temporal assignment ................................................................................... 54 period and determination period........................................ 54 year........................................................................................................ 55 Determination of taxable income .............................................................. 58 2.2.1 Determination of income ............................................................................ 58 of the methods of determining income ................................ 58 of profit................................................................................ 59 of surplus income.............................................................. 67 2.2.2 Seven types of income.................................................................................. 69 2.2.2.1 The income types............................................................................... 70 2.2.2.2 The income types ........................................................................... 89 2.2.2.3 and income from previous employment (Sec. 24 EStG)................................................................................................119 2.2.3 Determination of the total amount of income .....................................121 2.2.3.1 allowance (Altersentlastungsbetrag)........................................121 2.2.3.2 Tax for single parents .............................................................124 2.2.3.3 for farmers and foresters.......................................................124 2.2.4 Fiscal treatment of losses...........................................................................127 Loss ......................................................................................127 Loss ..............................................................................................128 2.2.5 Special expenses ..........................................................................................133 of special expenses .....................................................................133 deductible special expenses...................................................134 deductible special expenses .......................................................138 2.2.6 Extraordinary expenses .............................................................................157 of extraordinary expenses ........................................................157 expenses in general cases...............................................159 expenses in standardized cases.....................................160 2.2.7 Family benefit compensation ...................................................................164 2.2.8 Assessment basis and scale .......................................................................169 <?page no="8"?> Table of contents 9 The income .....................................................................................169 Scaled income tax ........................................................................................169 rates according to Secs. 34 and 34a EStG ................................171 of the personal income tax to be assessed ...............184 of the final payment and/ or the refund entitlement ................................................................................................................188 Partnerships ..................................................................................................195 2.3.1 Co-partner income ......................................................................................196 2.3.2 Other partners of a partnership ...............................................................205 Corporate income tax .................................................................. 209 Basic principles ............................................................................................209 3.1.1 Characteristic features ...............................................................................211 3.1.2 Personal tax liability ...................................................................................213 tax liability.................................................................................213 tax liability .....................................................................................215 3.1.3 Tax exemption ..............................................................................................215 Tax assessment basis ..................................................................................215 3.2.1 Determination of taxable income ............................................................215 3.2.2 Adaptations of the commercial balance sheet to the tax balance sheet................................................................................................................217 3.2.3 Additions and deductions to determine the taxable income outside of the balance sheet ............................................................................218 profit distributions .......................................................................219 equity contributions.....................................................................228 Tax-exempt income from investments in accordance with Sec. 8b (1) KStG ............................................................................................233 Non-deductible expenditures in accordance with Sec. 10 KStG .....235 -deductible expenditures in accordance with Secs. 4 (5), (5b), 4h, 4j EStG, Secs. 8a, 8b (3) and (5) KStG......................................236 ......................................................................................................246 3.2.4 From the total amount of income to the remaining corporate income tax payment/ refund......................................................................248 Trade tax......................................................................................... 255 Basic principles ............................................................................................255 4.1.1 Characterization of trade tax ....................................................................255 4.1.2 Subject of taxation.......................................................................................256 <?page no="9"?> 10 Table of contents 4.1.3 Personal tax liability ...................................................................................260 Business profit..............................................................................................260 4.2.1 Additions under Sec. 8 GewStG ...............................................................262 4.2.2 Deductions under Sec. 9 GewStG ............................................................269 4.2.3 Loss carryforward .......................................................................................276 4.2.4 Tax allowance, federal tax rate, municipal rate and advance payments ..............................................................................................................277 Breakdown ....................................................................................................280 Lump-sum crediting of trade tax .............................................................281 Final question on trade tax........................................................................282 Legal neutrality of taxation ........................................................285 Principle of legal neutrality of taxation .................................................285 Approaches for the implementation of legal form neutral taxation in Germany ...................................................................................................287 Final comprehensive case............................................................293 Information regarding corporate income tax .......................................293 Information regarding personalincome tax...........................................294 Solution notes ..................................................................................................294 Solution..........................................................................................................296 6.4.1 Determination of the taxable income/ provision for trade tax/ provision for corporate income tax ........................................................296 6.4.2 Calculation of the tax liability for 2018..................................................297 of the flat-rate withholding tax within the meaning of Sec. 32d EStG ....................................................................................298 of the partial-income method within the meaning of Sec. 3 no. 40 lit. d EStG..........................................................................301 List of figures..............................................................................................305 List of tables................................................................................................308 Translations ................................................................................................309 English - German ............................................................................................309 German - English ............................................................................................315 Index ............................................................................................................................321 <?page no="10"?> List of abbreviation s AB Assessment basis AG Aktiengesellschaft (stock company) AltEinkG Alterseinkünftegesetz (German Retirement Income Act) AO Abgabenordnung (The Fiscal Code of Germany) AP Assessment period AStG Außensteuergesetz (German International Transactions Tax Act) BAöG Bundesausbildungsörderungsgesetz (German Federal Education Assistance Act) BewG Bewertungsgesetz (German Valuation Act) BFH Bundesfinanzhof (Federal Fiscal Court) BGB Bürgerliches Gesetzbuch (German Civil Code) BMF Bundesministerium der Finanzen (German Federal Ministry of Finance) BStBl Bundessteuerblatt (German Federal Tax Law Gazette) cf. see DIW Deutsches Institut der Wirtschaftsprüfer (German Institute of Auditors) EEA European Economic Area EFTA European Free Trade Association e.g. for example ErbSt Erbschaftsteuer (Inheritance Tax) ESt Einkommensteuer (Personal income tax) EStDV Einkommensteuer-Durchührungsverordnung (German Implementing Ordinance for Income Tax) EStG Einkommensteuergesetz (German Income Tax Act) EStH Einkommensteuer-Hinweise (German notes on income tax law) EStR Einkommensteuer-Richtlinien (German guide to income tax law) et seqq. and the following EU European Union FG Finanzgericht (Fiscal Court) GewSt Gewerbesteuer (trade tax) GewStDV Gewebesteuer-Durchührungsverordnung (German Implementing Ordinance for Trade Tax) GewStG Gewerbesteuergesetz (German Trade TaxAct) GewStR Gewerbesteuer-Richtlinien (German guide to trade tax law) <?page no="11"?> 12 List of abbreviations GG Grundgesetz (German Constitutional Law) GmbH Gesellschaft mit beschränkter Haftung (similar to a limited liability company) GrESt Grunderwerbsteuer (land transfer tax) GrSt Grundsteuer (land tax) HGB Handelsgesetzbuch (German Commercial Act) i.a.w. in accordance with i.c.w. in conjunction with i.e. meaning KapESt Kapitalertragsteuer (capital yields tax) KfzSt Kraftfahrzeugsteuer (motor vehicle tax) KG Kommanditgesellschaft (similar to a limited partnership) KGaA Kommanditgesellschaft auf Aktien (similar to a partnership limited by shares) KSt Körperschaftsteuer (corporate income tax) KStG Körperschaftsteuergesetz (German Corporate Income Tax Act) KStR Körperschaftsteuer-Richtlinien (German guide to corporate income tax law) lit. letter LStDV Lohnsteuer-Durchührungsverordnung (German Implementing Ordinance for Wage Tax) LStR Lohnsteuer-Richtlinien (German wage tax guidelines) max. maximum MinöSt Mineralölsteuer (petroleum tax) no./ nos. number/ numbers OHG Offene Handelsgesellschaft (similar to a general partnership) p.a. per annum P&L Profit and loss account p./ pp. page/ pages Sec./ Secs. Section/ Sections sent. sentence SolZ Solidaritätszuschlag (solidarity surcharge) UMTS Universal Mobile Telecommunications System vs. versus VAT Value-added tax <?page no="12"?> Introduction to German profit tax law The importance of taxes Taxes form an important part of every citizen’s financial endeavors. The liability to pay taxes accompanies every citizen from the cradle to the grave. The tax liability is imposed by the polity to finance the services performed by the state and influences citizens’ economic dealings. The state must observe certain basic principles when levying taxes, e.g. the principles of legality and uniformity of taxation. In particular, taxation is supposed to be based on the economic capacity of the taxpayer. The state may not unduly call on individual citizens (strangulation effect) if it desires to participate in the success of the private economy in a sustainable manner. Non-uniform taxation can lead to evasive reactions by the economic actors and presents credibility and legitimacy problems that, inter alia, can lead to a decrease in tax revenue. Thus, a state must take care to levy taxes so as to reflect the relationship between the legal protection of ownership and the social obligation arising from ownership in a legal and comprehensible manner which is seen to be just. The opposition of the objectives and interests that play a role in taxation must be taken into account in levying taxes. Economic actors want to and must reduce the tax liability, inter alia because of the pressure of globalization. On the other hand, the taxes finance tasks whose fulfillment can be for the benefit of the economic actors and provide the state with the opportunity to intervene in the economic process, inter alia, for the benefit of all. Tax burden and tax justice Modern industrial states fulfill a number of political tasks of a social, regulatory and economic nature. The extent of the tasks vested in the respective political system is always reflected in its so-called Staatsquote, which indicates the ratio of government expenditures to gross national product (GNP). In Germany, this ratio was 44.3 % in 2016: Figure 1: Ratio of government expenditures to the GNP for Germany 2016 <?page no="13"?> 14 1 Introduction to German profit tax law Figure 2: Development of the expenditure-GNP ratio from 1980 to 2016 States levy contributions, predominantly in the form of taxes, to finance the public services. A high public expenditure quota generally means that the economic actors are subject to an increased liability to pay taxes and contributions. This liability to pay taxes and contributions is expressed by the socalled tax ratio which indicates the ratio of taxes and social contributions to the gross national product. In 2016, this tax ratio amounted to 42.7 %: Figure 3: Tax and contribution ratio for Germany 2016 Taxes influence the economic activities of the people and change their consumption, investment and savings habits. Thus, taxes must be arranged in a “just” manner. “Just” means that the circumstances of each individual case must be taken into account, as only specially tailored rules prevent generalized and therefore unjust legal consequences in individual cases. However, the more the tax laws take details into account, the more complex they become and the more difficult they become to apply or carry out. As is the case when there are too few regulations, the complexity of tax provisions caused by the increasing number of rules for specific cases leads to injustices because only those who have access to correspondingly qualified advice are able to make fiscally optimal arrangements. Those taxpayers who receive no or poor advice are thus at a disadvantage compared to those who receive good advice, because the former are unable to take advantage of the possibilities to avoid paying taxes. The term “Dummensteuer” (idiot tax) has also been used in this context. The term “just” <?page no="14"?> 1.3 The three tax disciplines 15 also means not over-regulating the system of taxation, but rather keeping it manageable and comprehensible for the majority of taxpayers. In addition to excessive regulations for individual cases, another reason for the complexity of our tax system is the fact that the assessment of taxes not only serves as a source of income for the state, but rather is used economically and socio-politically to steer the actions of individuals. Taxes are meant to guide behavior. Instead of enacting imperatives and prohibitions, the legislature encumbers undesired behavior with additional taxes and promotes desired behavior and those goods worthy of such promotion (so-called merit goods) with tax relief (e.g. lower value-added tax of 7 % for foodstuffs and magazines, instead of the normal 19 %). Thus, the state not only pursues fiscal interests, but also steering objectives as well (e.g. the restriction of cigarette consumption with the tobacco tax, or the promotion of energy saving with the ecology tax). The three tax disciplines In light of the allocative and distributive importance of taxes for the state and its economic actors, several scientific research facilities address their effects, their application, or their distribution. The tax disciplines can be broken down into the three sub-areas: tax law, financial science, and business taxation. The object of experience for all three disciplines is the phenomenon “taxes”, although the respective subject matters of their research differ. The demarcations between the individual areas are fluid. The discipline of tax law considers taxation to be a legal process. This discipline concentrates on the legal aspects of taxation and is concerned with the relationship between the state and its citizens with regard to taxation. The subject matter includes issues in the construction of tax provisions or the examination of their conformity with the constitution and/ or the law of the European Union. The discipline of financial science forms part of political economics and is thus macro-economically orientated. The economic actions of the state form the object of knowledge, to the extent that earnings and expenses are included. The discipline of financial science addresses, for example, issues involving the just distribution of tax revenue or the minimization of negative effects of taxation on production, consumption and competition (influence on the allocation of resources, minimization of deadweight loss). The subject matter of business taxation is the examination of effects of taxation on the business activities of companies. There are four main scientific areas of research within the discipline of business taxation: <?page no="15"?> 16 1 Introduction to German profit tax law • Problem-oriented assessment of tax law (presentation of legal norms): Knowledge of the most important national and international tax provisions is of fundamental importance for the discipline of business taxation. • Theory of tax effects in business economics: Analysis and description of the influence of taxation on the variables of fundamental importance to decisions made by economic actors. • Theory of tax planning in business economics: Advice for the decisionmakers of a company in exercising options under tax law and in the arrangement of planned circumstances in order to minimize the total tax burden. • The evaluative-normative theory of business taxation: Critical opinions on the current state of tax law (de lege lata) as well as planned changes (de lege ferenda). It is an indispensable prerequisite to first examine tax law in terms of a portrayal of legal norms because tax law constitutes, on the one hand, the framework within which fiscal arrangements are made and, on the other hand, the instrument of such arrangements. Building on this, the effects of taxation can be examined for subsequent targeted tax planning afterwards. Note There are three different tax disciplines: • Tax law • Financial science and • Business taxation The tax system 1.4.1 Earnings of the state The public sector is financed by public and extraordinary earnings. Ordinary earnings end up with the state and are thus available to the state indefinitely. A difference must be drawn between earned income of the state and (sovereign) compulsory levies. Earned income of the state is acquired by the public sector’s participation in the market, e.g. by way of private businesses with public shareholding (Deutsche Post, Deutsche Bahn, Deutsche Telekom, as well as banks, research centers, harbor companies, airport companies and construction companies, etc.). Compulsory levies are divided into taxes, fees, contributions and special duties. Extraordinary earnings are only available to <?page no="16"?> 1.4 The tax system 17 the state temporarily and must be paid back when a certain deadline has been reached. These extraordinary earnings also include public borrowing. Figure 4: Possibilities of financing for the state Taxes Taxes make up the largest portion of state earnings in all industrial countries, including Germany. According to the legal definition contained in Sec. 3 (1) AO (The Fiscal Code of Germany), taxes are “payments of money that do not represent counter-performance for a particular performance and that are imposed by a polity on all those who fulfill the statutory requirements for the tax liability, in order to generate income”. The term “tax” possesses the following characteristics: • Compulsory levies: Taxes are levied by public corporations by virtue of their financial sovereignty. The taxpayer is to pay these levies if certain statutory requirements are fulfilled. It is not voluntary. • Payments of money: According to their definition, taxes are payments of money, not performances in kind. They can be payment obligations that occur once (e.g. inheritance tax, and land transfer tax GrESt) or periodically recurring payment obligations (e.g. income tax, corporate income tax, and trade tax). • No counter-performance: Taxes neither establish an entitlement to counter-performance by the state, nor is the level of taxes calculated directly according to the public services received by the taxpayer. Thus, taxes are not calculated in accordance with the equivalence principle. • Public polity: Tax sovereignty is a prerequisite to levying taxes. In Germany, this is vested in the federal government (Bund), the federal states <?page no="17"?> 18 1 Introduction to German profit tax law (Länder), the municipalities (Gemeinden) as well as those religious communities that possess the status of a corporation under public law. • Statutory basis: Taxes must be levied from all who fulfill the statutory requirements for the tax liability. Taxes may not be levied in the absence of a statutory basis. • Realization of earnings also as secondary objective: Taxes not only serve in the realization of earnings, but also economicand socio-political (steering-) purposes. For this reason, the discipline of financial science also points out the possibility of using taxes to influence the behavior of the taxpayers (“ecology tax”). The levy of taxes is accompanied by the so-called ancillary expenses related to taxes. According to Sec. 3 (4) AO, these are late fees, interest, surcharges on arrears, administrative fines and costs. In doing so, the legislature does not intend to realize earnings, but rather to cause a certain behavior on the part of the taxpayer. Ancillary expenses related to taxes are imposed if the taxrelated obligations are not or are belatedly fulfilled by the taxpayer. Fees Fees (under public law) are also levies by the state for the realization of earnings. In contrast to taxes, however, the performance by the citizen (in the form of a fee) is matched by a counter-performance by the state. Thus, they are levied for the actual, individual use of public facilities; the equivalence principle applies. A distinction must be made between the following: • Administrative fees (e.g. passport fees, motor vehicle registration fee), • Utilization fee (e.g. road tolls, entrance fee for the local public swimming pool, trash collection fee), and • Licensing fees (e.g. for concession fees, UMTS-license fees). Contributions Contributions are expense reimbursements imposed for the potential utilization of the concrete services performed by public facilities. They also serve as financing. Contributions only entitle the party liable to pay to the possibility of utilizing the services performed, whereby a concrete counter-performance is rendered in the case of fees. The party liable to pay contributions must fulfill the payment obligation, even if he does not take advantage of the counter-performance (e.g. tourism levy). <?page no="18"?> 1.4 The tax system 19 Special levies Special levies are levies that are not assessed to cover the general fiscal requirements of the state, but rather serve to finance special tasks and are only levied from certain groups of citizens. In addition to financing, steering objectives are also pursued; in doing so, an incentive is intended for a certain behavior and undesirable behavior is to be sanctioned. An example of this is the equalisation levy in accordance with the German Severely Handicapped Persons Act (Schwerbehindertengesetz) paid by the employer if a certain minimum number of severely handicapped persons is not employed. 1.4.2 Classification of the tax types The tax system consists of all individual taxes levied as well as the way in which they are levied. Considering the numerous federal, regional and communal taxes that are levied in Germany from different taxpayers, for different taxable objects, and on different assessment bases in different forms - partially with dependencies and interdependencies - the German tax system is a very complex system. On 19 September 2003 the law of taxes and levies for the Federal Republic of Germany consisted of 118 laws, 87 ordinances as well as several hundred statements made by the German Federal Ministry of Finance (BMF). Additionally, there are innumerable laws that are not tax laws per se, but are of relevance to tax matters. Scholars have developed several different approaches to systemizing the (individual) taxes. Figure 5: Approaches of systematization • Direct and indirect taxes The distinction originates from the discipline of financial sciences and is related to the possibility provided by the legislature to shift tax liability. In the case of direct taxes, the tax debtor, the ultimate taxpayer, i.e. the party <?page no="19"?> 20 1 Introduction to German profit tax law that ultimately bears the tax burden, and the taxpayer are identical (e.g. income tax). The intended shift of the tax liability from the tax debtor to the ultimate taxpayer is characteristic of indirect taxes. Accordingly, in the case of value-added tax, although the business owner is the tax debtor and the taxpayer, it is the final private consumer, who is to be encumbered financially (ultimate taxpayer). Note Direct taxes: No shift of tax liability is envisaged Indirect taxes: Shift of tax liability is envisaged • Personal and impersonal taxes Personal and/ or impersonal taxes are taxes that allow for characteristics related to individuals (e.g. marital status, age). The most important personal taxes are personal income tax (Einkommensteuer - ESt), inheritance tax (Erbschaftsteuer - ErbSt) as well as the corporate income tax (Körperschaftsteuer - KSt). Another fundamental characteristic of the personal taxes is the distinction between the unlimited and limited tax liability. In the case of impersonal taxes, object-related taxes or real-estate taxes, the amount of taxes is generally determined solely by characteristics related to the object. The trade tax (Gewerbesteuer - GewSt) and the land tax (Grundsteuer - GrSt) are examples of impersonal taxes. • Classification according to economic factors In examining the economic factors and/ or the assessment basis of the taxes, the following groups of taxes can be identified: - Profit taxes (the economic success forms the assessment basis of the taxes, e.g. personal income tax, corporate income tax and trade tax), - Substance taxes (the amount of funds form the assessment basis of the taxes, e.g. land tax and deferred transaction tax), - Transaction taxes (are generally based on legal transactions, e.g. land transfer tax), - Excise tax (generally based on consumption; for all intents and purposes, however, it is usually the producer who is taxed, e.g. petroleum tax and tobaccotax). Value-added tax cannot be clearly classified according to the scheme above. Technically, it is arranged like the transaction tax and takes into account the change of disposing capacity. According to the intentions of the law, it is, however, an excise tax because the final consumer is to be encumbered. <?page no="20"?> 1.4 The tax system 21 Additional classification factors were developed especially within the discipline of financial sciences. In this respect, a distinction can be made, for example, between the parties entitled to the revenue (federal, regional, communal or community taxes) or according to the unit of measure forming the assessment basis (specific taxes or ad valor taxes). Specific taxes are related to physical magnitudes, such as quantity, weight or lot size (e.g. liters for petroleum tax, kWh for electricity tax). In contrast, the assessment basis of ad valor taxes are values (e.g. the taxable income in the case of personal income tax). 1.4.3 Taxation terminology Taxpayer and/ or taxable subject The taxable subject is the person, who is subjected to taxation. The taxable subject can be a natural person (personal income tax) as well as a legal entity (corporate income tax), such as a capital company. The term “taxable subject” is synonymous with “tax debtor” and “taxpayer.” Subject of taxation and/ or taxable object The subject of taxation and the taxable object are used synonymously and can be used to describe a thing, an action or a sum of money. The existence of the subject of taxation and/ or the taxable object constitutes the tax liability. For example, the personal income tax and/ or the corporate income tax are based on the income earned. An economic asset (e.g. real property, business establishment, motor vehicle) or an economic event (e.g. turnover) can be the connecting factor for taxation. Tax base The tax base provides information on the extent to which a subject of taxation is subjected to taxation. It is the quantified object of taxation. The assessment basis is often expressed in money (e.g. income). It can, however, also be a technical and/ or physical magnitude, such as cubic capacity (e.g. motor vehicle tax - KfzSt) or liters of fluid (e.g. MinöSt). Tax threshold, tax allowance, deductible amount A tax threshold is the part of the assessment basis up to the maximum value of which taxes are not levied. If the tax threshold is exceeded, the entire assessment basis shall be subjected to taxation. The tax threshold on private sales transactions of € 600 in accordance with Sec. 23 (3) sent. 5 of the German Income Tax Act (Einkommensteuergesetz - EStG) is the classic example. The <?page no="21"?> 22 1 Introduction to German profit tax law intended purpose of the tax threshold is to relieve the tax administration which should not be bothered with insignificant amounts. A tax allowance remains tax free regardless of the amount forming the assessment basis. It is an amount that can be deducted in the calculation of the tax base, but which is generally only granted to the extent that it does not cause the assessment basis to be below zero. An example is the basis tax allowance of € 9,000 in accordance with Sec. 32a (1) sent. 2 no. 1 EStG that exempts the taxpayer’s subsistence level from taxation. On account of the progressive character of personal income tax, tax allowances benefit taxpayers with high income more than taxpayers with low income because, when earning a higher income, the resulting reduction of the assessment basis and the tax rate is larger than it is when less income is earned. A deductible amount is not deducted from the assessment basis but rather directly from the tax debt. In doing so, it directly reduces the amount of taxes to be paid. While the tax allowance leads to more relief in a progressive tax scale with an increasing assessment basis, the deductible amounts provide relief to all taxpayers to the same degree and are thus perceived as more just. An example for a deductible amount is the deduction of donations to political parties by natural persons amounting to 50 % of the expenditures, at most € 825 (cf. Sec. 34g sent. 1 no. 1 and sent. 2 EStG). Note A tax threshold is the part of the assessment basis, up to the maximum value of which taxes are not levied. A tax allowance is the part of the assessment basis that is exempted from taxation. A deductible amount is deducted from the taxpayer’s tax debt. Tax rate and tax scale The tax rate indicates what percent of the assessment basis or what absolute amount of money per unit of the assessment basis is levied as taxes by the fiscal authorities. The term tax scale is used if the tax rate is not constant for the entire assessment basis. Thus, a tax scale consists of a sequence of tax rates. Tax scales can be simple tax scales (dependent on only one variable, e.g. the personal income tax scale, which is only dependent on the amount of taxable income) or combined scales (dependent on more than one variable, e.g. the inheritance tax scale, which is dependent on the amount of the inheritance as well as the degree of relationship). The scales of personal taxes are usually <?page no="22"?> 1.4 The tax system 23 constructed progressively, i.e. the tax rate and the resulting average tax burden increase with the assessment basis. The basic tax rate is the tax rate that must be paid for the first Euro of the taxpayer’s assessment basis. On the other hand, the top tax rate is the highest tax rate provided for in a tax scale (= maximum marginal tax rate). The average tax rate results from the amount of taxes to be paid divided by the respective assessment basis. If the tax rate is expressed as a percentage, the result is to be multiplied by a factor of 100. The marginal tax rate or the marginal rate of tax is the tax rate at which the last (highest) unit of the assessment basis achieved is taxed. The marginal tax rate results from the first derivative of the tax function. The differential tax rate is the average tax rate levied on an additional part of the assessment basis (B Z ). If the taxes on the assessment basis including B Z are depicted as S Z and as S for the taxes without this part of the assessment basis, the differential tax rate is calculated as (S Z - S)/ B Z . The scale can be designed as a calculation scale or as a threshold scale (graduated scale). In the calculation scale, the rate that applies to the last unit of taxation shall apply to the entire assessment basis. In the case of the threshold scale or graduated scale, the assessment basis is broken down into portions, to which a certain tax rate is then applied respectively. The personal income tax scale in Germany is designed as a threshold scale. In 2018 the following scale applies: • From € 0 to € 9,000: Basis tax allowance ; not subject to taxation (cf. Sec. 32a (1) sent. 2 no. 1 EStG) • From € 9,001 to € 13,996: Transition to linear-progressive development. The marginal tax rate increases from a basic tax rate of 14 % to 23.87 % (cf. Sec. 32a (1) sent. 2 no. 2 EStG). <?page no="23"?> 24 1 Introduction to German profit tax law • From € 13,997 to € 54,949: Linear-progressive development with a quick increase in the marginal tax rate up to 42 % (cf. Sec. 32a (1) sent. 2 no. 3 EStG). • From € 54,950 to € 260,532: Proportional development with a marginal tax rate of 42 % (cf. Sec. 32a (1) sent. 2 no. 4 EStG). • Above € 260,533: Proportional development with a top tax rate of 45 % (cf. Sec. 32a (1) sent. 2 no. 5 EStG), so-called wealth tax (Reichensteuer). Figure 6: Tax scale in 2018 Note Only the top tax rate in Germany is 45 %. The average tax rate is regularly (significantly) lower due to the tax tariff. 1.4.4 Tax sovereignty The distribution of the tax revenue to the federal government, the federal states and the municipalities is regulated in Art. 106 of the Basic Constitutional Law of Germany (GG). Most of the tax types are assigned exclusively to an individual federal, regional or local authority (Gebietskörperschaft) named in the Basic Constitutional Law (divided tax system). The revenue <?page no="24"?> 1.4 The tax system 25 from the most profitable tax types, especially the personal income tax, corporate income tax and value-added tax (community taxes), is, however, divided between the federal government and the federal states according to a set distribution key (combined tax system). The advantage of the combined system is that the distribution of the tax revenue to the regional authorities leads to the avoidance of multiple taxation by different levels. The tax sovereignty over the tax revenue can be classified as follows: Figure 7: Classification of the taxes according to the tax sovereignty Note The personal income tax and the corporate income tax are community taxes. The land tax and the trade tax are communal taxes. <?page no="25"?> 26 1 Introduction to German profit tax law Summary ► The expenses of the state are predominantly financed by levying taxes. The legal definition of tax is contained in Sec. 3 (1) of the Fiscal Code of Germany (AO). ► Different disciplines of science have taxes as object of knowledge. Tax types: • Impersonal and personal taxes • Direct and indirect taxes • Classification according to economic factors • Classification according to the regional authorities entitled to the revenue ► Taxation terminology: • Taxpayer and/ or taxable subject • Subject to taxation and/ or taxable object • Tax base • Tax threshold/ tax allowance/ deductible amount • Tax rate/ tax scale Questions 1. Which disciplines of science deal with taxes? 2. What types of income does the state receive? 3. What kinds of levies can be distinguished? 4. What is a tax allowance, what is a tax threshold and what is a deductible amount? What is the difference between the three? 5. What is the difference between the marginal tax rate, average tax rate and differential tax rate? 6. What taxes are levied solely by the federal governments, by the federal states or by the municipalities? What taxes are levied in the combined system? Literature Dietrich Grashoff, Florian Kleinmanns, Aktuelles Steuerrecht 2017 (Current tax law 2017), Munich, 13 th ed. 2017, pp. 7-16. Wolfgang Jakob, Einkommensteuer (Personal income tax), Munich, 4 th ed. 2008, p. 24. Dieter Schneeloch, Stephan Meyering, Guido Patek, Betriebswirtschaftliche Steuerlehre, Bd. 1: Grundlagen der Besteuerung, Ertragsteuern (Business taxation, Vol. 1: Principles of taxation, profit taxes), Munich, 7 th ed. 2016, pp. 1-42. Klaus Tipke, Joachim Lang, Steuerrecht (Tax law), Cologne, 22 nd ed. 2015, pp. 1-72, 185-194, 252. ► ► <?page no="26"?> Personal income tax Basic principles of personal income tax 2.1.1 Characterization, importance and principles of personal income tax Legal basis Personal income tax is levied in accordance with the law. According to Sec. 4 of the Fiscal Code of Germany (AO), “Law is every legal norm”. Taxation without a legal basis is not permitted. The legal bases of the personal income tax include the following: • Formally enacted laws : 1. Constitution : The German Basic Constitutional Law of 23 May 1949 2. General laws : E.g. the Fiscal Code of Germany (Abgabenordnung - AO) or the Income Tax Act (EStG), • Statutory regulations : The German Implementing Ordinance for Income Tax (Einkommensteuer-Durchührungsverordnung - EStDV) and the German Implementing Ordinance for Wage Tax (Lohnsteuer-Durchührungsverordnung - LStDV). Laws and subordinate legislation are generally binding. The following also have a substantial influence on legal practice: • The jurisdiction of the German Federal Fiscal Court (BFH) and the German Fiscal Courts (FG) • Administrative provisions: Income tax guidelines (Einkommensteuer- Richtlinien - EStR), wage tax guidelines (Lohnsteuer-Richtlinien - LStR), official statements from the German Federal Ministry of Finances (Bundesministerium der Finanzen - BMF), decrees of the federal states or orders from the regional tax offices (Oberfinanzdirektionen). Note Administrative provisions are only binding for the tax administration, not taxpayers. <?page no="27"?> 28 2 Personal income tax The jurisdiction of the courts is only binding for the respective case. The decisions do have influence beyond the individual case, however, because it must be assumed that the courts will make the same decision in similar cases. The administrative provisions are only binding for the tax administration, however, not for the taxpayers. Characteristics and demarcation of the personal income tax The personal income tax belongs to the group of profit taxes, as does the corporate income tax and the trade tax. This group includes all types of taxes in which economic success forms the tax base. The magnitudes of success that are examined thereby include the profit, the revenue, the surplus or even the income. As a personal tax, the personal income tax is linked with the tax subject “natural person.” In doing so, the principle of the personal ability to pay is accommodated by taking into account the taxpayer’s personal circumstances in the calculation of the income (e.g. the subsistence level as basis tax allowance under Sec. 32a (1) sent. 2 no. 1 EStG and the classification of insurance premiums for personal insurances as special expenses in accordance with Sec. 10 (1) nos. 3 and 3a in conjunction with (i.c.w.) (4) EStG. The so-called taxable income (zu versteuerndes Einkommen - z.v.E.) forms the assessment basis of the personal income tax. As a personal tax, the personal income tax may not be deducted from its own assessment basis in accordance with Sec. 12 no. 3 EStG. According to Sec. 10 no. 2 of the German Corporate Tax Code (KStG), the same applies to the corporate income tax. As an impersonal tax, the trade tax is based on the ability of the (commercial) enterprise as the taxable subject to pay. The assessment basis is the trade income. Although trade tax is levied for business purposes and therefore represents a business expense, it cannot be deducted as a business expense when calculating profits (cf. Sec. 4 (5b) EStG). Table 1: Differentiation of the profit tax types <?page no="28"?> 2.1 Basic principles of personal income tax 29 Fiscal and economic importance In 2016, the revenue from income tax amounted to approx. € 244.5 billion. Thus, together with value-added tax, it is the most important tax. Figure 8: Revenue from selected types of German taxes in 2016 Principles of income taxation The ability-to-pay principle is fundamental to the German tax system and is substantiated by several sub-principles. Although these principles have not been codified expressis verbis, i.e. they are not written in the law, they are, however, reflected in numerous provisions: • The principle of taking into consideration the personal ability to pay: Each taxpayer should participate in providing tax revenue according to his ability to pay. How the ability to pay should be measured is the subject of debate. Indicators, such as income, assets or consumption, are often used. There is consensus that taxpayers in the same situations must be taxed equally ( horizontal tax equity ), while taxpayers in different situations are - corresponding to the character of the difference - to be treated differently ( vertical tax inequity ). • Objective net income principle: The assessment basis of taxation is reduced by expenditures which are made to generate income and which stand in direct economic relation to this generation. Losses are also taken into account in the determination of the income because they lower the <?page no="29"?> 30 2 Personal income tax taxpayer’s ability to pay. Hence, losses in one type of income may be offset with earnings in other types of income. The deductibility of business expenses (Sec. 4 (4) EStG) and income-related expenses (Secs. 9, 9a EStG) as well as the forms of loss offsetting (Secs. 2 (3), 10d EStG) are examples of how the objective net income principle is realized in the determination of the taxable income. • Subjective net income principle: Expenditures made to maintain the taxpayer’s existence are to be exempted from taxation. In doing so, characteristics which lie solely in the private sphere of the taxpayer are taken into account. Examples of this can be found in the basic tax allowance laid down in the EStG currently amounting to € 9,000 and the admissibility of deducting special expenses and extraordinary burdens. • Principle of personal universality: All natural persons fulfilling the requirements to which taxation is linked are to be subjected to taxation without regard to their social position, status or origin. There are no exceptions founded in the taxpayer’s person (e.g. Federal President, nobility, etc.). • Principle of impersonal universality: Every subject of taxation is to be taxed evenly, regardless of its nature or composition (e.g. real estate, capital assets, securities, money). Differences in taxation that result from the nature of the subject of taxation are to be avoided. However, this principle is increasingly being broken, e.g. with regard to the taxation of capital yields accruing to the private assets of a natural person with the flat-rate withholding tax or the restriction on the offsetting of losses from capital assets pursuant to Sec. 20 (6) EStG. • Principle of progressive income taxation: The progression of the tax scale is a manifestation of the ability-to-pay principle. Accordingly, a better ability to pay - measured by a high income - should also result in a tax payment of higher proportions. The objective of arranging the scale progressively is the call for a contribution to the polity matching the ability to pay. • Principle of discrete period taxation: This principle is not a manifestation of the ability-to-pay principle, but rather a fiscal necessity. The abilityto-pay principle requires as a just assessment basis the lifetime income, which can only be determined after the taxpayer has passed on. The state is, however, dependent on continuous tax revenue in order to perform the tasks assigned to it. Thus, the income tax scale is based on one year in accordance with Sec. 32a EStG so as to ensure an even tax yield. Transactions that lie outside the current period of time for the determination of the taxable income are generally not taken into account in the respective assessment period. Allowances for the principle of taxing lifetime income are, however, made with the possibility of carrying losses forward and back. <?page no="30"?> 2.1 Basic principles of personal income tax 31 The two forms of income tax assement A distinction should be made between the two forms of income tax assessment: Figure 9: Forms of assessing income tax Assessing taxes is the basic form of tax assessment, whereby withholding taxes at the source forms an exception for certain types of income. When taxes are assessed, the taxpayer should list the income earned during the calendar year in a form and declare it to the fiscal authorities. After the submitted tax return has been reviewed, the fiscal authorities set the amount of taxes to be paid in a tax assessment. A distinction is drawn between the individual tax assessment and the joint tax assessment. Generally, the taxable income earned during the calendar year is calculated for each natural person individually (individual tax assessment, Sec. 25 (1) EStG). This applies to persons who are single, divorced, widowed or permanently separated. Only married couples may apply for joint assessment under Sec. 26b EStG, in which the assumption is made that each spouse has a stake in half of the other partner’s income. According to Sec. 32a (5) EStG, in the case of joint assessment the scaled income tax amounts to twice the resulting tax amount for half of the joint income subject to taxation. This method is known as “Ehegatten-Splitting” (spousal income splitting), Note The following are the cumulative requirements for the tax assessment in the form of spousal income splitting: • Civil law marriage and/ or marriage during the calendar year • Unlimited tax liability of both partners • Not permanently separated The exception to the assessing of taxes is taxation at the source of the income. Withholding taxes and/ or source taxes are not viewed as forming a separate <?page no="31"?> 32 2 Personal income tax type of taxes, but rather represent an advance payment of income tax that may be credited against the income tax after it has been determined. The purpose of withholding taxes is, among other things, to ensure tax revenue for the state. Hence, wage taxes on income earned from dependent-employment are deducted from the wages by the employer, who pays it to the fiscal authorities. The capital yields tax, for example, is withheld and paid to the fiscal authorities by the paying company (e.g. the GmbH when profits are distributed) and/ or by the paying institution (e.g. the bank for accrued interest). An exception is the so-called flat-rate withholding tax or withholding tax within the meaning of Sec. 32d EStG. Capital yields that flow into the private assets of a natural person are usually taxed at a reduced rate of 25 %. In these cases, the tax liability is already settled by the deduction of the capital yields tax, and the capital yields do not have to be assessed with the remaining income of the taxpayer (cf. Sec. 43 (5) EStG). However, if the special tariff of Sec. 32d (1) EStG is not applicable, the capital yields tax retains its character as an advance payment of income tax. Note The withholding tax and/ or the source tax do not form a separate type of tax, but rather merely a special form of tax assessment to ensure tax revenue. This gives it the character of an advance payment of income tax. Summary ► Income tax is counted among the profit taxes. Together with valueadded tax, it is the most important tax (measured by the total tax yield). ► The distinction is drawn between the forms of tax assessment - assessing taxes and withholding taxes at the source. ► Important legal bases are the German Constitutional Law, the Fiscal Code of Germany, the German Personal Income Tax Act and the German Implementing Ordinance for Wage Tax. ► The ability-to-pay principle is of fundamental importance to the law on personal income tax and is substantiated by the division into several sub-principles. Questions 1. What are the most important legal bases of personal income tax? 2. How can personal income tax be differentiated from other profit taxes? 3. What is the importance of income tax? 4. How are the forms of tax assessment differentiated? 5. What main principles and sub-principles form the basis of German income tax law? <?page no="32"?> 2.1 Basic principles of personal income tax 33 2.1.2 Personal and impersonal liability for personal income tax There are two steps necessary to determine the liability for personal income tax: First, it must be decided which persons are to be called upon to pay the income tax ( personalliability for personal income tax ). Secondly, it must be decided which of the positions are included in the taxation of the income ( impersonal liability to personal income tax ). Figure 10: Personal and impersonal liability for personal income tax 2.1.3 Personal liability for personal income tax Personal income tax is a personal tax. The German Income Tax Act (Einkommensteuergesetz - EStG) applies the liability for taxes to all natural persons (Sec. 1 (1) sent. 1 EStG), regardless of age, citizenship and legal capacity. Thus, even minors and otherwise legally incapacitated persons are liable for taxes; their tax obligations are attended to by their legal representatives. In contrast, legal entities are not subject to personal income tax, but rather corporate income tax. Partnerships , in particular the OHG (general partnership) and the KG (limited partnership) - known in the terminology of taxation as “copartnerships” - are neither subject to personal nor corporate income tax. The taxes on the profits of these companies are assessed from the individual partners relative to their participation and at their respective individual tax rates. A natural person’s personal liability for personal income tax begins at birth and ends at death … from the cradle to the grave! According to Sec. 1 (1) and (4) EStG, a distinction is drawn between unlimited and limited tax liability. The distinction is related to the scope of the taxable income. Unlimited tax liability is divided into the unlimited, extended unlimited and notional (unlimited) tax liability. The limited tax liability is classified either as the general limited tax liability or the extended limited tax liability. <?page no="33"?> 34 2 Personal income tax Figure 11: Personal income tax liability Types of unlimited tax liability a) Unlimited tax liability as defined by Sec. 1 (1) EStG According to Sec. 1 (1) EStG, “Natural persons who are domiciled or have their habitual residence in the country are subject to unlimited personal income tax.” Hence, the requirements for unlimited tax liability are as follows: • Natural persons , i.e. all living persons from the moment of their birth until their death. • Domestic , i.e. within the borders of the Federal Republic of Germany, including the portion of the continental shelf, in accordance with Sec. 1 (1) sent. 2 EStG. • Domicile , as defined in Sec. 8 of the Fiscal Code of Germany (Abgabenordnung - AO); required is the possession of a dwelling, in addition to the taxpayer’s intent to maintain and use the dwelling. • Habitual residence is defined in Sec. 9 AO (as opposed to temporary residence) as continuous residence lasting more than six months. Short-term interruptions are not taken into account in calculating the length of residence. Citizenship is irrelevant in determining whether tax liability exists. Example: Armin is a Turkish citizen. On 2 May he enters Germany, but does not establish a domicile. On 5 August he travels home to Turkey but returns to Germany, where he remains until 23 December. In spite of the residence being interrupted by the trip to Turkey, Armin is subject to unlimited tax liability in Germany for the entire period of time between 2 May and 23 December. The stay in Germany lasted longer than six months (Sec. 9 sent. <?page no="34"?> 2.1 Basic principles of personal income tax 35 2 clause 1 AO). According to Sec. 9 sent. 2 clause 2 AO, the trip home is not taken into consideration. It does not matter that Armin lacks German citizenship. Within the scope of the unlimited tax liability, all domestic and international earnings - the so-called global income - is subject to German taxation ( principle of global income taxation ). b) Extended unlimited tax liability as defined by Sec. 1 (2) EStG According to Sec. 1 (2) EStG the scope of persons subject to unlimited tax liability under subsection 1 is extended to include persons, who • are German citizens, • are not domiciled or not habitually residing in Germany, • have established employment with a domestic legal entity under public law and are paid from domestic public funds, and • are subject to limited tax liability in their country of domicile and/ or residence. The same applies to the dependents sharing the same household and who are German citizens or who have no income or exclusively domestic earnings. Note German ambassadors and consulate officers are subject to extended unlimited personal income tax in Germany. Example: Götz lives in the USA with his wife Elisabeth and is employed as a diplomatic ambassador of Germany. Elisabeth has no income. Götz and Elisabeth are German citizens, but entertain neither domicile nor habitual residence in Germany. As ambassador, Götz is employed by the German Ministry of Foreign Affairs and receives his wages from German public funds. Elisabeth fulfills the requirements of Sec. 1 (2) sent. 1 clause 2 EStG. Thus, the couple is subject to extended unlimited tax liability in Germany. c) National unlimited tax liability as defined by Sec. 1 (3) and Sec. 1a EStG Persons who have neither domicile nor habitual residence in the country, but who cross over the border from other countries (e.g. Switzerland, Austria, Netherlands, Poland or Czech Republic) into Germany in order to perform their work, are referred to as cross-border workers . These persons, as they do not fulfill the requirement under Sec. 1 (1) EStG are only subject to limited <?page no="35"?> 36 2 Personal income tax tax liability in Germany and unlimited tax liability in their country of domicile. In Germany, the taxpayer’s personal circumstances (subsistence level, special expenses, etc.) cannot be taken into consideration because this is supposed to be the case within the scope of the unlimited tax liability, i.e. in the foreign country of domicile. Cross-border workers, however, earn their income predominantly or exclusively in Germany and, accordingly, earn no or little income in their country of domicile. They are therefore unable to assert the personal aspects abroad for lack of taxable income. For this reason, crossborder workers run the risk of being discriminated against relative to “normal” employees because their personal circumstances are neither taken into account in the country of employment nor the country of domicile. In the so-called Schumacker-decision on 14 February 1995, in which this discrimination formed the subject matter of the lawsuit, the European Court of Justice decided that cross-border workers may now apply to be subject to unlimited tax liability. In doing so, the unlimited tax liability is fictitious. This is, however, only possible if (almost) all of the income is subject to German personal income tax. Note Requirements of the notional unlimited tax liability include the following: • Application, • at least 90 % of the total income earned must be subject to German personal income tax or • the taxable income not earned in Germany may not exceed the basic tax allowance of € 9,000 in accordance with Sec. 32a (1) sent. 2 no. 1 EStG and • a certificate must be issued by the foreign fiscal authorities indicating the foreign income. The tax benefits for those subject to unlimited tax liability may be taken advantage of if the requirements are fulfilled. These include special expenses, extraordinary burdens, child benefit, respectively tax allowances for children and basic tax allowance. Example: Karl, whose sole domicile is in Switzerland, only earns income to which German income tax applies. The requirements for habitual residence in Germany are not fulfilled. The necessary certificate indicating the amount of income earned at home is submitted. Karl is not subject to unlimited tax liability in Germany under Sec. 1 (1) EStG because he entertains neither domicile nor habitual residence domestically. Sec. 1 <?page no="36"?> 2.1 Basic principles of personal income tax 37 (2) EStG does not apply either. Without an application, Karl is therefore subject to limited tax liability in Germany according to Sec. 1 (4) EStG. The unlimited tax liability is presumed, however, in accordance with Sec. 1 (3) EStG after submission of the Swiss certificate because an application was filed and only German income was earned. This is advantageous to Karl because he can, for Example, claim special expenses, which would not have been possible in the case of limited tax liability (Sec. 50 (1) sent. 3 EStG). However, there is the problem that the German EStG contains subjector family-related benefits, which presuppose not only the unlimited tax liability of the income recipient himself, but also the unlimited tax liability of the spouse. Especially in the case of cross-border workers, the latter is usually not present, so that without further regulations neither a joint assessment with splitting table nor the so-called real splitting could be granted. Sec. 1a EStG therefore contains an additional advantage in the context of unlimited tax liability, which, however, according to the wording of the provision, only benefits EU and EEA nationals. In 1999, the EU concluded an agreement with Switzerland to ensure the free movement of persons between Switzerland and the EU states in accordance with the arrangements within the EU. On this basis, the European Court of Justice ruled in its ruling of 28 February 2013 that EU law is violated if joint taxation is refused because the spouse's place of residence is in Switzerland. The German tax authorities are following this ruling and granting the benefit of Sec. 1a (1) no. 2 EStG if the spouse is resident in Switzerland. This applies accordingly to the benefit under Sec. 1 (1) no. 1 EStG. Nationals of the EU or the EEA and of Switzerland can take advantage of the spouse splitting and the real splitting, • if, with regard to real splitting, the recipient of the benefits within the meaning of Sec. 10 (1a) EStG is not subject to unlimited tax liability and is resident or ordinarily resident in the EU, the EEA or Switzerland and the taxation of the benefit or payment at the recipient's place of residence is evidenced by a certificate issued by the competent foreign tax authority, or • if, with regard to spousal splitting, the spouse who is not permanently separated and who has no domicile or habitual residence in the country, has his or her domicile or habitual residence in the EU or EEA or Switzerland and applies for taxation for unlimited tax liability. If the regulations of the fictitious unlimited tax liability are claimed, the income of both spouses must be taken into account and the basic tax allowance (Sec. 32a (1) sent. 2 no. 1 EStG) doubled. <?page no="37"?> 38 2 Personal income tax Example: Richard, a citizen of Austria, lives in Vienna with his wife, Silvia. He commutes daily to Germany and performs his work there. The necessary certificate indicating the amount of income earned at home is submitted. Richard is not subject to unlimited tax liability in Germany because he entertains neither domicile nor habitual residence in Germany. Sec. 1 (1) EStG does not apply. Without an application, Richard is therefore subject to limited tax liability in Germany according to Sec. 1 (4) EStG. The unlimited tax liability is presumed, however, after submission of the Austrian certificate because an application was filed and only German income was earned. In accordance with Sec. 1a (1) no. 2 EStG, Richard is also granted the application of the spousal income splitting within the meaning of Sec. 26 (1) sent. 1 EStG, i.e. Silvia is also treated as being subject to unlimited taxation in Germany. If Richard were not a citizen of the EU/ EEA or Switzerland, he could, for Example, claim special expenses in Germany, but not spousal income splitting. Table 2: Cross-border workers and citizens of the EU/ EEA The European Economic Area (EEA) entered into force on 1 January 1994 and includes the former 12 countries of the EU (Belgium, Denmark, Germany, France, Greece, Great Britain, Ireland, Italy, Luxemburg, Netherlands, Portugal and Spain) as well as six of the former seven European Free Trade Association (EFTA) States i.e. Finland, Iceland, Liechtenstein, Austria, Norway and Sweden. Thus, the EU/ EEA privilege now applies to all EU-countries in addition to Iceland, Liechtenstein and Norway. Since 2013, residence in Switzerland has also been privileged. The scope of application of Sec. 1 (3) and Sec. 1a EStG can be illustrated once again as follows: <?page no="38"?> 2.1 Basic principles of personal income tax 39 Table 3: Scope of application of the notional unlimited tax liability Types of limited tax liability a) General limited tax liability as defined by Sec. 1 (4) EStG In the event that a natural person entertains neither domicile nor habitual residence in the country and does not opt for the notional unlimited tax liability, such a person is subject to limited tax liability, if and in as much as they earn domestic income within the meaning of Sec. 49 EStG. Example: The German citizen Juliane lives in Australia. She earns income inGermany from rent and lease (Sec. 21 EStG). Juliane is neither domiciled nor habitually resides in Germany. The income from rent is domestic income within the meaning of Sec. 49 (1) no. 6 EStG. Thus, Juliane is subject to limited tax liability for this income. She is able to deduct income-related expenses according to Sec. 9 EStG. Note Requirements for limited tax liability: • Natural person, who is • neither domiciled nor habitually residing in the country, has not opted in, and has • earned domestic income within the meaning of Sec. 49 EStG. Table 4: Scope of application of limited tax liability <?page no="39"?> 40 2 Personal income tax Within the scope of the limited tax liability, only domestic income is subject to German taxation ( source principle ), not however the global income. b) Extended limited tax liability as defined by Secs. 2 and 5 of the International Tax Relations Law (Außensteuergesetz - AStG) In order to hamper the relocation of the domicile to a low-tax country (e.g. Monaco, Liechtenstein, certain cantons in Switzerland), German citizens are subject to the extended limited tax liability in Germany following their relocation. It is necessary, however, that they maintain substantial economic interests domestically. According to Sec. 2 (2) AStG, a country is considered to be a lowtax country if the foreign tax burden is more than one-third less than the comparable burden in Germany. According to Sec. 2 (3) AStG, substantial economic interests are held in Germany if the taxpayer is an enterpriser or co-enterpriser in Germany or the income earned in Germany and/ or the assets located in Germany exceed certain amounts or pecuniary circumstances. In addition, for at least five of the last ten years before the relocation the taxpayer must have been subject to unlimited tax liability in Germany. The group of persons subject to extended limited tax liability is liable to pay taxes in Germany for a period of ten years following the relocation of the domicile for all income that is not foreign income within the meaning of Sec. 34d EStG. Thus, the scope of this income exceeds the domestic income specified in Sec. 49 EStG (e.g. private sales transactions are taken into account in accordance with Sec. 23 (1) no. 2 EStG) and represents an intensification of the general limited tax liability. Note Requirements for extended limited tax liability: • Natural person, who has • relocated in a low-tax country, who was • subject to unlimited tax liability as a German citizen for five of the last ten years, and who maintains • substantial economic interests domestically. Example: The German citizen Karl, who has lived in Germany from the time of his birth (10 February 1976), relocates his domicile to Monaco in the first part of 2018. He remains a co-partner of the German Stella OHG (general partnership). Before his relocation from Germany, Karl was subject to unlimited tax liability domestically for a total of more than 30 years. By moving away, he loses his domicile and/ or habitual residence in Germany, i.e. the requirements for the unlimited tax liability are not fulfilled. Karl is, however, subject to extended limited tax liability for personal income tax because his new domicile is located in a low-tax <?page no="40"?> 2.1 Basic principles of personal income tax 41 country and he still maintains substantial economic interests in Germany (on account of being a copartner). In the event that he maintains his domicile in Monaco, he will remain subject to extended limited liability for personal income tax until 2028. If Karl had not relocated his domicile to a low-tax country, but rather to France, for Example, he would only be subject to limited tax liability, but not to the extended limited tax liability. The diverse possibilities of tax liability in Germany are summarized again in the schema of questions in figure 12. Problem of double taxation The coexistence of limited and unlimited tax liability often leads to overlapping claims to tax by different countries, which can result in the repeated taxation of the same income. Unilateral (national) provisions and bilateral treaties (so-called double taxation conventions) exist to reduce and/ or prevent such double taxation. The latter provide different restrictions of the principle of global income taxation in the case of unlimited tax liability and/ or the principle of domestic income taxation in the case of limited tax liability. Ideally, the result is that each country’s right of taxation is restricted to such an extent by the restrictive norms of a double taxation convention, that the rights of taxation no longer overlap and double taxation is prevented. 2.1.4 Impersonal liability for personal income tax The legislature defines what is considered to be income and thus the basis for the assessment in assessing personal income tax. This task is performed by Sec. 2 EStG. In 1946, the German legislature was obligated by the Allies to set top tax rates amounting to 95 %, but these tax rates would have throttled the regeneration of the economy, so the tax burden could only be kept at a tolerable level by a corresponding permeation of the basis of the assessment of taxes. This resulted in the problems of excessive tax rates that are applied to a thinned-out assessment basis which continues to exist today. The types of income Assessment basis for the personal income tax is the income earned by the taxpayer during the calendar year. In doing so, allowance is made for the principle of discrete period taxation. Financial science essentially has two theories on how to determine “income”: • Source theory ( Quellentheorie ) : Income is everything that flows to the taxpayer from a constant source. Accordingly, income does not include one-time or completely irregular earnings, such as inheritance and lottery winning. <?page no="41"?> 42 2 Personal income tax <?page no="42"?> 2.1 Basic principles of personal income tax 43 • Accretion theory (Rein vermögenszugangstheorie ): Income is the (pure) growth in assets reduced by the expenditures incurred in connection therewith. Thus, it does not matter whether it is a recurrent or one-time transaction nor from where the income originates. Thus, the definition of income according to the accretion theory is wider than the definition supplied by the sources theory, which necessitates a regularly flowing source. The German law on personal income tax did not assume either of the theories as a whole, but rather chose a compromise between the theories in defining income. Sec. 2 (1) sent. 1 EStG contains a conclusive list of the seven types of income, which are regulated explicitly in Secs. 13 to 24 EStG: • Income from agriculture and foresting (Sec. 13 EStG), • Business income (Sec. 15 EStG), • Income from self-employment (Sec. 18 EStG), • Income from dependent-employment (Sec. 19 EStG), • Income from capital assets (Sec. 20 EStG), • Income from rent and lease (Sec. 21 EStG), and • Other income within the meaning of Sec. 22 EStG. Figure 13: Organization of income according to the way the income is determined <?page no="43"?> 44 2 Personal income tax Even though the law on personal income tax contains its own definition of income for its own purposes, the theories of the financial sciences are recognizable in the background. The individual types of income can be classified according to the way income is determined as profit income types ( alternatively: business income types ) in accordance with Sec. 2 (1) sent. 1 nos. 1 to 3 EStG and surplus income types ( alternatively: household income types ) in accordance with Sec. 2 (1) sent. 1 no. 4 to 7 EStG (see fig. 13). Generally, the profit income types follow the accretion theory , whereas the surplus income types follow the source theory . Example: Wilhelm and Marianne each possess and realize rental earnings from land in Munich. Marianne holds the land in her personal property, whereas Wilhelm holds it as in the operating assets of his business. Both sold their land in February 2018. For Marianne, the rental earnings represent income from rent and lease (Sec. 21 EStG). On the other hand, Wilhelm has operating income within the scope of business income (Sec. 15 EStG) because the land belongs to the operating assets of the business. This, however, leads to a disadvantage for Wilhelm because the profit from the sale is subject to taxation (= accretion theory), whereas the profit from the sale is generally not subject to taxation (= sources theory) for Marianne, because the sale does not represent a continuous source of income. Table 5 depicts the schema of income determination as well as the underlying theories and norms of both types of income: Table 5: Profit vs. surplus types of income However, the principle described above is increasingly being breached. One example of this is the flatrate withholding tax. Here, not only current capital income, such as interest and dividends, is recorded, as was the case in <?page no="44"?> 2.1 Basic principles of personal income tax 45 principle before, but also certain capital yields from the sale of investments. On the other hand, the loss of a capital claim in the private sphere may lead to a loss to be recognized for tax purposes, provided it is certain that the loss of the claim is final. 1 Thus, income from capital assets follows both the sources theory and the accretion theory. In addition, the individual types of income can also be divided according to their priority into primary income types (Sec. 2 (1) sent. 1 nos. 1 to 4 EStG) and ancillary income types (Sec. 2 (1) sent. 1 nos. 5 to 7 EStG). The ancillary types of income are generally subsidiary, i.e. if earnings can be assigned to the primary type of income and the ancillary types of income, the primary type of income has priority. Example: In the example above, Wilhelm had let real estate that is assigned to the operating assets of his business. Thus, the income could either be considered business income in accordance with Sec. 15 EStG (= primary type of income) or income from rent and lease in accordance with Sec. 21 EStG (= ancillary type of income). Because the primary types of income have priority over the ancillary types of income, Wilhelm earns business income in accordance with Sec. 15 EStG. Figure 14: Organization of income according to its priority The taxpayer can earn income from several different types of income at the same time. In this case, the income consists of different income types. It is 1 See BFH, 24 October 2017, DStR 2017 p. 2801. <?page no="45"?> 46 2 Personal income tax known as a synthetic income tax (e.g. in Germany) if the earnings are combined to form income which is subject to uniform taxation and to the whole of which a single tax rate applies. This also corresponds to the basic system of German income tax system. If, however, each separate type of income is subject to a separate rate, this is known as a so-called schedule system . This system can be found, for example, in Great Britain and in Latin America as well as in Germany in the context of the flat-rate withholding tax. Example: Hermann possesses a house in which he operates a hair salon. Hermann lets both of the apartments which are also located in the building, but were not put in the operating assets of the business, to two parties for accommodation purposes. As the owner of the hair salon, Hermann earns business income (Sec. 15 (1) no. 1 EStG) and as landlord, he earns income from rent and lease (Sec. 21 EStG). Figure 15: Determination of the taxable income The total income, potentially reduced by the proportional tax allowance for elderly retired persons, the tax allowance for single parents and the deduction <?page no="46"?> 2.1 Basic principles of personal income tax 47 under Sec. 13 (3) EStG, represents the total amount of income (Sec. 2 (3) EStG). The income is the result after deduction of special expenses, a potential deduction of losses and after deduction of extraordinary burdens (Sec. 2 (4) EStG). The income, potentially reduced by the child tax allowance, forms the taxable income subject to taxation. As a whole, this represents the assessment basis for Hermann’s scaled personal income tax (Sec. 2 (5) sent. 1 EStG). Thus, the business income and the income from rent and lease are not taken into account and taxed separately. A special feature in the determination of taxable income is, however, the capital income which is subject to the flat-rate withholding tax in accordance with Secs. 32d (1) and 43 (5) EStG. As a rule, these are not taken into account when determining the total amount of income, income and taxable income. Sec. 12 no. 1 EStG plays an important role in connection with the determination of income and proscribes the deduction of expenditure made for lifestyle from the individual types of income, Example: In his free time, Ferdinand likes to go to the cinema and eats potato chips there. These expenses may not be claimed from the taxes (Sec. 12 no. 1 EStG), as they are not related to the generation of income but are privately incurred. This proscription often leads taxpayers to mask expensive hobbies (e.g. private horseback riding, hunting or beekeeping) as business operations subject to taxation, so as to transform clearly private expenditures (e.g. upkeep for the horses) into tax-relevant business expenses, which are to be deducted from other positive income. Such costs, incurred within the scope of pursuing a hobby without the intention of earning income, are known in German as “Liebhaberei” (income from a hobby) and are not tax-deductible. They therefore do not reduce taxable income; correspondingly, income generated by a hobby activity does not constitute taxable earnings. Example: Ferdinand is a doctor and earns income from self-employment. His wife, Margarete, rides horses as a hobby and possesses a horse for which annual costs amount to € 100,000. Margerete now intends to give a 1-hour riding lesson once a year (! ) for € 10, so that - in principle - business income amounting to € 10 is earned and is to be reduced by the expenditures, which themselves represent business expenses. Accordingly, this would lead to operating losses of € 99,990, which could be credited against the positive income earned by Ferdinand from self-employment. HOWEVER: The riding lesson given by Margarete is part of her hobby and is obviously not aimed at earning a profit. The costs of the horse may not be claimed as business expenses. The € 10 for the riding lesson may also not be claimed as <?page no="47"?> 48 2 Personal income tax business income; thus, no income was earned. Ferdinand also may not reduce his earnings from self-employment by the costs of his wife’s horseback riding within the scope of the joint assessment. Income that does not belong to one of the seven types of income is not taxable and therefore is not subject to personal income tax (e.g. lottery winnings, inheritance and gifts). The seventh type of income (other income within the meaning of Sec. 22 EStG) is not a catchall for income that does not belong to the first six types of income. Only that income that is explicitly listed in Sec. 22 EStG belongs to this type of income. Example: Alfons wins € 5,555 for correctly filling out a crossword puzzle. The prize cannot be assigned to one of the seven types of income and thus is not subject to personal income tax. However, if he subsequently invests this amount profitably with a bank and earns interest from this, these must be subject to the flat-rate withholding tax in accordance with Sec. 32d (1) EStG. Determination of the personal income tax Figure 16: Determination of income tax liability According to Sec. 2 (6) EStG, a distinction is drawn between scaled and assessed personal income tax. The scaled personal income tax generally results from the application of the basic rate (Sec. 32a (1) EStG) and/ or for jointly = Taxable income (Sec. 2 (5)) Basic tax rate / Splitting rate (Sec. 32a (1),(5)) = Scaled income tax  = Final payment or refund entitlement = Personal income tax to be assessed ./ . Advanced payments of personal income tax (Sec. 36 (2) sent. 1 no. 1) ./ . Withheld wage tax and capital yields tax (Sec. 36 (2) sent. 1 no. 2)  ./ . Trade tax rate relief allowance (Sec. 35) ./ . 50 % of the donations to political parties (Sec. 34g) + Child benefit, if child allowance is more favourable (Sec. 31 sent. 4) + Tax according to Sec. 32d (3) EStG (mandatory assessment) + Tax according to Sec. 32d (4) EStG (assessment option) <?page no="48"?> 2.1 Basic principles of personal income tax 49 assessed couples from the application of the splitting rate (Sec. 32a (5) EStG) to the taxable income. The personal income tax to be assessed (annual tax liability) is determined after deduction of certain tax abatements and/ or after addition of tax increases. The effective final payment (personal income tax liability) and/ or the amount to be refunded (personal income tax credits) is calculated by crediting payments already made or withheld (advance payment of personal income tax, wage taxes and capital yield taxes paid, Sec. 36 (2) EStG) to the personal income tax to be assessed. Classification of earnings and expenses The income in a type of income are the difference of the (taxable) earnings and the (tax deductible) expenses . Certain earnings, however, are not taken into account in the calculation of the taxable income. Inversely, not all of the taxpayer’s expenses lead to a reduction of the tax liability. a) Earnings Earnings can be received both as business earnings and as earnings in the non-operating area (household income). In both cases, a distinction must be drawn between earnings that are exempt from taxation and which are subject to taxation. Figure 17: Classification of earnings • Tax-exempt earnings/ business earnings : Taxexempt earnings/ business earnings are exempt from taxation on the grounds of legal norms. Secs. 3 and 3b EStG list the tax exempt earnings/ business earnings. Examples include unemployment benefits and/ or support, child benefit, surcharges for work performed on Sundays, holidays and nights. It does not make sense, for example, to tax the unemployment benefits received from the state because, otherwise, a portion of the support received would then flow back into the public coffers. • Taxable earnings/ business earnings include the following : <?page no="49"?> 50 2 Personal income tax Taxable earnings: According to Sec. 8 (1) EStG, “all goods that consist of money or possess a value in money, and that flow to the taxpayer within the scope of the surplus income”. Taxable business earnings: No legal definition for business earnings exists in the German law on personal income tax. Following Sec. 4 (4) EStG, business earnings can be defined as “earnings that are prompted by the business operations”. Example: The tax consultant, Johann, receives from his client, the gardener Martin, € 2 00 cash and three fruit trees for his consultation. The € 2 00 and the fruit trees, which possess a value in money, flow to Johann within the scope of his self-employment (Sec. 18 EStG) and thus represent business earnings. b) Expenses Expenses must be divided into those expenses which are deductible as business expenses or income-related expenses within the scope of determining the income, and those expenses which are not to be assigned to the earning of income, but rather as private expenses to the private sphere of the taxpayer. Figure 18: Classification of expenses Generally, the objective net income principle requires that business expenses and income-related expenses can be deducted: Deductible business expenses : Despite the lack of a legal definition for “business earnings”, business expenses are defined in Sec. 4 (4) EStG as “expenses that are prompted by the business operations”. They are only incurred within the scope of profit income. Deductible income-related expenses : Income-related expenses generally consist of expenses that are caused by the pursuit of taxable earnings <?page no="50"?> 2.1 Basic principles of personal income tax 51 (principle of causation). According to Sec. 9 (1) sent. 1 EStG, the following requirements must be fulfilled: - acquisition, - assurance and of the earnings. - maintenance Income-related expenses are deductible within the scope of the surplus income types. Not all income-related expenses are listed in Sec. 9 EStG, but rather merely a selection of the most important income-related expenses in practice. Non-deductible business expenses and/ or income-related expenses : Although certain expenses have characteristics of business expenses and/ or income-related expenses, they may not be taken into account in the determination of income. These predominantly include expenses that possess a particularly close relationship to one’s private lifestyle, but also expenses that may not be deducted or are only deductible to a certain degree for fiscal or other reasons. The corresponding rules can be found in Secs. 4 (5) to (6), 9 (5) EStG. Sec. 12 EStG also applies if the above mentioned expenses are generally business-related or work-related. Note • Business expenses are incurred within the scope of profit income. • Income-related expenses are incurred within the scope of surplus income. Example: The cement trader, Hermann, was sentenced to pay a pecuniary penalty of € 1 00,000 because of illegal price-fixing. Even though the penalty was businessrelated, it may not be deducted in the determination of the profits (Sec. 12 no. 4 EStG) because the penal character would otherwise be moderated. In this context, expenditures for a home office could in principle not be deducted either, unless the office formed the centre of all operational and professional activities. Following the decision of the Federal Constitutional Court 2 , which declared this provision unconstitutional, the deductibility of expenditures for a home office was newly regulated by the JStG in 2010. Accordingly, in the years from 2007 onwards, expenditures for a home office are now also deductible if the taxpayer has no other place of work available 2 See BVerfG from 6 July 2010, 2 BvL 13/ 09, BStBl II 2011, p. 318. <?page no="51"?> 52 2 Personal income tax to him for his business and professional activities. In this case, however, the deduction amount is limited to € 1,250. The expenditures are only fully deductible if the home office is the centre of all business and professional activities. Table 6: Selected non-deductible business expenses Example: The German teacher Christina does not have a workplace in the school building for correction work. For this reason, she performs these activities in her home office. Christina can deduct the expenses for the home office up to a maximum amount of € 1 ,250 as income-related expenses. As the centre of her professional activities is still located in the school building, a full deduction of the expenses is not possible. Expenses that are related to tax-exempt income may not be deducted as business expenses or income-related expenses (Sec. 3c EStG). <?page no="52"?> 2.1 Basic principles of personal income tax 53 Example: Hans is unemployed and receives unemployment benefits. Hans may not claim the costs of traveling to the German Federal Employment Agency in accordance with Sec. 3c (1) EStG because the unemployment benefits are tax-exempt under Sec. 3 no. 2 EStG. The deductibility of interest on borrowed capital is based on the objective net income principle. However, this basic principle is broken in income tax by the provision of Sec. 4h EStG, which restricts the deductibility of interest on borrowed capital under certain conditions (so-called interest barrier). For capital companies, the special provisions of Sec. 8a KStG also apply (cf. chapter on corporate income tax). In this way, the legislator wanted to make excessive and above all tax-motivated financing with outside capital less attractive from a tax point of view, since in the past, groups in particular have relocated profits abroad in this way. The basic system is explained in detail in the Corporate Income Tax chapter. In addition, with effect from 1 January 2018, the provision of Sec. 4j was newly inserted into the EStG, whereby expenditures for the transfer of rights, which are subject to low taxation abroad, cannot be deductible as business expenses in Germany or only to a limited extent (socalled license barrier). According to Sec. 12 no. 1 EStG, expenses incurred for one’s private lifestyle may not be deducted. These include expenses for the taxpayer’s clothing, nourishment and accommodation. These expenses possess no relation to the earning of income and represent neither business expenses nor income-related expenses. The proscription for private expenses is consistent with the concept of taxation according to the ability to pay. Private expenses do not reduce the ability to pay, but rather are an expression of the ability to pay. The expenses that may not be deducted in accordance with Sec. 12 EStG predominantly include the following: • Household expenditures and those expenditures incurred in supporting dependents of the taxpayer’s family (Sec. 12 no. 1 EStG), • voluntary donations and donations made on the grounds of a voluntarily established legal duty (Sec. 12 no. 2 EStG), • personal taxes, e.g. personal income tax, corporate income tax, solidarity surcharge (Sec. 12 no. 3 EStG), • pecuniary penalties (not: fines) as well as the other legal consequences related to property, in which the penal character prevails (Sec. 12 no. 4 EStG). As an expression of the subjective net income principle, special expenses and extraordinary expenses represent an exception to the principle that expenditures incurred privately are not deductible in accordance with Sec. 12 <?page no="53"?> 54 2 Personal income tax no. 1 EStG. Those expenditures which are allowed are listed conclusively in Secs. 10 to 10c, 10e to 10g EStG and Secs. 33 to 33b EStG. 2.1.5 Temporal assignment Assessment period and determination period In Germany the personal income tax is arranged as an annual tax (Sec. 2 (7) sent. 1 EStG) and thus takes into consideration the principle of discrete period taxation. According to Sec. 2 (7) sent. 2 EStG, the basis for the assessment of the personal income tax is to be determined for each calendar year. Those criteria of taxation that lie outside of the taxable period are generally not taken into account in the determination of the taxable income. The carrying forward and back of losses in accordance with Sec. 10d EStG forms an exception hereto. Generally, a distinction is drawn between the assessment period and the determination period. • Assessment period : This is the period of time for which taxes are assessed. This is always the calendar year in the case of personal income tax (Sec. 25 (1) EStG). The income that the tax-payer has earned during a calendar year is to form the basis of the personal income tax. • Determination period : This is the period of time within which the assessment basis is determined (Sec. 2 (7) sent. 2 EStG). The boundaries of the determination period are drawn by the profit realization principles related to taxation or the inflow-outflow principle. Example: The taxpayer, Franz, receives a telephone bill for December 2017 on 15 January 2018 and immediately transfers the money. The money is booked from his account on 17 January 2018. The question is to what month the telephone expenses are to be assigned. The principle of the temporal assignment of earnings respectively expenses depends on whether there is a bookkeeping duty or not (i. e. profit income vs. surplus income). Accordingly, a distinction must be drawn between the inflow-outflow principle on the one hand, and the realization principle on the other. The profit in the business income types is generally determined by the accrual method. In doing so, the realization principle (principle of economic assignment) applies. According to the realization principle, profits are deemed to have been earned by the taxpayer in the year in which these were realized according to the principles of taxation. <?page no="54"?> 2.1 Basic principles of personal income tax 55 In contrast, the inflow-outflow principle is merely applied to surplus income types. According to the inflow-outflow principle, income is assigned to the calendar year in which they flowed to the taxpayer (Sec. 11 (1) sent. 1 EStG), and expenses are to be assigned to the calendar year in which they were incurred (Sec. 11 (2) sent. 1 EStG). An exception is made, however, in the case of regularly recurring income and expenses which are incurred shortly - up to 10 days - before or after the end of the calendar year to which they belong economically; these are then to be assigned to the calendar year to which they belong economically (Sec. 11 (1) sent. 2 and (2) sent. 2 EStG, H 11 “Allgemeines” EStH - general guide-lines for personal income tax). Table 7: Realization principle vs. inflow-outflow principle Continuing the example: • Bookkeeping duty: According to the profit realization principles of taxation, the expenditure is to be assigned to the month in which it occurred and/ or to which is belongs economically. This principle is relevant in case of profit income with exeption of the proft determination according to Sc. 4 (3) EStG. This would be the month of December 2017 because the calls were placed during that month. • No bookkeeping duty: According to the inflow-outflow principle, the economic affiliation generally doesn’t matter; decisive is rather the time the liquidity flows off. This principle is relevant in case of surplus income and in case of the profit income determination according to Sec. 4 (3) EStG. If Franz does not enter it into the balance sheet, the expenditure would then be assigned to the month January 2018 and would therefore have to be taken into account for tax purposes one year later than under accounting principles. Fiscal year The income for the business income types is determined for the fiscal year. The profit determination period is specified as the business year under commercial law according to Sec. 240 (2) of the German Commercial Act (HGB); under tax law (Sec. 4a (1) sent. 1 EStG) it is specified, however, as the fiscal <?page no="55"?> 56 2 Personal income tax year. The fiscal year generally spans a period of 12 months and usually coincides with the calendar year. Note In the case of surplus income and business persons who determine their profit in accordance with Sec. 4 (3) EStG, the fiscal year must coincide with the calendar year (Sec. 4a (1) no. 3 EStG). Business persons whose company is registered in the commercial register, may have a deviating fiscal year. The profit is deemed to have been earned in the calendar year in which the fiscal year ends (Sec. 4a (2) no. 2 EStG). If the fiscal year lasts less than 12 months, this is known as a short fiscal year (Rumpfwirtschaftsjahr). A short fiscal year results when a business is begun, bought, sold or abandoned during the fiscal year or in a case where the profit determination period changes from a calendar year to a deviating fiscal year and vice-versa. The transformation of the fiscal year from a calendar year to a deviating period is only taken into account in taxation if it is done with the consent of the fiscal authorities because the change can be used accordingly to affect tax policy (Sec. 4a (1) sent. 2 no. 2 EStG). Note Possibilities for a deviating fiscal year: • Agriculturalists and foresters: Fiscal year (= crop year) usually lasts from 1 July to 30 June of the following year. • Business persons who are entered in the commercial register may have fiscal years deviating from or matching the calendar year. Example: The fiscal year of the Anton-GmbH, which is registered in thecommercial register, begins on 1 April of a year and ends on 31 March of the following year. In the fiscal year 2017/ 2018, the profit earned by the Anton-GmbH amounted to € 120,000. According to Sec. 4a (2) no. 2 EStG, the profit € 120,000 earned by the Anton- GmbH belongs to the calendar year, in which the fiscal year ends. The fiscal year of the Anton-GmbH ends in 2018, i.e. the profits must be taxed in 2018. <?page no="56"?> 2.1 Basic principles of personal income tax 57 Summary ► Only natural persons may be called on to pay personal income tax. ► The global income is taken into account in the unlimited tax liability, while only income earned domestically is included in the limited tax liability. ► The EStG differentiates between seven types of income. Earnings that may not be assigned to any of the income types are not subject to taxation. ► A distinction must be drawn between tax-exempt and taxable earnings, as well as between deductible and non-deductible expenses. ► The principle of the temporal assignment of earnings and/ or expenses depends on whether there is profit income or surplus income. Accordingly, a distinction must be drawn between the inflow-outflow principle on the one hand, and the realization principle on the other. ► Business persons may - but do not have to - have a fiscal year that deviates from the calendar year. Questions 1. Who is subject to unlimited tax liability in Germany and what are the consequences of the unlimited tax liability? 2. How are the terms “domestic”, “domicile” and “habitual residence” defined and in what norms are they regulated? 3. Who is subject to limited tax liability and what are its consequences? 4. How can double taxation occur and how can this problem be solved? 5. How is the taxable income determined and which paragraphs regulate the process of determination? 6. What is the difference between scaled and assessed personal income tax? 7. What criteria of systemizing exist for the classification of the seven income types? What terms are used for them? 8. Which earnings and expenses can be distinguished? 9. Give examples for non-deductible expenses. Why did the legislator restrict the deductibility? 10. Why may expenditures for one’s private lifestyle not be claimed? Are there any exceptions to this? 11. What are the tenets of the inflow-outflow principle and the realization principle and from the point of view of which taxpayers are they to be observed respectively? 12. What is the meaning of assessment period, determination period and fiscal year? 13. “The fiscal year coincides with the calendar year.” Is this statement true or false? If the statement is false, please provide reasons for your answer. <?page no="57"?> 58 2 Personal income tax Literature Gernot Brähler, Internationales Steuerrecht (International tax law), Wiesbaden, 8 th ed. 2014, pp. 9-102. Dietrich Grashoff, Florian Kleinmanns, Aktuelles Steuerrecht 2017 (Current tax law 2017), Munich, 13 th ed. 2017, pp. 17-30. Wolfgang Jakob, Einkommensteuer (Personal income tax), Munich, 4 th ed. 2008, pp. 24-72. Dieter Schneeloch, Stephan Meyering, Guido Patek, Betriebswirtschaftliche Steuerlehre Bd. 1: Grundlagen der Besteuerung, Ertragsteuern (Buisness taxation, Vol. 1: Principles of taxation, profit taxes), Munich, 7 th ed. 2016, pp. 43-56. Klaus Tipke, Joachim Lang, Steuerrecht (Tax law), Cologne, 22 nd ed. 2015, pp. 283-300. Determination of taxable income The determination of the taxable income in Germany follows the basic scheme elucidated above and contained in Sec. 2 EStG. Accordingly, the seven types of income presented briefly are subject to personal income tax in accordance with Sec. 2 (1) sent. 1 EStG. The classification of the income types into profit income types and surplus income types not only reflects the income theories forming the bases thereof, but also stipulates the way the income that is taken into account in the basis of the tax assessment is determined. Thus, before the seven individual types of income are elucidated extensively, the methods of determination of income for the individual types of income are presented in the following chapter. 2.2.1 Determination of income Overview of the methods of determining income According to Sec. 2 (1) and (2) EStG, the income belonging to the first three types of income is the profit and the income from the rest of the four types of income is the surplus from the earnings over the income-related expenses. Whereas the surplus is determined uniformly for all four of the surplus income types by deducting the expenses within the meaning of Sec. 9 EStG from the earnings within the meaning of Sec. 8 EStG, the profit can by determined for the individual profit income types using three different methods: by the accrual method, the cash method accounting as well as by income averaging in the case of agriculturists and foresters. <?page no="58"?> 2.2 Determination of taxable income 59 Figure 19: Methods of determining income Determination of profit a) Methods of determining profit  Accrual method in accordance with Sec. 4 (1), Sec. 5 EStG The most important and exact method of determining profit is known as the accrual method. This method of determining profit takes its name from the process by which the profit is determined. As codified in Sec. 4 (1) sent. 1 EStG, the profit is calculated as the “resulting difference between the business assets at the end of the fiscal year and the business assets at the end of the previous fiscal year, increased by the value of the withdrawals and reduced by the value of the contributions”: Business assets at the end of the fiscal year ./ . Business assets at the end of the previous fiscal year + Withdrawals ./ . Contributions = Profit <?page no="59"?> 60 2 Personal income tax In order to correctly ascertain the profit, the taxpayer’s business sphere must be kept strictly apart from the private sphere. Consequently, withdrawals from the operating assets may not reduce the taxable profit nor may contributions increase the profit. According to Sec. 4 (1) sent. 2 EStG, “withdrawals consist of all assets (cash withdrawals, goods, products, usages and performances) which the taxpayer has taken from the business during the fiscal year for his household or for purposes other than those of the business”. Withdrawals are valued as follows: • When liquid funds are withdrawn, the nominal value is applied so that there are no problems in the valuation. • Withdrawals in kind , i.e. withdrawals of assets both from fixed and current assets, are to be assessed at their partial value (Sec. 6 (1) no. 4 EStG). As a rule, the partial value corresponds to the market value or the market price. • An expense withdrawal is made through the use of business assets outside the company or through the use of business services for puposes outside the company. The pro rata business expenses attributable to the use of the assets and services for non-operating purposes are recognized as the value of the withdrawal. The expenditures are thus neutralized to the extent that they were not incurred for operational purposes. No profit can therefore be realized. There are special regulations regarding the private use of a company car (Sec. 6 (1) no. 4 sent. 2 EStG). The work performed by the taxpayer itself cannot be withdrawn. It is not considered to be an expense withdrawal if the taxpayer personally performs work-related services for private purposes. According to Sec. 4 (1) sent. 8 EStG, contributions are “all economic assets (cash contributions and other assets) that the taxpayer has added to the business during the course of the fiscal year”. Analogous to the withdrawals, a distinction must be made between cash contributions, material contributions and work performed. • A cash contribution is made if the taxpayer provides his company with additional liquid funds. In this case there are no valuation problems, as these are carried at nominal value. • Material contributions are made if other assets are provided to the company. The valuation is generally performed according to the partial value (Sec. 6 (1) no. 5 sent. 1 EStG). This is intended to prevent increases in the value of private assets, which are not taxable, from being subject to taxation. Due to the partial value approach, only those changes in value are <?page no="60"?> 2.2 Determination of taxable income 61 taken into account for tax purposes that occur during the period in which the assets belong to the business assets. • By way of derogation, contributions shall not be valued at more than acquisition or production cost if the asset in question has been acquired or manufactured within the last three years (Sec. 6 (1) no. 5 sent. 1 lit. a EStG), the transferred asset represents at least 1 % of the share capital of a capital company according to Sec. 17 (1) sent. 1 EStG within the meaning of Sec. 6 (1) no. 5 sent. 1 lit. b EStG, or capital assets within the meaning of Sec. 20 (2) EStG are affected (Sec. 6 (1) no. 5 sent. 1 lit. c EStG Example: Gustav acquires € 8,000 worth of A-shares and € 20,000 worth of B-shares in 2016. In 2018, he invests these shares in his business assets. The partial value at the time of the contribution is € 6,000 for the A Shares and € 25,000 for the B Shares. The A-shares are to be valued at the partial value of € 6000, as this is lower than the acquisition costs. The B-shares must be set however with the acquisition costs at a value of € 20,000. In the event of a later sale, Gustav would have to pay tax on the increases in value arising from private assets. In the case of contributions of depreciable assets, the acquisition and manufacturing costs shall be reduced by the depreciation for wear (Sec. 6 (1) no. 5 sent. 2 EStG). • Expense contributions take account of expenditures incurred for business purposes which the taxpayer has borne privately or through another business belonging to him. Only the expenditures actually borne by the taxpayer may be taken into account. Note German personal income tax law differentiates between the • accrual method within the meaning of Sec. 4 (1) EStG and • the accrual method under Sec. 5 EStG. The definition of profit under Sec. 4 (1) EStG applies, however, to both. Both Sec. 4 (1) EStG and Sec. 5 EStG require double bookkeeping (balance sheet as well as income statement). They differ in the group of persons addressed and the legal bases from which they are derived. <?page no="61"?> 62 2 Personal income tax The bookkeeping duty is stipulated in Secs. 140 and 141 AO. According to Sec. 140 AO, “If, pursuant to laws other than tax laws, books and accounts that are of importance to taxation must be kept, the taxpayer is to fulfill the obligations required by the other laws for the taxation as well.” The German Commercial Act (HGB) is an example of a “law other than tax law”, which contains rules on the commercial bookkeeping duty of business people. Sec. 238 (1) sent. 1 HGB forms the starting point of the commercial bookkeeping duty: “Every merchant is obligated to keep books in which the merchant’s commercial transactions and the state of the merchant’s financial affairs are accounted for in accordance with the principles of orderly bookkeeping.” The interaction between Sec. 238 (1) sent. 1 HGB, which codifies the commercial bookkeeping duty, and Sec. 140 AO, which ties in with this bookkeeping duty for purposes of taxation, essentially means that every person obligated to keep books in accordance with HGB is also obligated to keep books for tax purposes. In this case, German tax law derives its bookkeeping duty from the German Commercial Act. Therefore, the provision in Sec. 140 AO is also known as the derivative duty of tax bookkeeping . Note Anyone who is typically already subject to accounting under the German Commercial Act is subject to derivative duty of tax bookkeeping. For small sole traders, the link between the status of a businessman and the obligation under commercial law to keep books and balance sheets is partially removed; under the conditions of Sec. 241a HGB they can be exempted from the obligations under Secs. 238 to 241 HGB. Sole traders who do not have a cumulative sales revenue of more than € 600,000 and an annual net profit of € 60,000, so-called thresholds, in two consecutive financial years, can make use of the exemption. When a company is newly founded, the exemption from the obligation to keep books under commercial law applies as soon as the value falls below the threshold values on the first balance sheet date. The values of Sec. 241a HGB were consciously approximated to Sec. 141 AO, which provides corresponding characteristics for turnover and profit with regard to the obligation to keep books for commercial entrepreneurs and farmers. In order to guarantee the constitutional mandate of uniformity of taxation, Sec. 141 AO standardizes an original duty of tax bookkeeping . For this purpose size criteria are specified in Sec. 141 AO, with whose transgression <?page no="62"?> 2.2 Determination of taxable income 63 likewise the bookkeeping obligation occurs. Sec. 141 AO also applies to farmers and business people who are not obligated to keep books in accordance with Sec. 238 HGB. In comparison, self-employed persons within the meaning of Sec. 18 EStG enjoy a special status because, in spite of having business income, they are obligated to keep books neither according to Sec. 140 nor Sec. 141 AO. Note Anyone who is not subject to derivative bookkeeping but exceeds the (size) criteria of Sec. 141 AO is subject to original tax bookkeeping. Sec. 5 EStG applies to business people who either keep books as required by legal provisions (Secs. 140 and 141AO) or who do so voluntarily. The accrual method according to Sec. 5 EStG is also called qualified accrual method because additional to the tax profit determination methods of Secs. 4-7i EStG, the principles of orderly bookkeeping under German commercial law, especially Secs. 238 seqq. HGB, must be observed. According to Sec. 5 (1) sent. 1 EStG, the principles of orderly bookkeeping are to be applied in principle, unless different tax regulations were applied (voluntary or mandatory) ( authority of the commercial balance sheet for the tax balance sheet - authority principle ). For taxpayers who do not keep books as business people, Sec. 5 EStG does not apply, but Sec. 4 (1) EStG (general accrual method). Although there is no explicit reference to the application of the relevant commercial law provisions, Secs. 238, 240 to 242 (1) HGB and Secs. 243 to 256 HGB, these are to be applied in the accrual method in accordance with Sec. 4 (1) EStG. However, the authority principle is not to be observed. Sec. 4 (1) EStG covers self-employed people within the meaning of Sec. 18 EStG who voluntarily keep books, as well as farmers and foresters. However, the authority principle according to Sec. 5 (1) sent. 1 half-sent. 2 EStG was modified in the meantime in order to be able to take into account valuations deviating from commercial law for tax purposes. Accordingly, in the case of business people who are obliged by law to keep books and regularly prepare financial statements, the business assets to be shown in accordance with the principles of proper accounting under commercial law at the end of the financial year are to be stated, unless a different approach is or was chosen in the context of exercising a tax option. The authority principle thus applies only to the extent that commercial law requires capitalization and passivation, as there are no tax law reservations regarding recognition or measurement (Sec. 5 (6) EStG). These may also be tax law options which may <?page no="63"?> 64 2 Personal income tax now be exercised irrespective of commercial law requirements. An exception exists in this regard pursuant to Sec. 6 (1) no. 1b EStG in connection with the calculation of production costs. Reasonable portions of the costs for general administration as well as reasonable expenditures for the company's social facilities, for voluntary social benefits and for the company pension scheme within the meaning of Sec. 255 (2) sent. 3 HGB need not be included in the calculation of production costs if this option is exercised in accordance with the commercial balance sheet. Example: Pursuant to Sec. 6 (1) no. 2 sent. 2 EStG, the lower partial value of current assets can be applied in the case of expected permanent impairment. In this case, the strict lower of cost or market principle pursuant to Sec. 253 (4) of the German Commercial Act (HGB) requires a write-down under commercial law. In the area of application of the authority principle, there was therefore also an impairment obligation under tax law. By modifying the authority principle, there is an actual tax law option to carry out the write-down to partial value or to waive it. The derivative duty of tax bookkeeping in accordance with Sec. 140 AO does not apply to self-employed persons within the meaning of Sec. 18 EStG because they are not business people and thus commercial law is not applicable to them. The original duty of tax bookkeeping in accordance with Sec. 141 AO also does not apply because Sec. 141 (1) sent. 1 AO only creates obligations for “commercial entrepreneurs” as well as for farmers and foresters. Self-employed persons may voluntarily keep books for tax purposes and, in doing so, opt for the accrual method provided for by Sec. 4 (1) EStG. The profit may not, however, be determined according to Sec. 5 (1) EStG because this is reserved for business people within the meaning of Sec. 15 (1) EStG. However, since the accrual method including that under Sec. 4 (1) EStG involves a not inconsiderable amount of work and requires detailed accounting knowledge, self-employed persons within the meaning of Sec. 18 EStG and business people who are not legally obliged to keep books regularly apply the simplified determination of profit under Sec. 4 (3) EStG (= cash method accounting) explained below.  Determination of profit according to Sec. 4 (3) EStG (cash method accounting) The determination of profit according to Sec. 4 (3) EStG (also known as cash method accounting) is used by • owners of smaller businesses (who are not obligated to keep books according to commercial law or tax law, and who do not keep books voluntarily) as well as by <?page no="64"?> 2.2 Determination of taxable income 65 • self-employed persons in accordance with Sec. 18 EStG (who do not keep books voluntarily). In contrast to the realization principle, which applies to the determination of profit using the accrual method, the cash method accounting is based on the inflow-outflow principle. In the cash method accounting, the outpayments affecting expenditures are deducted from the inpayments affecting the net income at the moment they take effect. In spite of the simplicity of determining the profit compared to the balance sheet method, the cash method of accounting results in the same total profit over the lifespan of the company. With regard to the periodic calculation of the profit, differences between the individual periods may result when comparing the determination of profit in accordance with Sec. 4 (3) EStG with the determination of profit using the accrual method (Sec. 4 (1) and (5) EStG); these differences will, however, be reconciled at the latest when the business is either sold or abandoned (mandatory transition to balancing accounts). The following cases represent deviations from the inflow-outflow principle: • Transitory items: business earnings and expenses that are withheld and paid out on behalf and account of a third party do not affect the determination of profit. Example: The driving instructor Max collects the fee for the DMV test from his student Frank and forwards it to the DMV. The receipt of the fee is not considered to be operating revenue nor is the payment of the fee to the DMV considered to be a business expense. • Depreciable fixed assets (Sec. 4 (3) sent. 3 EStG): The acquisition cost of the depreciable fixed assets only reduce the profit inasmuch as they are amortized annually. When such assets are sold, the remaining book value is to be set off as a business expense. • Acquisitions costs of non-depreciable fixed assets (Sec. 4 (3) sent. 4 EStG): At the time of sale the acquisition costs are considered as business expenses. • Loans: The procurement and provision of loans are neither business earning nor business expense because they have no affect on the net income. The same applies to the redemption payments on loans. The interest payments, however, are considered to be business expenses. • Regularly recurring earnings and expenses (Sec. 11 (1) sent. 2 and (2) sent. 2 EStG): These belong to the calendar year in which they originate economically if they are paid within up to 10 days before or after that calendar year. <?page no="65"?> 66 2 Personal income tax Example: Rental expenditures for the month December 2017 that are paid on 1 January 2018 in spite of actually being intended to debit the year they are paid, i.e. 2018, are assigned to 2017 as a recurring expenditure . Note The inflow-outflow principle of Sec. 11 EStG applies to the cash method accounting. It can be applied by the following groups of people: • Owners of smaller businesses • Self-employed persons within the meaning of Sec. 18 EStG • Farmers the size of whose operations exceed the limits set by Sec. 13a EStG or who may voluntarily keep books on business earnings and expenses. The advantage of the profit determination in accordance with Sec. 4 (3) EStG lies in its manageability and the possibility of influencing the profit by carefully selecting the time payment is made.  Determination of profit according to the average rates under Sec. 13a EStG The determination of profit in accordance with Sec. 13a EStG (mentioned only for the sake of completeness) is a fixed rate method of estimating the profit of farmers and foresters depending on the value per hectare for agricultural use. This method of determining profit simplifies the calculation of the profit and benefits the agricultural and foresting sector because the assessment is generally too low. Farmers and foresters usually apply the average income method of determining profit in accordance with Sec. 13a EStG. In the event that the limits set out by Sec. 13a (1) EStG are exceeded, however, the profit must be determined according to Sec. 4 (1) EStG or Sec. 4 (3) EStG. The Profit may not be determined according to Sec. 5 (1) EStG because farmers and foresters do not have business operations within the meaning of Sec. 15 (1) EStG. b) Scope of applicationforthe methods of determining profit Not all of the three methods of determining profit are available to every business owner. A summarization of all provisions under commercial law and tax law that affect the method of determining profit presents the following basic scheme: <?page no="66"?> 2.2 Determination of taxable income 67 Table 8: Methods of determining profit Determination of surplus income The surplus and/ or household income is calculated as the surplus of earnings over the income-related expenses: Earnings ./ . Income-related expenses = Income According to Sec. 8 (1) EStG, “earnings are all goods that consist of money or possess a value in money, and that flow to the taxpayer within the scope of one of the types of income under Sec. 2 (1) sent. 1 nos. 4 to 7 EStG”. Increases in the value of the assets are not - with the exception of capital gains according to Secs. 17, 23 and 20 (2) i.c.w. (4) EStG - taken into account. The receipt of the economic power of disposal (e.g. payment, bank credit or receipt of a check) determines when the inflow of earnings is registered (Sec. 11 EStG). Income-related expenses within the meaning Sec. 9 (1) sent. 1 EStG are “expenditures made to procure, secure and maintain earnings”. Sec. 9 (1) sent. 3 EStG provides an exemplary list of expenditures that are considered to be <?page no="67"?> 68 2 Personal income tax income-related. Other expenditures than those listed there may be deducted inasmuch as they are incurred in connection with the procurement of surplus income ( principle of causation ). The income-related expenses are to be kept separate from private living expenses (Sec. 12 EStG). The expenditures that are incurred before earnings are generated (or for aborted projects) can be deducted if a direct connection with the intended earnings is apparent (e.g. expenditures for job-searching, such as want ads and the costs of applying for the job). The same applies to income-related expenses incurred subsequently. Income-related expenses that have been reimbursed, but have already been claimed, are to be treated as earnings. Note The principle of causation applies to the deduction of income-related expenses, i. e. the taxpayer may only claim those expenditures that were incurred in the procurement of surplus income. Example: In 2017, an apartment owner named Ferdinand rented his 2-room apartment in Ilmenau to a student. In 2018 Ferdinand sells this apartment. Previously, he had extensively renovated the bathroom in June 2017. For this he took out a 2-year loan. According to the final definition (Secs. 9 (1) and 11EStG), the interest would not be an income-related expense, as the income is generated in the past. Nevertheless, the interest expenses are caused by the activity aimed at earning income. Due to the prevailing causal interpretation of Sec. 9 EStG, Ferdinand can nevertheless deduct the interest in 2018 as subsequent income-related expenses, as the bathroom renovation could be assessed as an immediately deductible maintenance expense within the framework of rental income for 2017. However, this requires that the proceeds from the sale are used to repay the loan. If the expenses for a depreciable movable asset do not exceed € 800 net and the asset also meets the requirements for a low-value asset, the expenses can be immediately written off (Secs. 9 (1) sent. 1 no. 7 sent. 2 and 6 (2) EStG). If these requirements are not met cumulatively, the asset is to be depreciated over its useful life according to the depreciation table. In addition, it is possible to make use of the so-called pool depreciation in accordance with Sec. 6 (2a) EStG. Example: The teacher Leonore bought a computer in 2018 for € 1,500 to work on the preparation of her courses in the afternoon. Leonore may only claim the costs of this computer over the course of three years, i.e. € 500 per year respectively (assuming a linear write-of). <?page no="68"?> 2.2 Determination of taxable income 69 Lump-sum allowances for income-related expenses are intended to simplify their administration and recordkeeping. These are to be used in the calculation if the taxpayer has no income-related expenses or fewer than those amounts enumerated in Sec. 9a EStG. A distinction must be made between the lump-sum allowances for certain types of income and for certain occasions. • Lump-sum allowances for certain income types: - Sec. 9a sent. 1 no. 1 EStG: the so-called lump-sum allowance for employees (Arbeitnehmer-Pauschbetrag) amounting to € 1,000 (and/ or € 102 for income in the form of pensions and related benefits) for income from dependent-employment (Sec. 19 EStG). - Sec. 9a sent. 1 no. 3 EStG: a lump-sum allowance amounting to € 102 for income within the meaning of Sec. 22 nos. 1, 1a and 5 EStG. - Sec. 20 (9) sent. 1 EStG: a savers’ lump-sum amounting to € 801 for income from capital assets (Sec. 20 EStG). The deduction of actual incomerelated expenses is not possible. • Lump-sum allowances for certain occasions, such as additional expenses for meals, commuting allowance, removal costs, etc. The deduction of the lump-sum allowances for income-related expenses may not result in negative income (Sec. 9a sent. 2 EStG). If the taxpayer proves, however, that explicitly higher income-related expenses under Sec. 9 (1) EStG were incurred, such losses will be accepted. Example: Alfons generates earnings from dependent-employment (Sec. 19 EStG) amounting to € 900. He provides: a) no proof of income-related expenses. Alfons can only use the lump-sum allowance for employees of € 900 pro rata, so that the income from dependent-employment is € 0. The remaining € 100 of the lump-sum allowance for employees remain unused, as no loss may arise from a lump-sum allowance. b) proof of income-related expenses amounting to € 1,500. Alfons proves higher actual income-related expenses (than the lump-sum allowance). The (negative) income from dependent-employment is thus ./ . € 600 (= € 900 ./ . € 1500), i.e. Alfons makes a loss of € 600. 2.2.2 Seven types of income The basic similarities and differences between the types of income with regard to the determination of profit and surplus formed the focus of the last chapter. This chapter will deal individually with the seven types of income. For the sake of comprehensibility, the income types will be divided into the profit and surplus income types. <?page no="69"?> 70 2 Personal income tax 2.2.2.1 The profit income types a) Basic common characteristics The following basic characteristics, which are contained expressis verbis in Sec. 15 (2) sent. 1 EStG and described in the R 15.1-15.4 EStR (guidelines for the income tax code), are prerequisite elements of all types of operating income: • Self-employment (R 15.1 EStR) Self-employment is characterized by entrepreneurial initiative and responsibility, i.e. self-employed persons act on their own behalf and/ or at their own risk, and bear the responsibility for the success or failure of the business. This identifying feature serves to differentiate with the dependency that exists with regard to income from dependent-employment (Sec. 19 EStG). It depends, however, in the end on the appearance of the circumstances as a whole. The following characteristics provide indications for the classification (see Table 9). Table 9: Differentiation of self-employment from dependent-employment <?page no="70"?> 2.2 Determination of taxable income 71 • Sustainability (R 15.2 EStR) The activity is considered to be sustainable if it is carried out with the intention to be repeated regularly and with the intention to develop a continuous source of income based on the activity. Even a one-time activity can be sustainable if it is performed with the intention of being repeated or if several individual activities are interrelated (e.g. the construction of a tunnel). Example: Johann is employed at the car manufacturer Audi. As an employee, he receives a car every two years at a preferential price. After two years have passed, Johann sells the car at a profit. The profit from the sale is not subject to personal income tax. The activity is not considered sustainable because Johann only makes one transaction every two years. • Intention of realizing profits (H 15.3 EStH) Furthermore, the taxpayer must have the intention of earning a surplus of the business earnings over the business expenses and thus an increase in the operating assets in the form of a total profit. If the activity is only performed with the intention of reducing taxes from the income, so that losses are balanced with other income by way of loss compensation and/ or loss deduction, no intention of realizing profits is assumed (Sec. 15 (2) sent. 2 EStG). The intention of realizing profits must be manifested in objective circumstances. In this regard, it depends on whether the nature of the business and the way the business is carried out is suited to earn a total profit from the time it is founded until it is abandoned. It does not matter whether profit was actually earned, but rather that measures were taken that manifest the intention to earn profit. The intention of realizing profits is also required for household income in the form of the intention to realize a surplus. In the absence of the intention to realize profits, such activities are considered to be hobbies irrelevant to taxation (Sec. 12 EStG). • General economic participation (R 15.4 EStR) The taxpayer participates in the general economy by offering services to the general public (or a limited portion thereo) for money. No minimum number of recipients is required. It suffices if the business person only acts for one contractual partner and/ or for a certain group of customers. It is, however, important that the activity manifests itself. The production for one’s own use is thus not considered to be an activity relevant to taxation. Example: Maximilian washes his wife’s car every week for € 30. Maximilian does not participate in the general economy because he is acting for his own benefit. <?page no="71"?> 72 2 Personal income tax Note The four positive criteria of the profit income types are: • Self-employment • Sustainability • Intention of realizing profits • General economic participation b) Income from agriculture and foresting (Sec. 13 EStG) As general prerequisites for the assumption of agricultural and forestry activity, the general positive requirements of the profit income types (Sec. 15 (2) sent. 1 EStG) as well as an activity within the meaning of Sec. 13 EStG must be fulfilled. Agriculture and forestry is defined as the systematic usage of the natural powers of the earth to produce and exploit plants and animals (initial production). German personal tax law contains no explicit definition of the term “agriculture and forestry”, but rather lists the income in Sec. 13 <?page no="72"?> 2.2 Determination of taxable income 73 (1) and (2) EStG that is to be assigned to the income from agriculture and forestry. In particular, the income from agriculture and forestry includes the following: • Income from agriculture and forestry, vineyards and gardens, as well as animal breeding and husbandry (within the limits of Sec. 13 (1) no. 1 EStG); • Income from hunting inasmuch as it is related to the agricultural or forestry operations; • Income from accompanying agricultural and forestry operations, i.e. from ancillary services, from accompanying agricultural and forestry operations, or from annuities for the abandonment of production; • Income from the disposal of an agricultural and forestry operation, a part thereof or a portion of agricultural and forestry assets (Sec. 14 i.c.w. Sec. 14a and/ or Sec. 16 EStG). Farmers and foresters who must keep books according to Sec. 140 or Sec. 141 (1) AO, determine their profit using the accrual method in accordance with Sec. 4 (1) EStG. Taxable farmers and foresters who are not subject to the bookkeeping duty generally determine their profit according to average rates (Sec. 13a EStG). In the absence of both the duty to keep books and the duty to calculate on the basis of average rates, the profit can be determined using the cash method accounting (Sec. 4 (3) EStG). The tax benefits available to farmers and foresters include the following: • Tax allowance for farmers and foresters amounting to € 900 for total income of maximum € 30,700 (Sec. 13 (3) EStG). • No trade tax liability Note Precondition for the assumption of income from agriculture and forestry: • Fulfillment of the general positive requirements set out by Sec. 15 (2) EStG; • Income within the meaning of Sec. 13 (1) and (2) EStG. <?page no="73"?> 74 2 Personal income tax c) Business income (Sec. 15 EStG) As in the case of agriculture, forestry and self-employment within the meaning of Sec. 18 EStG, the general positive features of business income types must also be fulfilled here. However, income from agriculture, forestry and self-employment within the meaning of Sec. 18 EStG is explicitly excluded in accordance with Sec. 15(2) sent. 1 EStG (negative criteria). From this, case law has developed the third negative characteristic “no mere asset management” in accordance with § 14 AO. By the constituent fact characteristic “not only asset administration” private actions, which are directed toward the pure administration of the own fortune, are to be eliminated from the commercial incomes. The private landlord also meets the general positive features of commercial income. Due to the subsidiarity of rental income compared to commercial income according to Sec. 21 (3) EStG, the landlord would earn income from commercial operations without this unwritten element of the offence. The differentiation between pure asset administration and a commercial activity can be very difficult in certain individual cases. On the one hand, the purchase and sale of assets is generally considered to be a commercial activity. <?page no="74"?> 2.2 Determination of taxable income 75 Figure 20: Characteristics of business income On the other hand, private asset administration also includes the transfer of the assets. The difference can be described as follows: Private asset administration is only assumed if the activity consists purely of administrating the own assets while correspondingly reaping the fruits and the transfer of assets does not come to the fore. By contrast, commercial income is assumed if the realization of the assets by the transfer thereof decidedly contributes to the earning of profit (R 15.7 EStR). Table 10: Differentiation between asset administration and business activities <?page no="75"?> 76 2 Personal income tax Example: Alfons specializes in buying rented apartments. When the tenants terminate their rental contract, he then completely renovates the apartments and resells them. An average of four apartments are sold and resold this way each year. According to the facts given, it must be assumed that he is selling real property commercially. The apartments purchased are predominantly intended to be resold and not to be used to earn rent. As a result of the qualification as commercial income, not only is the income from rent subject to taxation, but also the profit from the sales transactions. In addition to income tax, the realized profit is also subject to trade tax. Figure 21 shows the scope of business income. Figure 21: Scope of business income In the case of commercial sole proprietorships, it is not the sole proprietorship that is subject to income tax, but the owner behind it as a natural person. A partnership as an association of persons has only partial legal capacity and is therefore not subject to income tax. In this case, the partners are the tax subjects within the meaning of Sec. 15 (1) sent. 1 no. 2 EStG. In this case, they receive business income proportionately in the amount of their shareholding if the partnership itself maintains a business operation (= business operations by virtue of commercial activity ) or if one or more limited liability companies - in the absence of commercial activity - are the solely personally liable partners of the partnership (= business operations by virtue of commercial nature ). In addition, the partners are considered to be co-partners. <?page no="76"?> 2.2 Determination of taxable income 77 A partner is considered to be a co-partner if he or she bears the business risk and displays business initiative. Note Both in the case of sole proprietorships and partnerships, the income is taxed via the owner or partner as natural persons within the scope of the private income tax assessment. Pursuant to Sec. 16 EStG, the following disposal transactions of a business are distinguished: 1. Disposal of an entire commercial operation (Sec. 16 (1) no. 1 sent. 1 EStG): In this case, the essential principles of the business are transferred to the acquirer in return for payment while maintaining the business organism. The actual continuation of the business is not necessary (R 16 (1) EStR). It is also harmless to retain assets that do not belong to the essential basis of the business in order to sell them at a later opportunity. 2. Disposal of a business unit (16 (1) no. 1 EStG): A partial enterprise is an organically self-contained part of the entire business that is equipped with a certain degree of independence and is capable of existing independently (e.g. a restaurant that belongs to a brewery). A share in a capital company that represents the entire nominal capital of the company is also considered to be an independent division. 3. Disposal of the entire co-partnership share or general partner share (Sec. 16 (1) nos. 2 and 3 EStG). 4. Abandonment of the commercial operation or of a share within the meaning of Sec. 16 (1) nos. 2 and 3 EStG. Example: Disposal of the entire commercial operation Hermann sells his repair shop to Dorothea for € 500,000. He assigns outstanding claims and accounts receivable as well as the entire inventory of the shop to the purchaser. The profit from the disposal is calculated in accordance with Sec. 16 (2) EStG as follows: Disposal price ./ . Disposal costs ./ . Taxable book value of the equity capital (business assets according to Secs. 4 (1) or 5 EStG) = Capital gain (or loss) <?page no="77"?> 78 2 Personal income tax Note According to Sec. 16 (1) sent. 2 EStG, if a co-partner of a partnership sells only a part of his or her share, the profit from the sale is a current profit within the meaning of Sec. 15 EStG and not a beneficial profit within the meaning of Sec. 16 EStG. The purpose of tax relief on capital gains is to provide tax relief on the accumulated profit from the realization of all hidden reserves at the end of the business activity. This is achieved by means of two preferential regulations: • Grant of an allowance according to Sec. 16 (4) EStG. Accordingly, a taxpayer who has reached the age of 55 or is permanently disabled receives, on request, an allowance of € 45,000. This tax allowance may only be claimed once by the taxpayer (during his or her lifetime). It is reduced, however, by the amount that the capital gains exceed € 136,000. Particularly smaller capital gains are thus completely removed from the tax burden. • The remaining capital gain is also taxed at a discounted tax rate within the meaning of Sec. 34 (1) EStG (“the one-fifth rule”) or instead - upon petition by the taxpayer - according to certain requirements at the special rate under Sec. 34 (3) EStG (“reduced average tax rate”). Note Cumulative requirements for receiving the disposal tax allowance: • Disposal or abandonment of the business within the meaning of Sec. 16 EStG • 55 years of age or permanently disabled • Tax allowance not yet claimed Example: Disposal of the entire commercial operation Wilhelm sells his entire commercial operation on 31 December 20 for € 420,000 to Friedrich. In connection with the sale, consultation costs are incurred amounting to € 5,000. The balance sheet for the commercial operation at the time of the disposal contains the following positions: Assets Balance Sheet as of 31 December 2018 Equity and Liabilities Capital assets € 275,000 Current assets € 125,000 Equity capital € 250,000 Accounts payable € 150,000 Balance sheet total € 400,000 Balance sheet total € 400,000 <?page no="78"?> 2.2 Determination of taxable income 79 Wilhelm receives earnings in accordance with Sec. 16 (1) sent. 1 no. 1 EStG because he sold his entire commercial operation to Friedrich at a profit. The capital gain is calculated in accordance with Sec. 16 (2) EStG as follows: Disposal price ./ . Disposal costs ./ . Book value of the equity capital € 420,000 ./ . € 5,000 ./ . € 250,000 = Capital gain ./ . Tax allowance (cf. Sec. 16 (4) EStG) € 45,000 = € 165,000 Deduction (€ 165,000 ./ . € 136,000) ./ . € 29,000 € 16,000 ./ . € 16,000 = Taxable capital gain € 149,000 In accordance with Sec. 34 (2) no. 1 EStG, the capital gain amounting to € 149,000 represents extraordinary income within the meaning of Sec. 34 EStG. Accordingly, the profit is preferentially taxed at the reduced tax rate of Sec. 34 (1) EStG (“the one-fifth rule”) or alternatively - upon petition and fulfillment of the requirements - at the special rate according to Sec. 34 (3) EStG (“reduced average tax rate”). Example: Disposal of a co-partnership share Heinrich, Margarete and Valentin all hold equal shares in the Teufel-OHG (general partnership). On 31 December 2018, Heinrich sells his share to Lieschen for € 800,000. The balance sheet below shows the book values and the actual values of the individual positions: Balance Sheet of the Teufel-OHG as of Assets December 2018 (in K€ 31) Equity and Liabilities Book Act. Book Act. value value value value Company value - 300 Capital (Heinrich) 600 800 Land 300 600 Capital (Margarete) 600 800 Buildings 600 600 Capital (Valentin) 600 800 Goods 900 900 Balance sheet total 1,800 2,400 Balance sheet total 1,800 2,400 <?page no="79"?> 80 2 Personal income tax Note When a co-entrepreneur’s share is sold, its book value corresponds to the co-entrepreneur’s capital account and any special business assets. Heinrich sells his shares in the individual assets to Lieschen not at the balance sheet values, but rather at their actual value. Heinrich makes a beneficial capital gain in accordance with Sec. 16 (1) sent. 1 no. 2 EStG because the hidden reserves are revealed. The capital gain is calculated in accordance with Sec. 16 (2) EStG as follows: Disposal price ./ . Disposal costs ./ . Book value of the equity capital € 800,000 ./ . € 0 ./ . € 600,000 = Capital gain ./ . Tax allowance (cf. Sec. 16 (4) EStG) € 45,000 = € 200,000 Deduction (€ 200,000 ./ . € 136,000) ./ . € 64,000 = ./ . € 0 = Taxable capital gain = € 200,000 In accordance with Sec. 34 (2) no. 1 EStG, the capital gain amounting to € 200,000 represents extraordinary earnings within the meaning of Sec. 34 EStG. Accordingly, the profit is preferentially taxed at the reduced tax rate of Sec. 34 (1) EStG (“the one-fifth rule”) or alternatively - upon petition and fulfillment of the requirements - at the special rate according to Sec. 34 (3) EStG (”reduced average tax rate”). Note If the sale does not take place at the end of the financial year, the preparation of an interim financial report is required. The taxation of capital gains of disposal of shares must be differentiated acoording to whether they are held as a part of the private or business assets. • Business assets include business income pursuant to Sec. 15 EStG, irrespective of the amount of the share and the retention period. Any capital gains are subject to the individual tax rate using the partial-income method pursuant to Sec. 3 no. 40 lit. a EStG. • In the case of private assets , the amount of the share must first be determined: <?page no="80"?> 2.2 Determination of taxable income 81 - In the case of an investment of less than 1 %, there is income from capital assets pursuant to Sec. 20 (2) EStG irrespective of the retention period, which is subject to flat-rate withholding tax pursuant to Sec. 32d EStG. - If, on the other hand, the amount of the participation was greater than 1 % at any time within the last five years, business income is generated in accordance with Sec. 17 EStG irrespective of the retention period. These are taxed at the individual tax rate using the partial-income method pursuant to Sec. 3 no. 40 lit. c EStG. The different taxation of sales transactions is illustrated in Figure 22. Figure 22: Sale of shares in capital companies In accordance with Sec. 17 EStG, the capital gains of shares to a capital company held as part of the private assets are also included among the business income if the seller held a share of at least 1 % of the company’s capital at any time within the last five years prior to the disposal. Originally (until 1988), the percentage of shares that could be held was limited to 25 %. A share of this amount is deemed by the legislature to be similar to co-partnership, which justifies the taxation of the hidden reserves in the participation. From <?page no="81"?> 82 2 Personal income tax 1 January 1999 to 31 December 2001, the percentage of shares that could be held was limited to 10 %. By sinking this limit to 1 % in 2002, the argumentation no longer makes sense, so that the assignment of the earnings from commercial operations to Sec. 17 EStG must be viewed very critically. Example: Participation share within the meaning of Sec. 17 EStG Therese has held a 5 % share of the Meister-AG (capital company) for years. On 12 August 2018, she sold half of her shares (= 2,5 % in the Meister-AG), which she held in her private assets. Therese has held a share of at least 1 % in the Meister-AG within the last five years. Therefore, the capital yield represents business income and is taxable in accordance to Sec. 17 (1) and (3) i.c.w. Sec. 3 no. 40 lit. c EStG. If Therese hold 0.5 % of the Meister-AG in her private assets, Therese will receive income from capital assets in accordance with Sec. 20 EStG in the event of a sale, regardless of the retention period. In this case. Taxation takes place through the flat-rate withholding tax according to Sec. 32d (1) EStG. It should also be noted that current income from investments in capital companies held as private assets represents capital income within the meaning of Sec. 20 (1) EStG. Only if shares within the meaning of Sec. 17 EStG are sold, is there business income rather than income within the meaning of Sec. 20 (2) EStG. Note The disposal of shares within the meaning of Sec. 17 EStG leads to business income. However, the current capital income (= dividends) leads to income within the meaning of Sec. 20 EStG. Capital gains within the meaning of Sec. 17 EStG are not subject to the flatrate withholding tax, but are taxed according to the principles of the so-called partial-income method. According to Sec. 3 no. 40 EStG, only 60 % of the capital gain are subject to taxation at the individual tax rate. In return, pursuant to Sec. 3c (2) sent. 1 EStG, only 60 % of the disposal and acquisition costs may be deducted when determining the capital gain. The capital gain is reduced by the tax allowance afforded by Sec. 17 (3) EStG. The amount of the tax allowance depends on what share of the entire nominal capital is sold. If all shares are sold, the tax allowance amounts to € 9,060. The amount of the benefit is reduced correspondingly if only a portion of the shares are sold. In the event that a 25 % share is sold, the tax allowance would then amount to € 2,265 (25 % of € 9,060). According to Sec. 17 (3) sent. 2 EStG, the tax allowance is further lowered by how much the capital gain exceeds the portion of € 36,100 that corresponds to the share in the capital company that is sold. Due to already reduced taxation through the partial-income <?page no="82"?> 2.2 Determination of taxable income 83 method, the capital gain is not additionally favoured by Sec. 34 EStG. Sec. 34 (2) EStG therefore does not mention gains within the meaning of Sec. 17 EStG. Example : Margarete holds a 30 % share in the Friedrich-AG in her private assets. She purchased the shares on 7 August 2017 for € 128,000 on the Frankfurt Stock Exchange. Some time later she sells her 30 % share for held as part of private assets € 153,000. Her costs of sale amounted to € 3,000. How high is the taxable capital gain in the event that the shares are sold on 24 January 2018? Margarete earned income within the meaning of Sec. 17 EStG because she held a share of 30 % in the Friedrich-AG as part of private assets within the last five years directly prior to the disposal. The retention period is not relevant here. The capital gain is subject to the partial-income method persuant to Sec. 3 no. 40 lit. c and Sec. 3c (2) EStG. The benefit of Sec. 17 EStG can be claimed here. 60 % of the disposal price (Sec. 3 no. 40 lit. c EStG) € 91,800 ./ . 60 % of the costs of disposal (Sec. 3c (2) EStG) ./ . € 1,800 ./ . 60 % of the costs of procurement (Sec. 3c (2) EStG) ./ . € 76,800 = Capital gain = € 13,200 ./ . Tax allowance (cf. Sec. 17 (3) EStG): possible tax allowance (30 % x € 9,060) € 2,718 Amount of reduction (€ 13,200 ./ . 30 % x € 36,100) ./ . € 2,370 Remaining tax allowance € 348 ./ . € 348 = Taxable capital gain = €12,852 The capital gain within the meaning of Sec. 17 EStG favoured by the partial-income method amounts to € 12,852. A further benefit from the flat-rate withholding tax is not possible. d) Income from self-employment (Sec. 18 EStG) For income from self-employment to be existent, the following three conditions must be fulfilled: 1. Fulfilment of the general positive features of Sec. 15 (2) sent. 1 EStG as well as 2. An activity within the meaning of Sec. 18 (1) EStG, 3. The activity must be permanent; it may be temporary or part-time, but not occasional (Sec. 18 (2) EStG). An occasional activity is subject to Sec. 22 no. 3 EStG. <?page no="83"?> 84 2 Personal income tax Figure 23: Characteristics of income from self-employment A characteristic of self-employment is that the commitment of capital and/ or business assets is of less importance than the taxpayer’s personal (intellectual and physical) labor. The activity is carried out to a large extent on the basis of the taxpayer’s education or ability. The work performed by the taxpayer personally is of particular importance. Income from self-employment can be earned by individuals as well as by associations of individuals. The taxpayer’s <?page no="84"?> 2.2 Determination of taxable income 85 activity is still considered self-employment if the taxpayer employs trained workers and assumes responsibility and direction of such employees (Sec. 18 (1) no. 1 sents. 3 and 4 EStG). German personal tax law differentiates between five different groups of selfemployed activities (see figure 24). Figure 24: Scope of income from self-employment The most important group consists of the income from freelancing in accordance with Sec. 18 (1) no. 1 EStG. The following are characteristics of the first subcategory (self-employed scientific, artistic, journalistic, scholastic or instructional activity): • Scientific work is performed by individuals who actively research and carry out their work according to scientific methods. • Artistic work is performed by individuals who work creatively and whose work achieves a certain level of artistic proficiency. • Journalistic work is performed by individuals who publish their own thoughts and ideas in written works. • Scholastic work is performed by individuals who impart their abilities and knowledge to others (e.g. language, driving and dance teachers). <?page no="85"?> 86 2 Personal income tax • Instructional work is performed by individuals who deal methodically with the (intellectual and physical) development of young people. The catalogue of occupations listed in the second subcategory is exemplary, i.e. the catalogue occupations do not only consist of those occupations mentioned in Sec. 18 (1) no. 1 EStG. In particular, occupations in health care, financial and legal consultation, as well as technical occupations are included in which the personal education and the personally qualified work performed by the individual is crucial. A third subcategory was added to Sec. 18 (1) no. 1 EStG (“similar occupations”) because the types and fields of occupations have changed over time. Accordingly, the underlying education of the persons forming this occupational group must be comparable with those occupations in the catalogue. Occupations that are similar to those in the catalogue include, for example, midwives, masseurs and computer science graduates. Due to the lack of a legal definition of freelance activity, the demarcation from commercial activity is often unclear in practice, e.g. fashion and advertising photographers are not artistically active and thus practice a trade. H 15.6 “Definition of independent work/ commercial enterprise” EStH lists examples of independent and commercial activities. The list of income from other independent work mentioned in Sec. 18 (1) no. 3 EStG (remuneration for executions of wills, for asset management and supervisory board activities) is also only exemplary. This includes all types of administrative activity if they are not carried out within the framework of a commercial operation. Note The income from self-employed work includes: 1. The catalogue professions 2. State lottery collectors 3. Executors, asset managers, supervisory board members 4. Income from investments in asset management companies The distinction between a self-employed and a commercial activity is of fundamental importance, as the income of a self-employed person is exempt from trade tax, among other things. In addition, tradespeople are generally required to fulfil extensive accounting and balancing obligations. A self-employed activity only exists if it complies with Sec. 18 EStG. According to H 15.6 “Mixed activity” EStH, if a commercial activity is carried out in <?page no="86"?> 2.2 Determination of taxable income 87 addition to a freelance activity, the two activities must be treated separately or uniformly for tax purposes. A basic distinction must be made here as to whether a sole proprietorship or a partnership is to be considered. Partnerships can only generate commercial income or income from freelance activities. In contrast, sole proprietorships can carry on both a freelance and a commercial activity side by side. Separate treatment is the case for sole proprietorships if the natural person carries out both a commercial and an independent activity and there is no or only a certain material and economic connection between the two activities. Thus, business income (Sec. 15 EStG) and income from self-employment (Sec. 18 EStG) are generated side by side, and this is a so-called separable mixed activity . 3 Example: Silvia is an attorney at law and thus earns income from Sec. 18 EStG. At the same time, she has installed a photovoltaic system on her family house and generates business income from this in accordance with Sec. 15 EStG. If income from different sources cannot be separated, since separation would tear apart an internally related activity, it is an inseparably mixed activity . In accordance with the focus of the activity, the person is ultimately self-employed within the meaning of Sec. 18 EStG or has income within the meaning of Sec. 15 EStG. The decisive factor here is the overall picture of the activity. A trade is assumed if the activity is to be regarded as an unit according to the view of the trade and if freelance work plays a subordinate role. The decisive factor here is not the relative ratio of turnover or profit, but which source of income characterises the overall activity. 4 If, in the opposite case, commercial income plays a subordinate role for sole proprietorships, the total income is freelance. Example: Alfons is a tax consultant and, in addition to preparing the annual balance sheet and tax returns, he also handles the accounting for his clients. The accounting on behalf of the client is basically a commercial activity according to Sec. 15 EStG. 5 On the other hand, tax consultancy and balance sheet preparation are freelance activities within the meaning of Sec. 18 (1) no. 1 EStG. It is, however, an inseparably mixed activity, since the activities are mutually dependent and intertwined in such a way that the entire business is to be regarded as uniform in accordance with the view of the public, i.e. the result of one activity is 3 See BFH, 11 July 1991, BStBl. 1992 II, p. 353. 4 See BFH, 2 October 2003, BStBl. 2004 II, p. 363. 5 See BFH, 28 June 2001, BStBl. 2002 II, p. 338. <?page no="87"?> 88 2 Personal income tax useless without the other activity. 6 Since, however, bookkeeping is generally of secondary importance in the tax support contract, the entire activity resulting from this is to be regarded as a freelance activity. If several persons exercise a freelance activity within the meaning of Sec. 18 EStG jointly in the form of a partnership, each partner earns income from a freelance occupation. An example of this would be a merger of three doctors to form a joint practice. However, if the partnership carries out a commercial activity in addition to the freelance one, the division into independent and commercial income is based on the coinage theory (Geprägetheorie) or the stain or infection theory (Abärbetheorie bzw. Infektionstheorie) pursuant to Sec. 15 (3) EStG. According to this, partnerships are in principle not allowed to be freelance and at the same time commercially active. The coinage theory investigates the question of whether the activity of a partnership is commercial or freelance. According to Sec. 15 (3) no. 2 EStG, in the case of an actual agricultural, forestry or freelance partnership, an activity is regarded as commercial if the personally liable shareholder (general partner) is one or more capital companies and only these or a non-shareholder are authorised to manage the company. In this case, this is a so-called commercial partnership , e.g. a GmbH & Co. KG. Unlike a sole proprietorship, a mixed activity of a partnership cannot be divided into two types of income. If a partnership only generates a small amount of commercial income, the commercial income type is colored to all other areas of activity. It therefore regularly generates total and full commercial income (Sec. 15 (3) no. 1 EStG). Exceptionally, an infection will not occur if • the net commercial revenues do not exceed a de minimis threshold of 3 % of the company´s total net revenues and, • in addition, the maximum amount of € 24,500 in the assessment period. 7 Example: The architect Achim takes on the unprofessional businessman Bert as a partner in his practice, who looks after the business interests of the company. Since Bert is an unprofessional partner, both partners receive business income. 8 6 See BFH, 27 June 1974, BStBl. 1975 II, p. 147. 7 BFH from 27 August 2014, BStBl. 2015 II, p. 996. 8 See BFH, 22 August 1961, HFR, p. 274. <?page no="88"?> 2.2 Determination of taxable income 89 Note The coinage theory (Geprägetheorie) takes precedence over the stain/ infection theory (Abärbetheorie bzw. Infektionstheorie). The stain theory only applies to partnerships, since a clear separation of the various types of income is more difficult for a large number of co-entrepreneurs than for sole proprietorships. In addition, co-partnerships are given the opportunity to avoid the application of the waste color regulation by tax structuring, in particular by founding a further partnership. 2.2.2.2 The surplus income types a) Income from dependent-employment (Sec. 19 EStG) Employees earn income from dependent work within the meaning of Sec. 19 EStG. According to Sec. 1 (1) of the German Implementing Ordinance for Wage Tax (Lohnsteuer-Durchührungsverordnung - LStDV) employees are defined as “individuals who are employed publicly or privately, or who are or were occupied and receive wages from this or previous employment. Employees are also the legal successors of this individual inasmuch as the wages from previous employment are drawn by the successor”. Employment is deemed to exist if the employee is obliged to perform work for the employer in such a way that the employee’s business dealings are under the direction of the employer or that the employee is obliged to follow the instructions of the employer within the business organization of the latter (Sec. 1 (2) LStDV). Sec. 19 EStG includes all recurring and one-time payments that flow to the employee or the employee’s legal successor on account of existing or previous <?page no="89"?> 90 2 Personal income tax public or private employment. The payments may consist either of money or material benefits (also known as “payments in kind”). Figure 25: Scope of the income from dependent-employment Note Income within the meaning of Sec. 19 EStG includes the following: • Recurring and one-time cash payments and payments in kind • From an employee’s previous or existing employment • Certain payments made by the employer to occupational pernsion schemes Payments in kind within the meaning of Sec. 8 (2) EStG include, for example, free room and board, or the private use of a company car. They merely depict an abbreviated path of payment and thus belong to the income from dependent work. The privileges received in this way constitute a monetary advantage and are generally subject to income tax deduction as wages. Payments in kind are valuated with the usual end-price at the place of delivery, i.e. at the retail price incl. VAT, from which 4 % is then to be deducted. The remaining amount is to be curtailed by the price actually paid by the employee. Subsequently, the so-called “discount allowance” of € 1,080 (Sec. 8 (3) sent. 2 EStG) is to be deducted. The remaining amount is to be subject to taxation as wages within the meaning of Sec. 19 EStG. The offer price is regularly accepted as the customary selling price. According to the latest case law, the usual price discounts must be taken into account when taxing employee discounts, since in some sectors the prices actually paid are often lower than the declared prices. According to the BFH, the offer price can always be deviated from if a lower price is actually charged in accordance with <?page no="90"?> 2.2 Determination of taxable income 91 general commercial practice, e.g. in the automotive industry. 9 The taxable wages in the form of payments in kind are determined as follows: Price offer ./ . Usual discount = Usual retail end-price ./ . 4 % of the ususal retail end-price = Remaining end-price ./ . Price actually paid by the employee = Wages (benefit in money’s worth) ./ . Discount allowance (€ 1,080) = Taxable wages (taxable benefit in money’s worth) Example: Albert is employed by the automobile manufacturer, Audi-AG. In the automotive industry, a private customer discount of 10 % is assumed. He purchases a vehicle of the brand Audi for the following amount: List price of the car ./ . Personal discount of 20 % € 25,000 ./ . € 5,000 = Sales Price = € 20,000 Albert’s taxable wages are calculated as follows: Price offer ./ . Usual discount € 25,000 ./ . € 2,500 = Usual retail end-price ./ . 4 % of the usual retail end-price € 22,500 ./ . € 900 = Remaining end-price ./ . Price actually paid by the employee = € 21,600 ./ . € 20,000 = Wages (benefit in money’s worth) ./ . Discount allowance (€ 1,080) = € 1,600 ./ . € 1,080 = Taxable wages (taxable benefit in money’s worth) = € 520 Albert must pay taxes on € 520 as income from dependent-employment. With effect from 1 January 2015, whether and to what extent benefits from company events lead to wages is regulated for the first time by Sec. 19 (1) no. 1a EStG. According to this, benefits paid on the occasion of a company event 9 See BFH, 17 June 2009, VI R 18/ 07, DStR 2009, p. 1803. <?page no="91"?> 92 2 Personal income tax generally lead to a wage. This does not apply to benefits of up to € 110 per company event and per participating employee and for up to two company events per year. In particular, the pensions of public officials and company annuities (= retirement benefits) are included in the income received from previous employment within the meaning of Sec. 19 (1) no. 2 EStG - not however retirement benefits from an insurance carrier (e.g. social security pensions). Those belong to the other income within the meaning of Sec. 22 EStG. Up until and including the tax assessment period 2004, retirement benefits were generally subject to full taxation, whereas only the interest portion of social security pensions were taxed as other income within the meaning of Sec. 22 no. 1 EStG. There has long existed the so-called pension tax allowance (Versorgungs-Freibetrag) under Sec. 19 (2) EStG, which exempted up to 40 % of the retirement benefits from taxation in order to compensate for the tax benefit of the social security pensions. Now, however, the German Retirement Income Act (Alterseinkünftegesetz), which entered into force on 1 January 2005, an incremental alignment of the taxation of pensions from the statutory pension insurance occurs to the subsequent taxation of the pensions of public officials. As a result, the relief afforded by the pension tax allowance will be whittled away little by little until 2040. In doing so, the percentage that determines the amount of the tax allowance will be lowered in steps of 1.6 percentage points yearly (assuming 40 % of the retirement benefits are received when payments start by 2005). As of 2021, the decrease will sink to steps of 0.8 percentage points. At the same time, the maximum amount of € 3,000 (for existing cases and a pension beginning in 2005) will be lowered incrementally to € 0 by 2040. The determination of the pension tax allowance actually granted depends on the respective year in which the payment of retirement benefits begins. If payments start before 2005, the calculation is based on the amount of retirement benefits paid for January 2005 and then multiplied by twelve. If pension payments begin at a later point in time, the calculation is based on the amount of retirement benefits paid in the first month and then multiplied by twelve (Sec. 19 (2) sent. 4 EStG). It must be taken into consideration that the tax allowance determined in accordance with Sec. 19 (2) sent. 8 EStG is generally - i.e. if no irregular adjustments such as credited income are made - set for the entire term of the pension payments. Example: In March 2017, Armin (35) was struck blind in a car accident. Afterwards, Armin was no longer able to perform his work as a public official. He has received pension payments for public officials amounting to € 1,000/ month since April of the same year. How high is the pension tax allowance that Armin may claim in 2018? <?page no="92"?> 2.2 Determination of taxable income 93 The pension payments for public officials are considered to be retirement benefits within the meaning of Sec. 19 (2) sent. 2 no. 1 lit. a EStG. The determination of the tax allowance is based on the year the pension payments begin (2017). The assessment is based on twelve times what is paid in retirement benefits in the first full month (12 x € 1,000 = € 12,000). According to Sec. 19 (2) sent. 3 EStG, 20.8 % of the retirement benefits - amounting to € 2,496 - are exempt from taxation. Armin may not, however, claim a pension tax allowance of more than € 1,560. Income from non-independent work also includes so-called future security benefits. These are expenses incurred by an employer “to cover an employee or persons close to him or her in the event of sickness, accident, invalidity, old age or death” (Sec. 2 (2) no. 3 sent. 1 LStDV). Sec. 19 (1) no. 3 EStG supplements this provision and clarifies which payments made by the employer to occupational pension schemes count as income from non-independent activities. These include, for example, contributions and special payments for an unfunded pension. In addition to the pension tax allowance, income-related expenses may also be deducted from the income within the meaning of Sec. 19 EStG. An exemplary list of the most important expenditures related to work is contained in Sec. 9 (1) sent. 3 EStG. In particular, these include the following: • Fees paid to trade organizations (e.g. trade union fees); • Expenditures incurred for traveling to and from work from home; • Expenditures incurred for work materials (e.g. technical literature, tools); • Depreciation for wear (e.g. for PC and printer); • Account maintenance charges (a lump-sum allowance of € 16 is accepted). If the taxpayer’s income-related expenses actually incurred are lower than the lump-sum allowance for employees (Sec. 9a sent. 1 no. 1 EStG), the latter is granted instead. If the expenditures actually incurred exceed the lump-sum allowance, these can be claimed as income-related expenses inasmuch as corresponding proof thereof is made (e.g. invoices, account statements, etc.). The lump-sum allowance for employees generally amounts to € 1,000. As of 2005, however, a lump-sum allowance for income-related expenses amounting to € 102 is granted if income from dependent-employment is earned in the form of pension and related benefits within the meaning of Sec. 19 (2) EStG. The practical disappearance of the lump-sum allowance, which was also granted until now as a compensatory element, can be explained with the alignment of the taxation of annuities and pensions. In the transitional phase, the effect of these measures is, however, lessened by the grant of a supplement to the pension tax allowances in the relevant cases. This will - consistent with the corresponding regulations - be shrunk from € 900 (if pension payments begin <?page no="93"?> 94 2 Personal income tax by 2005) to € 0 (if pension payments begin in 2040) and set together with the pension tax allowance for the entire length of the pension payments. Example (continued): Armin is granted a supplement to the pension tax allowance because, as a recipient of retirement benefits, he is only able to claim a lump-sum allowance for income-related expenses amounting to € 102. According to the table for Sec. 19 (2) EStG, this supplement amounts to € 486 and is based on the year the pension payments begin (2017). Therefore, a total of € 2,028 (€ 1,560 + € 468) remains exempt from taxation. This amount is generally set for the entire time retirement benefits are paid. As a result, Armin earned the following income from dependent-employment: Earnings (12 x € 1,000) ./ . Pension tax allowance (with supplement) ./ . Lump-sum allowance for income-related expenses € 12,000 ./ . € 2,028 ./ . € 102 = Income from dependent-employment = € 9,870 The income from dependent-employment is calculated as follows: Gross wages from existing and previous employment (according to Sec. 19 (1) nos, 1 and 2 EStG) + so-called future security benefits paid by the employer within the meaning of Sec. 19 (1) no. 3 EStG ./ . Pension tax allowance (plus supplement) for recipients of retirement benefits according to Sec. 19 (2) EStG ./ . Actual income-related expenses or lump-sum allowance for employees according to Secs. 9, 9a sent. 1 no. 1 lit. a or b EStG = Income from dependent-employment within the meaning of Sec. 19 EStG Note • The pension tax allowance for pensions and all other retirement benefits included in Sec. 19 (2) EStG will be lowered to € 0 by 2040. • The lump-sum allowance for income-related expenses only amounts to € 102 (otherwise € 1,000) for income from dependent-employment in the form of retirement benefits. To compensate this, a supplement to the pension tax allowance is granted during the transition to equal taxation of annuities and pensions. <?page no="94"?> 2.2 Determination of taxable income 95 b) Income from capital assets (Sec. 20 EStG) Sec. 20 EStG regulates the taxation of capital income and lists its scope in (1) and (2). Table 11 shows selected income from capital assets. In addition to the current earnings from capital assets pursuant to Sec. 20 (1) EStG, Sec. 20 (2) EStG also covers the facts of sale. This relates in particular to gains from the sale of capital assets acquired after 31 December 2008. Figure 26 illustrates the basic system of taxation of dividends and interest earnings. The decisive factor is the allocation of capital income to private or business assets. Figure 26: Basic system of the taxation of capital income <?page no="95"?> 96 2 Personal income tax Table 11: Scope of the income from capital assets The type and amount of taxation depends on the allocation of capital income to private or business assets. First, however, an uniform capital yields tax of 25 % is levied. As a matter of principle, the compensation for private assets takes the form of a schedular separate tax rate of 25 % (flat-rate withholding tax) plus solidarity surcharge, i. e. a total of 26.375 %. In the case of church tax liability, an additional 8 % or 9 % is levied depending on the federal state. Taking into account the church tax as a special edition, this results in a flat-rate withholding tax of 27.82 % or 27.99 % (Sec. 32d (1) sent. 3 EStG). If, on the other hand, the capital earnings can be allocated to income from agriculture and forestry, from business operations, from self-employment or from renting and leasing, the subsidiarity rule of Sec. 32d (1) sent. 1 EStG i.c.w. Sec. 20 (8) EStG applies. In these cases, dividends are subject to the partial-income method pursuant to Sec. 3 no. 40 lit. d EStG, according to which only 60 % of earnings are taxable. In return, only 60 % of the business expenses that are economically related to the income can be claimed (Sec. 3c (2) EStG). Interest accruing to business assets, on the other hand, is not favoured by the partial-income method and is fully taxable at the individual income tax rate. In both cases, the capital yields tax acts as an advance income tax payment. Table 12 again illustrates the different tax consequences of allocating capital assets to the private or business assets of a taxpayer. <?page no="96"?> 2.2 Determination of taxable income 97 Table 12: Tax consequences from the allocation of capital income to private or business assets Pursuant to Sec. 32d EStG, capital income accruing to private assets is generally subject to a flat-rate withholding tax of 25 %. In this case, the capital yields tax loses its character as an advance payment of income tax, and the tax liability is settled at source with the flat-rate tax deduction (Sec. 43 (5) sent. 1 EStG). However, there are numerous exceptions to this principle (see Figure 27). According to Sec. 44 (1) sent. 1 EStG, the debtor of the capital yields tax remains the creditor of the income. The tax arises at the time when the capital yields accrue to the creditor (Sec. 44 (1) sent. 2 EStG). The distributing capital company (e.g. for domestic dividends) or the paying agent of the capital yields (= bank) are obliged to deduct the capital yields tax (e.g. for foreign dividends, interest payments or taxable capital yields [Sec. 44 (1) EStG]). However, the taxpayer is not always bound by the flat-rate withholding tax rate, but has the option under Sec. 32d (6) EStG to opt for a tariff assessment (so-called assessment option). This is always advantageous if the taxpayer's personal marginal tax rate is below 25 %, e.g. in the case of low income, high income-related expenses, special expenses, extraordinary expenses or losses from other types of income. If the taxpayer would like to make use of the assessment option, he can have his credit institution issue him with a tax certificate in the sense of Sec. 45a (2) EStG on the capital yields. At the tax- <?page no="97"?> 98 2 Personal income tax Figure 27: The systematics of Sec. 32d EStG payer's request, the tax office will use this certificate to ex officio check whether the collective agreement assessment leads to a lower tax rate (socalled most favourable tax treatment). However, pursuant to Sec. 32d (6) sents. 3 and 4 EStG, the request can only be filed uniformly for all capital income of the taxpayer for the respective assessment period and, in the case of married couples assessed together, only for all capital income of both spouses. The income from capital assets is then included in the total income and is therefore subject to the personal income tax rate of the taxpayer. If the option for assessment is chosen, positive income from capital assets can be offset against losses from other types of income. However, it is not possible to offset negative income from capital assets in this way. Example: Hans is a pensioner and is subject to a marginal tax rate of 20 %. He receives interest earnings of € 2,000 from a savings book. However, since his interest earnings are subject to 25 % flat-rate withholding tax, his tax advisor advises him to exercise the so-called assessment option of Sec. 32d (6) EStG and apply to the tax office to assess his capital income together with the remaining income. However, Hans requires a tax certificate for this purpose, which he must apply for from his bank in accordance with Sec. 45a (2) EStG. On the basis of the certificate the tax office examines ex officio whether the application of the general income tax regulations leads to a lower tax assessment (so-called most favourable tax treatment). If this is not the case, the application is deemed not to have been filed. Systematics of Sec. 32d EStG Flat-rate compensation according to Sec. 32d (1) EStG Assessment Exceptional circumstances Sec. 32d (1) and (2) EStG Compensation via assessment Assessment option Sec. 32d (6) EStG Mandatory assessment Sec. 32d (3) EStG Assessment choice right Sec. 32d (4) EStG <?page no="98"?> 2.2 Determination of taxable income 99 Note The taxpayer cannot be put at a disadvantage by filing an application pursuant to Sec. 32d (6) EStG, since the tax office has to examine the advantageousness of the application for the taxpayer. In the case of so-called compensation via assessment pursuant to Sec. 32d (3) and (4) EStG, a distinction must be made between two cases in which the flatrate withholding tax rate is only applied by way of assessment. 1. In the case of the compulsory assessment pursuant to Sec. 32d (3) EStG, the taxpayer must state in his income tax return those capital yields on which no capital yields tax has previously been levied (e.g. income from foreign deposits and accounts, interest between private individuals, sale of GmbH shares in the case of non-essential shareholdings). These capital yields are also subject to the special tariff of Sec. 32d EStG in the amount of 25 %. Since no capital yields tax was complied with, the income tax rate increases by 25 % of the corresponding income (Sec. 32d (3) sent. 2 i.c.w. Sec. 2 (6) sent. 1 EStG). Example: Karl is a small shareholder of IN-GmbH since 2 January 2018. His participation is less than 1 %. The acquisition costs amount to € 5,000. At the end of 2018, he sells the investment with sale proceeds of € 15,000. In addition, Karl has to bear € 2,000 in selling costs. Karl's savers’ lump-sum has already been exhausted by other capital yields. Pursuant to Sec. 20 (2) no. 1 EStG, the capital gain belongs to the income from capital assets and is calculated pursuant to Sec. 20 (4) sent. 1 EStG by deducting the acquisition and disposal costs from the proceeds from the sale: Proceeds from the sale ./ . acquisition costs ./ . costs of disposal € 15,000 ./ . € 5,000 ./ . € 2,000 = Capital gain within the meanings of Sec. 20 (4) EStG = € 8,000 Since the capital gain, as taxable capital income, is not subject to the flat-rate withholding tax, this must be stated in Karls income tax return (Sec. 32d (3) EStG). Without taking the solidarity surcharge into account, the income tax rate increases by (25 % × € 8,000 =) € 2,000 (Secs. 32d (3) sent. 2 i.c.w. 2 (6) sent. 1 EStG). 2. A further form of compensation via the assessment is the assessment choice right under Sec. 32d (4) EStG. This always applies if capital yields tax has been levied on the one hand, but tax-reducing circumstances have <?page no="99"?> 100 2 Personal income tax not been taken into account on the other. Sec. 32d (4) EStG lists a nonexhaustive series of circumstances which enable the taxpayer to subsequently assert tax-reducing circumstances which have not been taken into account. In addition, it is possible to verify the procedure for or the amount of the withholding tax. On the basis of this regulation, the taxpayer can, for example, use an unrecognised loss or a savers’ lump-sum that has not yet been fully utilised as part of the assessment. In order to achieve this, a first step pursuant to Sec. 32d (3) sent. 2 EStG is to increase the income tax rate by 25 % of the income now reduced by the circumstances. In a second step, the capital yields tax already withheld is to be credited against the income tax liability pursuant to Sec. 36 (2) no. 2 EStG. This is necessary because the withheld capital yields tax was levied without taking into account the tax-reducing circumstances and is therefore higher than the amount used as the basis for the tax assessment. Example: Josef has submitted an exemption order to Bank A in the amount of € 801. In addition, he incurred losses of € 1,000 from the sale of shares. At Bank B, on the other hand, he made gains of € 2,000 from the sale of shares. Bank B then withholds 25 % capital yields tax in the amount of € 500 pursuant to Secs. 44 (1) i.c.w. 43a (1) no. 1 EStG. The capital yields tax withheld by Bank B generally has a compensatory effect (Sec. 43 (5) sent. 1 EStG). However, neither the savers’ lump-sum nor the loss offset in accordance with Secs 43a (3) sent. 2 i.c.w. 20 (6) sent. 5 EStG have been taken into account in the context of the capital yields tax deduction. Josef can therefore apply under Sec. 32d (4) EStG i.c.w. Sec. 43 (5) sent. 3 EStG for these circumstances to be taken into account in his assessment. Income from capital assets ./ . Losses offset according to Secs. 43 (3) sent. 3 i.c.w. 20 (6) sent. 5 EStG € 2,000 ./ . € 1,000 = Total income from capital assets ./ . savers’ lump-sum pursuant to Sec. 20 (9) EStG € 1,000 ./ . € 801 = Tax assessment base of the special tariff pursuant to Sec. 32d (1) EStG Tax rate 25 % = € 199 = Tax burden ./ . Withheld capital yields tax = € 50 ./ . € 500 = Taxable refund = € 450 After taking into account all tax-reducing circumstances, Josef is entitled to a tax refund of € 450. This results from the fact that the collectively agreed income tax pursuant to Sec. 2 (6) sent. 1 EStG is increased by € 50 (Sec. 32d <?page no="100"?> 2.2 Determination of taxable income 101 (4) EStG). In return, however, the withheld capital yields tax of € 500 pursuant to Sec. 36 (2) no. 2 EStG will be offset against the income tax liability. In the case of the assessment option or the so-called compensation via the assessment, where the capital income generally falls under the special tariff of Sec. 32d EStG, but the taxpayer chooses the assessment specifically in order to achieve a lower tax burden (exception of the amount), the compensatory effect of the capital income tax is omitted. In addition, the flat-rate withholding tax does not apply to capital yields that can be attributed to a main type of income or that fall under the exceptions pursuant to Sec. 32d (2) EStG (exceptions on the merits). Figure 28: Exceptions to the special tariff of Sec. 32d EStG 1. Subsidiarity of the supplementary income Sec. 32d (1) sent. 1 EStG stipulates i.c.w. Sec. 20 (8) EStG that capital income is not subject to flat-rate withholding tax if it can be allocated to income from agriculture and forestry, from business operations, from self-employment or from rental and leasing. This allocation allows offsetting against other types of income. Example: Franz operates a coffee house in the centre of Saarbrücken and holds a 20 % share in the Kaiser-GmbH. In 2018, profit distributions amounting to € 75,000 are credited to his bank account. To finance the shares, Franz took out a loan, the financing costs amount to € 30,000. In addition, Franz is credited € 3,000 interest from a money market account which he maintains with the Max-Bank. What is the tax treatment of the income if the GmbH shares and the money market account are to be allocated to the <?page no="101"?> 102 2 Personal income tax (a) private assets (b) sole proprietorship of Franz and Franz is subject to a tax rate of 40 %? The savers’ lump-sum is neglected. a) Both the profit shares and the interest payments represent income from capital assets pursuant to Sec. 20 (1) no. 1 or no. 7 EStG and cannot be attributed to any main type of income. Thus they are subject to the special tariff of Sec. 32d EStG in the amount of 25 %. The capital yields tax levied pursuant to Sec. 43 (1) sent. 1 no. 1 and no. 7 i.c.w. Sec. 43a (1) no. 1 EStG has a compensatory effect pursuant to Sec. 43 (5) EStG. A deduction of the actually incurred income-related expenses, however, is excluded (Sec. 20 (9) sent. 1 EStG). Net earnings from capital assets + Withheld capital yields tax € 78,000 + € 26,000 = Gross earnings from capital assets Flat-rate withholding tax 25 % = € 104,000 = Tax burden = € 26,000 b) As the capital yields are to be allocated to the business assets, the exception in Sec. 32d (1) sent. 1 EStG i.c.w. Sec. 20 (8) EStG applies. The withheld capital yields tax thus has no compensatory effect (Sec. 43 (5) sent. 2 EStG), but retains its character as an advance payment of income tax and can be offset against Franz's income tax liability. Consequently, the amount withheld as capital yields tax must also be added to the income (Secs 43a (2) sent. 1, 36 (2) no. 2 EStG). According to Sec. 3 no. 40 lit. d EStG, 40 % of the distributed profits of the GmbH are tax exempt. The financing costs represent business expenses that are economically related to the distributions and can be deducted at 60 % pursuant to Sec. 3c (2) EStG. The interest is fully taxable. The taxable income and the income tax liability are determined as follows: Distribution of profits - GmbH Net earnings from capital assets + Creditable capital yields tax (Secs. 43a (2) Sent. 1, 36 (2) no. 2 EStG) € 75,000 + € 25,000 = Gross earnings from capital assets =€ 100,000 Thereof 60 % (Sec. 3 no. 40 lit. d EStG) ./ . Income-related expenses 60 % of € 30,000 (Sec. 3c (2) EStG) € 60,000 ./ . € 18,000 = Income from capital assets = € 42,000 = € 42,000 <?page no="102"?> 2.2 Determination of taxable income 103 Interest Net earnings from capital assets + Creditable capital yields tax (Secs. 43a (2) sent. 1, 36 (2) no. 2 EStG) € 3,000 + € 1,000 = Gross earnings from capital assets = € 4,000 = € 4,000 = Taxable income according to Sec. 20 EStG Income tax rate 40 % = Tax burden (Tariff income tax) ./ . Creditable capital yields tax (Secs. 43a (2) sent. 1, 36 (2) sent. 2 no. 2. EStG) = € 46,000 = € 18,000 ./ . € 26,000 = Tax refund = € 7,600 Franz is therefore advised to keep his GmbH participation in the business assets in order to allow a deduction of the financing costs as business expenses (tax savings: € 100,000 × 25 % ./ . € 42,000 × 40 % = € 8,200). The interest income should flow however if possible to the private assets, in order to come into the benefit of the flat-rate withholding tax (tax saving: € 4,000 × 40 % ./ . € 4,000 × 0.25 % = € 600). 2. Exception of the Sec. 32d (2) EStG Sec. 32d (2) EStG lists a number of capital yields for which the flat-rate withholding tax does not apply, but which are assessed together with the other types of income (see Table 13). a) With the introduction of the flat-rate withholding tax, the legislator saw the danger that business profits would be “sucked of” from the companies through design measures (in particular shareholder loans) and that equity would increasingly be replaced by liabilities. Sec. 32d (2) no. 1 EStG covers in particular interest on borrowed capital that flows from the company to related parties or shareholders who hold more than 10 % of the capital of the capital company. If the requirements of Sec. 32d (2) no. 1 are met, the capital income is not subject to the flat-rate withholding tax but is assessed in full together with the remaining income of the taxpayer. In return, however, the general income tax regulations on loss compensation and deduction of income-related expenses (Sec. 32d (2) no. 1 sent. 2 EStG) also apply to this income. <?page no="103"?> 104 2 Personal income tax Table 13: Exceptions of Sec. 32d (2) EStG b) Sec. 32d (2) no. 2 EStG concerns benefits from certain life insurance policies within the meaning of Sec. 20 (1) no. 6 sent. 2 EStG. These are already favoured by the fact that only half of the difference between the insurance benefit and the contributions paid is to be recognised as earnings. A further benefit from the flat-rate withholding tax should be avoided. The taxable income is therefore also assessed with the remaining income. c) The provision of Sec. 32d (2) no. 3 EStG takes account of the fact, that the acquisition of shareholdings in capital companies by private individuals is often of an entrepreneurial nature and cannot be classified purely as a capital investment. If the taxpayer has a share of at least • 25 % in the capital company or • a share of 1 % in the capital company and works professionally for it, he has the right to choose not to subject the distribution of profits to the flat-rate withholding tax but to assess it together with his other income using the partial-income method. The advantage of this regulation is that in this way a deduction of income-related expenses (e.g. for the external financing of the participation) is made possible at 60 % in accordance with Sec. 3c (2) EStG. Note Capital income within the meaning of Sec. 32d (2) EStG is assessed together with the remaining income of the taxpayer. In this respect, the general regulations on loss compensation and deduction of income-related expenses apply (Secs. 32d (2) sent. 2 i.c.w. 20 (6) and (9) EStG. A deduction of the savers’ lump-sum is not possible! <?page no="104"?> 2.2 Determination of taxable income 105 Example: Andreas and Christina found a GmbH to operate an optics business. As existence founders they bring up the capital stock half each by cash contributions. While Christina can bring in her saved private capital, Andreas has to take out a loan with the bank to be able to make his cash contribution. This results in interest on the loan, which Andreas would like to claim for tax purposes. In the context of the flat-rate withholding tax a deduction of income-related expenses for the interest is however excluded, since the savers’ lump-sum does not permit any other deduction of income-related expenses. Andreas therefore opts for the partial-income method according to Sec. 32d (2) no. 3 EStG and can thus claim at least 60 % of the loan interest in his private tax return. d) Sec. 32d (2) no. 4 EStG covers income with regard to hidden profit distributions within the meaning of Sec. 20 (1) no. 1 sent. 2 EStG and earnings within the meaning of Sec. 20 (1) no. 9 sent. 1 half-sent. 2 EStG. Income from hidden profit distribution generally leads to income from capital assets and is therefore subject to the flat-rate withholding tax. However, the flat-rate withholding tax only applies, if the hidden profit distribution was already subject to corporate income tax at the level of the supplying company. In the event that the hidden profit distribution actually reduced the income of the distributing corporation and was therefore not subject to corporate income tax, taxation at the individual income tax rate is required. Although income from capital assets continues to systematically belong to the types of surplus income, it is no longer possible to deduct the actual income-related expenses incurred, if the flat-rate withholding tax is applied. The costs of financing the acquisition of capital assets are particularly affected by this. Instead, Sec. 20 (9) EStG grants the taxpayer the savers’ lumpsum of € 801 or € 1,602 for married couples assessed together. This applies both to current income pursuant to Sec. 20 (1) EStG and to capital gains pursuant to Sec. 20 (2) EStG. The savers’ lump-sum must be divided equally between the two spouses, whereby the transfer of an unused allowance to the other spouse is permitted pursuant to Sec. 20 (9) sent. 3 EStG. An unrestricted deduction of income-related expenses is only possible for capital yields that are exempt from the flat-rate withholding tax pursuant to Secs. 20 (8) and 32d (2) EStG. Figure 29 illustrates to what extent a deduction of income-related expenses is possible or only the savers’ lump-sum applies. For the capital yields from sales transactions added in Sec. 20 (2) EStG, the profit must be determined in accordance with the provisions of Sec. 20 (4) EStG. Accordingly, the acquisition costs and the costs of disposal are deducted from the proceeds from the sale. <?page no="105"?> 106 2 Personal income tax Figure 29: Income-related expenses regarding capital income The provision is based here on the comparable regulations for determining the assessment basis in the cases of sale of Secs. 17 and 23 EStG. Proceeds from the sale ./ . acquisition costs ./ . costs of disposal = Capital gain within the meaning of Sec. 20 (4) EStG Losses reduce the economic capacity of the taxpayer. According to a decision of the Federal Fiscal Court of 24 October 2017 (DStR 2017, p. 2801), the final default of a capital claim within the meaning of Sec. 20 (1) no. 7 EStG in the private sphere leads to a loss to be recognised for tax purposes pursuant to Sec. 20 (2) sent. 1 o. 7, sent. 2, (4) EStG even after the introduction of the flatrate withholding tax. In accordance with the objective net income principle, they must therefore in principle also be compensable with positive income. This principle is taken into account in German income tax law through intraperiodic (Sec. 2 (3) EStG) and interperiodic loss compensation (Sec. 10d (1) and (2) EStG). However, this principle is broken by restricting the offsetting of losses from capital assets against positive income from other types of income and by restricting the offsetting of positive income from capital assets against losses from other types of income. Sec. 20 (6) EStG standardizes two closed offsetting groups: The offsetting area for income from capital assets and the offsetting area for the remaining types of income. Both offsetting areas must be strictly separated from each other, as they are subject to different tax rates. For income from capital assets within the meaning of Sec. 20 EStG, the favourable 25 % flat-rate withholding tax applies; for all other income within the meaning of Sec. 2 (1) nos. 1 to 4, 6 and 7 EStG, the normal rate applies. The separation of the offsetting groups is intended to prevent <?page no="106"?> 2.2 Determination of taxable income 107 the non-privileged types of income from being offset against the privileged type of income under Sec. 20 EStG. Within the income from capital assets within the meaning of Sec. 20 EStG, however, there are two different levels at which positive and negative income can be offset: The level of the “paying agent” ̵ usually a credit institution and the level of the taxpayer. Since income from capital assets accrues at the level of the paying agent, the offsetting of income at the level of this paying agent within the meaning of Sec. 43a (3) EStG takes precedence over the offsetting of income at the level of the taxpayer within the meaning of Sec. 20 (6) EStG. Sec. 20 (6) sent. 1 EStG regulates the priority relationship by reference to Sec. 43a (3) EStG. The paying agent must compensate any negative capital yields (including accrued interest paid) up to the amount of the positive capital yields. In the case of spouses with a joint exemption order, this applies to all accounts or all securities accounts. As a result, negative capital yields are already offset at the level of the paying agent to the extent of the positive capital yields incurred there. Example: The spouses Birgit and Martin each have their own securities account at X-Bank. Birgit and Martin have issued a joint exemption order in the amount of € 500 with this bank. Birgit achieves positive capital yields of € 1,500 at X-Bank, Martin negative capital yields of € 1,000. Through the joint exemption order within the meaning of Sec. 43a (3) sent. 2 EStG, the capital income will now initially be offset between the spouses at the level of the bank across securities accounts. The remaining positive capital yields in the amount of € 500 (= € 1,500 ./ . € 1,000) are exempted from the flat-rate withholding tax by the joint exemption order in the amount of € 500. When offsetting at the level of the paying agent, however, it should be noted that the paying agent must maintain two loss offsetting pots per taxpayer in accordance with Sec. 43a (3) sent. 2 EStG. The pot of losses from sales of shares and the pot of losses from sales of other capital assets. Both pot types may not be offset against each other. Example: The spouses Sabine and Doni each have their own securities account at X-Bank. Sabine and Doni have issued a joint exemption order of € 500 with this bank. Sabine obtains with the X-Bank positive capital yields from bond sales at a value of € 1,500, Doni negative capital yields from sales of shares at a value of € 1,000. By the common exemption order in the sense of Sec. 43a (3) sent. 2 EStG the capital earnings would be offset now first on level of the bank depot-spreading under the spouses. The remaining positive capital yields in the amount of € 500 (= € 1,500 ./ . € 1,000) would be exempt from the flat-rate withholding tax through <?page no="107"?> 108 2 Personal income tax the joint exemption order in the amount of € 500. Since however the losses of Doni originate from sales of shares, which can be set off only against profits from sales of shares, Sabine must pay flat-rate withholding tax on the capital yields exceeding the exemption order, while Doni must carry forward the losses from sales of shares, until he will obtain profits from sales of shares in the future. If, after offsetting, positive income remains in the pots at the level of the paying agent, it is subject to the flatrate withholding tax there. If negative income from capital assets remains in one or both pots after offsetting at the level of the paying agent, the taxpayer has the right to choose. The taxpayer can now leave these losses at the level of the paying agent so that they can be offset against positive capital yields in future years. However, upon application in accordance with Sec. 43a (3) sent. 4 EStG, he can also transfer the losses to the taxpayer level for further offsetting on a potty-related basis by issuing a certificate. This is necessary, for example, in order to be able to offset losses with positive income from capital assets at another paying agent within the scope of the assessment option pursuant to Sec. 32d (4) EStG. However, pursuant to Sec. 20 (6) sent. 1 EStG, it is not permitted to offset positive income from other types of income (schedule system; no vertical loss compensation). Similarly, Sec. 20 (6) sent. 1 half-sent. 2 EStG does not permit compensation with other types of income via Sec. 10d EStG. In addition, the negative income from the sale of shares within the income from capital assets is also subject to the special deduction restriction at taxpayer level and may only be offset here against profits from the sale of shares (e.g. at another paying agent). The aim of this regulation is to prevent loss offsetting against other income from capital assets (e.g. interest and dividends) in the event of falling stock market prices and thus to avoid a drastic reduction in tax revenue. The respective losses can, however, be carried forward within their respective offsetting groups in accordance with Sec. 10d (4) EStG in future assessment periods in order to offset them against later profits (Sec. 20 (6) sent. 2 and 3 EStG). A loss carryback, however, is excluded. Note No compensation for losses from capital assets with losses from other types of income possible c) Income from rent and lease (Sec. 21 EStG) Individuals equipped with the rights and obligations of a landlord and/ or lessor, who provide third parties with the use of privately held non-cash objects and rights, are subject to taxation according to Sec. 21 EStG. The <?page no="108"?> 2.2 Determination of taxable income 109 principle of subsidiarity for ancillary income types is referred to in Sec. 21 (3) EStG. Accordingly, Sec. 21 EStG is only applicable to income if it is not already assigned to one of the other types of income. In practice, however, it is often difficult to distinguish between income from rent and lease and business income. Sec. 21 (1) sent. 1 EStG contains a conclusive list of the earnings that are assigned to the income from rent and lease. The income is generally considered to be the gross rental payments, i.e. the rent plus ancillary costs. The income from rent and lease includes the following: • Income from rent and lease from immovable property, e.g. land, buildings and elements of buildings (Sec. 21 (1) sent. 1 no. 1 EStG). • Income from the rental and lease of object aggregates (Sec. 21 sent. 1 no. 2 EStG). An object aggregate is a group of movable objects that form an economic unit (e.g. office equipment, library, room furniture). In contrast, the rental of individual movable assets is not considered to be income from rent and lease, but rather other income within the meaning of Sec. 22 no. 3 EStG. <?page no="109"?> 110 2 Personal income tax Income from rent and lease of immovable assets Sec. 21 (1) sent. 1 no. Income from rent and lease of object aggregates Sec. 21 (1) sent 1 no Income from temporary provisions of rights Sec. 21 (1) Income from the disposal of receivables from rent and lease Sec. 21 (1) sent 1 no 4 • Income from temporary provision of rights, e.g. copyrights (Sec. 21 (1) sent. 1 no. 3 EStG). However, income from the transfer of such rights by the author or inventor himself is deemed to be self-employed income within the meaning of Sec. 18 EStG. • Income from the disposition of rent and lease claims (Sec. 21 sent. 1 no. 4 EStG). Figure 30: Scope of income from rent and lease The income-related expenses are deductible from the income that is connected with the income within the meaning of Sec. 21 EStG. The taxpayer must always prove the individual expenditures thereby. A lump-sum allowance for income-related expenses (such as for income from dependent-employment or from capital assets) does not exist for income from rent and lease. Income-related expenses include, for example, the following: • Interest on debts; • Maintenance expenses (R 21.1 EStR); • Deduction for depreciation (Sec. 7 (4) and (5) EStG) as well as • Other income-related expenses (e. g. land tax, the costs for the caretaker and property management, the costs of hot water and heating, garbage collection fees, insurances, the costs of oil-tank inspection). The income from rent and lease is calculated as follows: Earnings ./ . Income-related expenses = Income within the meaning of Sec. 21 EStG Example: In 2005, Karl had built a house with room for three families (he already had the real estate). The construction costs amounted to € 1,000,000. All three apartments are of the same size. Karl lives in the apartment on the top floor (third floor) and <?page no="110"?> 2.2 Determination of taxable income 111 the other apartments (first and second floor) are each rented to private parties for € 600 a month respectively. The following expenditures were incurred in 2018 for the building: recurring expenditures of € 6,000 and interest on debts amounting to € 12,000. Calculate Karl’s income from rent and lease: No rent is earned for the part of the building used and inhabited by Karl. Therefore, the costs that are incurred for this part of the building may not be deducted as income-related expenses. The income from rent and lease is calculated as follows: 1 st floor: € 600 × 12 € 7,200 2 nd floor: € 600 × 12 € 7.200 3 rd floor: € 0 € 0 Earnings from rent and lease = € 14,400 One-third of the expenditures incurred during 2018 must be allocated to each of the three apartments. The income-related expenses for the rented apartments are calculated as follows: Recurring expenditures 1 st floor: 1/ 3 × € 6,000 2 nd floor: 1/ 3 × € 6,000 = € 2,000 = € 2,000 € 4,000 Interest on depts 1 st floor: 1/ 3 × € 12,000 2 nd floor: 1/ 3 × € 12,000 = € 4,000 = € 4,000 € 8,000 Declining depreciation (Sec. 7 (5) sent. 1 no. 3 lit. c EStG) 1 st floor: 1/ 3 × 0.025 × € 1 mill. 2 nd floor: 1/ 3 × 0.025 × € 1 mill. = € 8,333 = € 8,333 € 16,667 Total income-related expenses € 28,667 The income is thus calculated as follows: Earnings € 14,400 ./ . Income-related expenses € 28,667 = Loss from rent and lease = € 14,267 d) Other income (Sec. 22 EStG) Sec. 22 EStG applies to the income that is not already assigned to one of the first six types of income within the meaning of Sec. 2 (1) sent. 1 EStG, but which is subject to taxation nonetheless. Sec. 22 EStG does not serve thereby as a catchall provision. In fact, only that income which is listed conclusively in Sec. 22 EStG is included. A distinction can be made between six types of income within the meaning of Sec. 22 EStG: <?page no="111"?> 112 2 Personal income tax Figure 31: Scope of the other income  Income from recurring remunerations (Sec. 22 no. 1 EStG) According to R 22.1 EStR, “Recurring remunerations are considered to be other income within the meaning of Sec. 22 no. 1 sent. 1 EStG if they do not belong to the other types of income and inasmuch as they do not represent the repayment of capital, e.g. purchase price installments, from an economic point of view. The requirement for the assumption of recurring remuneration is that they are based on a uniform decision or a uniform legal cause and recur with relative regularity”. Recurring remuneration includes, for example, annuities (e.g. annuities certain and life annuity funds, remuneration based on permanent burdens and other recurring payments). Annuities certain have an explicitly defined term. Life annuity funds depend on the lifespan of the annuity recipient, i.e. they end upon the death of the recipient. Permanent burdens (recurring cash benefit or benefits in kind) differ from pensions in that their payments are not equal in amount and are received irregularly. <?page no="112"?> 2.2 Determination of taxable income 113 Particularly the German Retirement Income Act (Alterseinkünftegesetz - Alt- EinkG) 10 , which entered into force on 1 January 2005, has brought about significant changes to the way life annuity funds are subject to taxation. Up to and including the assessment period 2004, only the earnings yield of the annuities, i.e. the earned interest on the annuity equity, were subject to personal income tax. In return, however, only part of the expenditures made for retirement provisions was deductible as special expenses. As a result, the new regulations that provide for increased deductions for special expenses usually relieve the taxpayer. In addition, the reduction of the assessment basis leads to an advantage in the progression as compared to the previous legal situation. The scope of Sec. 22 no. 1 sent. 3 lit. a double lit. aa EStG applies thereby: Life annuity funds from statutory pension insurance, as well as agricultural pension funds, professional pension schemes and funded life annuity insurance policies from 2005 onwards within the meaning of Sec. 10 (1) no 2 lit. b EStG. Correspondingly, the transition to the taxation of the retirement benefits will also not take place at one time because the AltEinkG provides for an incremental exemption of retirement provisions in accordance with Sec. 10 (3) EStG. Rather, the legislature set a taxable portion of 50 % for all annuities that already existed in the assessment period 2005 - so-called present pensions (Bestandsrenten) - and/ or that were granted for the first time in that year. Initially, the taxable portion increases for each new “annuity cohort”, i.e. each new generation of retirees, by two percentage points. As of 2020, increases of one percentage point per annum respectively are planned, so that in the end 100 % of the retirement benefits which are received by the cohort that receives annuities for the first time in 2040, will be subject to taxation. The taxable portion is solely dependent upon the year the payments of annuities begin. As soon as the taxable portion of the annuity has been determined, the pension allowance is calculated as the difference between the annual sum of the annuity and the taxable portion. This tax allowance is determined separately. In doing so, it must be taken into consideration that the allowance for pensions is generally (i.e. in the event that no irregular adjustments to annuity, such as credited income, are made during the term) fixed for the entire term of the annuity . However, the taxpayer will usually not receive the full yearly annuity in the year in which the annuity begins because the day the annuity begins is seldom 1 January. For this reason, the allowance for 10 See BStBl. II 2009, p. 296. <?page no="113"?> 114 2 Personal income tax pensions is always determined in the year following the year in which the annuity begins. Example: As of 1 August 2018, Eduard receives retirement benefits from the statutory pension insurance amounting to € 2,000/ month. According to Sec. 22 no. 1 sent. 3 lit. a double lit. aa EStG, the taxable portion of the annuity amounts to 76 %. The other income is thus calculated as follows: 2018 Gross annuity (5 months € 2,000) Taxable portion (76 % € 10,000) ./ . Lump-sum allowance for income-related expenses € 10,000 € 7,600 ./ . € 102 (Sec. 9a sent. 1 no. 3 EStG) = Other income (Sec. 22 EStG) = € 7,498 2019 Gross annuity (12 months € 2,000) € 24,000 Taxable portion (76 % of € 24,000) € 18,240 ./ . Lump-sum allowance for income-related expenses ./ . € 102 (Sec. 9a sent. 1 no. 3 EStG) = Other income (Sec. 22 EStG) = € 18,138 The year 2019 is the year following the year in which the annuity begins. Therefore, the allowance for pensions amounting to € 5,760 is fixed for the future at this point. Annual sum of the annuity € 24,000 ./ . Taxable portion € 18,240 = Allowance for pensions = € 5,760 2020 Gross annuity (12 months × € 2,000) € 24,000 ./ . Allowance for pensions € 5,760 ./ . Lump-sum allowance for income-related expenses (Sec. 9a sent. 1 no.3 EStG) ./ . € 102 = Other income (Sec. 22 EStG) = € 18,138 <?page no="114"?> 2.2 Determination of taxable income 115  Income from maintenance payments in the meaning of Sec. 10 (1a) EStG (Sec. 22 no. 1a EStG) In 2015, the deductions were restructured into (1a) in Sec. 10 EStG. Sec. 22 no. 1a EStG is the counterpart to Sec. 10 (1a) EStG. The legal link between these provisions ensures that a special expenditure deduction in respect of payments pursuant to Sec. 10 (1a) EStG is followed by taxation as other income by the recipient. In terms of content, these payments primarily concern maintenance payments, recurring retirement benefits and compensation payments within the framework of pension equalisation. Maintenance payments are taxable as other income for the maintenance recipient if they are deducted by the divorced or permanently separated spouse by mutual agreement as special expenses pursuant to Sec. 10 (1a) no. 1 EStG. The amount deducted as special expenses corresponds to the amount taxable as other income. However, it is limited to a maximum of € 13,805. If, in addition, contributions to health and long-term care insurance are paid for the separately living or divorced spouse, these can also be claimed from the 2010 assessment period (Sec. 10 (1a) no. 1 sent. 2 EStG). The implementation of this so-called real splitting leads to tax advantages if the service provider (e.g. the divorced husband) is subject to a higher tax rate than the recipient (e.g. the divorced wife). Note • The transition to deferred taxation of life annuity funds will not take place at one time, but rather corresponding with the incremental exemption of retirement provisions. • The allowance for pensions, which is formed in the year after the annuity begins, generally retains its validity for the entire term of the annuity. Since the introduction of this standard in the assessment period of 2008, the income from retirement benefits has been taxable on the part of the beneficiary if it is claimed by the payer as special expenses pursuant to Sec. 10 (1a) no. 2 EStG. The main case of application is the transfer of assets in return for retirement benefits within the framework of the so-called anticipated succession, in which, for example, parents transfer a business to their children during their lifetime. In return, the children undertake to pay monthly cash benefits based on the parents' need for care. There is no commercial balance between the benefits, i.e. the recurring benefits are measured solely on the basis of the <?page no="115"?> 116 2 Personal income tax beneficiary's need for care and the economic capacity of the obligor, irrespective of the value of the assets to be transferred. The process is therefore seen as a transfer of assets without consideration for income tax purposes. The term “pension adjustment under the law of obligations” originates from family law (Secs. 1587 et seqq. BGB). During the marriage period, spouses acquire expectancies or prospects of various pension claims (e.g. old-age pension, pensions due to reduced earning capacity). If the rights of one partner acquired during the marriage exceed those of the other partner, in the event of divorce the spouse with the lower balance is entitled to half of the difference (so-called gain equalisation). The settlement takes place either through a so-called publiclaw or a pension settlement under the law of obligations. The solution under the law of obligations represents a transfer of assessable and taxable income from one spouse to another. The entitled spouse must pay tax on the benefit in accordance with Sec. 22 no. 1a EStG if the spouse obliged to pay compensation deducts the payments made as special expenses in accordance with Sec. 10 (1a) no. 4 EStG. In 2015, the deductions in Sec. 10 (1a) EStG were supplemented by a further fact. Compensation payments to avoid pension equalisation after divorce or dissolution of a civil partnership are deductible as special expenses pursuant to Sec. 10 (1a) no. 3 EStG, provided that they are subject to taxation pursuant to Sec. 22 no. 1a EStG for the equalisation recipient.  Income from private sales transactions within the meaning of Sec. 23 EStG (Sec. 22 no. 2 EStG) As a further exception to the source theory in personal assets, in addition to Sec. 17 and Sec. 20 (2) EStG, private sales transactions are also taxable. Sec. 23 EStG lists the sales transactions that only belong to private assets. These include exclusively gains from assets held as private assets and for which the period between acquisition and disposal does not exceed • ten years in the case of real estate and rights equivalent thereto • one year in the case of other assets (not securities! ). This period increases to ten years if the asset serves as a source of income. Speculative intent is not required. The Federal Fiscal Court ruled in its ruling of 22 April 2008 11 that the tax involvement in a sale within one year of acquisition also applies to objects of daily use. For example, losses from the sale of a private car could be offset against tax. In order to prevent the tax losses feared as a result of this ruling, the Annual Tax Act 2010 declared the sale of objects of daily use to be irrelevant for tax purposes (Sec. 23 (1) sent. 1 no. 2 EStG). 11 See BGBl. I p. 1427. <?page no="116"?> 2.2 Determination of taxable income 117 Example: The taxable Emanuel bought an used car on 1 January 2017 for € 36,500. Already in August of the following year he sells it for € 29,000. He cannot make the loss at a value of € 7,500 valid for tax purposes. It must also be taken into account that any profit from the sale of the car is tax exempt. An exception, however, would be the sale of antiques. Continuation of example: In August 2017, Emanuel acquired a vintage car. He could offset any loss from this sale transaction against gains from other sale transactions in 2018, as the legislation assumes that the taxpayer intends to make a profit. The sales profit is calculated as follows: Disposal price ./ . Amortized costs (procurement costs + ancillary procurement costs + subsequent procurement costs ./ . depreciation) ./ . Income-related expenses (caused by the disposal) = Sales profit within the meaning of Sec. 23 EStG Example: Anton participates in a container leasing model on 1 October 2018. He acquires a container for a cargo ship from an investment company, which he then lets a) 11 years b) 5 years against payment. Anton pays tax on the rent less depreciation as income from other services. The investment company must repurchase the container at a previously agreed price at the end of the rental agreement. a) Anton uses the container leasing model as a source of income; the retention period is thus extended to 10 years. The sales profit is nevertheless tax exempt for Anton, as the sale takes place outside the 10-year period. b) The 10-year period also applies here, as Anton generates earnings from the container. The sale is taxable, as Anton sells the container again after 5 years . Note In the event that the total profit from all sales transactions amounts to less than € 600 per calendar year, the profit remains tax free in accordance with Sec. 23 (3) sent. 5 EStG. If this tax threshold is crossed, the full amount of the sales proit is subject to income tax. Private losses on disposals may only be offset by profits from private disposals (Sec. 23 (3) sent. 7 EStG). A loss deduction pursuant to Sec. 10d EStG is excluded. <?page no="117"?> 118 2 Personal income tax  Income from other performances (Sec. 22 no. 3 EStG) According to H 22.8 EStH (Guide to Income Tax Law), “Within the meaning of Sec. 22 no. 3 EStG a performance is any act, toleration or forbearance that can form the subject matter of a contract and that is carried out for payment.” This also includes, for example, the rental of individual movable assets or occasional placements. In the event that the income from all other performances amounts to less than € 256 per calendar year, the profit remains tax free in accordance with Sec. 22 (3) sent. 2 EStG. If this tax threshold is crossed, the full amount of the income is subject to income tax.  Income received on the basis of laws concerning members of parliament and similar benefits (Sec. 22 no. 4 EStG) This income only includes the benefits paid in accordance with a law concerning members of parliament to members of the European Parliament, the lower house of the German parliament (Bundestag), as well as the parliaments of the German states (Landtage). Only those expenditures resulting from the mandate may be deducted as income-related expenses that are not reimbursed by way of the expenditure compensation (Sec. 22 no. 4 sent. 2 EStG) or that are not considered to be costs of election campaigning (Sec. 22 no. 4 sent. 3 EStG).  Payments from retirement contracts (Sec. 22 no. 5 EStG) Sec. 22 no. 5 EStG is to be applied to benefits from old-age provision contracts within the meaning of Sec. 82 EStG (so-called Riester pension), to benefits from pension funds (Sec. 4e EStG), pension scheme (Sec. 4c EStG) and direct insurance (Sec. 4b EStG). The pension provision products listed below are subject to so-called subsequent taxation, i.e. old-age pensions are taxed in the payout phase as other income within the meaning of Sec. 22 no. 5 EStG, while tax exemption is granted for contributions, payments, income and increases in value in the down payment phase. The extent of the taxation depends on the extent to which the contributions were exempted from taxation in the savings phase (Sec. 3 nos. 63 and 66 EStG), promoted by special expenditure deduction (Sec. 10a EStG) and pension bonus (Secs. 79 et seqq. EStG) or acquired by tax exempt contributions in accordance with Sec. 3 no. 56 EStG. According to Sec. 10a (2) EStG, the contributions can only be deducted as special expenses if this is more favourable than granting the old-age provision allowance. The most favourable tax treatment is carried out ex officio. Of the pension products finally listed in Sec. 22 no. 5 EStG, the so-called Riester pension is of central importance. Its introduction is a reaction to the cuts in benefits from the statutory pension insurance and is intended to provide an incentive for the formation of voluntary private or company funded old-age provision. The aid is to come in the form of a progressively effective <?page no="118"?> 2.2 Determination of taxable income 119 deduction for special expenses (Sec.10a EStG), a retirement supplement independent of progression (Sec. 83 EStG) and/ or the exemption of contributions into retirement provisions in accordance with Sec. 3 nos. 63 and 66 EStG. Thus, this special type of retirement provision exists in addition to the resulting tax relief when taking out private life annuity insurance within the meaning of Sec. 10 (1) no. 2 lit. b EStG within the scope of the basic pension ( socalled Rürup pension ). If, during the earning phase, the taxpayer contributes into a retirement contract from an insurance company certified for the Riester pension, the right to state aid will vest in the taxpayer. Any deductions for special expenses granted in accordance with Sec. 10a EStG will thus have no effect on the maximum amounts under Sec. 10 (3) EStG. 2.2.2.3 Compensation and income from previous employment (Sec. 24 EStG) Benefits in the form of compensation or income from previous employment can exist in all seven types of income. However, Secs. 13 to 23 EStG apply exclusively to current earnings so that compensation and income from previous employment cannot be assigned to the respective income type. Note The benefits within the meaning of Sec. 24 EStG do not represent a separate type of income, but rather Sec. 24 EStG merely supplements the provisions under Secs. 13 to 23 EStG. The income within the meaning of Sec. 24 EStG includes the following:  Compensations (Sec. 24 no. 1 EStG) • Compensation for lost or the loss of earnings (Sec. 24 no. 1 lit. a EStG). Such is the case if a settlement is paid because employment is terminated and it was the employer who terminated the employment relationship. • In the case of compensation for the forbearance from carrying out an activity (Sec. 24 no. 1 lit. b EStG), the termination of the employment relationship can be brought about by the employee. • Compensation payments to commercial agents pursuant to Sec. 89b HGB (Sec. 24 no. 1 lit. c EStG). These compensatory benefits are to be assigned to the respective income type to which the lost benefits would have belonged if they had actually been <?page no="119"?> 120 2 Personal income tax earned. In accordance with Sec. 34 (2) no. 2 EStG, the benefits within the meaning of Sec. 24 no. 1 EStG are considered to be extraordinary income. The reduced tax rate under Sec. 34 (1) EStG (one-fifth rule) can thus be applied in order to compensate for the disadvantage in progression resulting from the combination of income. Example: In the employment agreement with his employer, the truck driver Georg reserved the right to resign from the company upon turning 45 years old. In return, he is paid a settlement amounting to € 20,000. In the event that Georg exercises his right to resign from the company, the settlement is considered to be compensation within the meaning of Sec. 24 no. 1 lit. b EStG. The benefits are to be subsumed under income from dependent-employment within the meaning of Sec. 19 EStG.  Income from previous employment (Sec. 24 no. 2 EStG) Income from previous employment (Sec. 24 no. 2 EStG) is subject to the normal income tax rate, even if the benefits do not flow to the individual who originally performed the work, but rather to that individual’s legal successor. This income is subject to the normal income tax rate. Example: The painter Richard passes away. He bequeaths to his son Ferdinand several paintings, which Ferdinand then sells. Even though Ferdinand himself was never a painter, the sale of the paintings results in subsequent income from (artistic) self-employment within the meaning of Sec. 18 (1) no. 1 i.c.w. Sec. 24 no. 2 EStG .  Renumeration for the usage of land and buildings (Sec. 24 no. 3 EStG) Like income within the meaning of Sec. 24 no. 1 EStG, remuneration for the usage of land for public purposes, etc. (Sec. 24 no. 3 EStG) is also considered to be extraordinary income (Sec. 34 (2) no. 3 EStG), inasmuch as it is subsequently paid for a period of time at least three years back, and is thus subject to the reduced tax rate of Sec. 34 (1) EStG (one-fifth rule). <?page no="120"?> 2.2 Determination of taxable income 121 Figure 32: Scope of benefits within the meaning of Sec. 24 EStG 2.2.3 Determination of the total amount of income 2.2.3.1 Elderly allowance (Altersentlastungsbetrag) The elderly allowance according to Sec. 24a EStG was originally introduced for taxpayers who have reached the age of 64 and do not receive any pension payments but, for example, income from the taxpayer`s active engagement or from other sources. This is intended to compensate for the preferential treatment of, among other things, social security pensions (taxation only of the share of earnings) and retirement benefits under Sec. 19 (2) EStG (granting of a pension allowance) (Sec. 24a sent. 2 nos. 1-5 EStG). Together with the step-by-step transition to a subsequent taxation, however, precisely these benefits will be gradually reduced. Correspondingly, the amount of the elderly allowance will also be reduced until it is completely abolished in the assessment period 2040. This can be deducted from the total amount of income in the form of an annually decreasing percentage (cohort principle), but limited by the maximum amount, until the final reduction. However, its deductibility is dependent on certain personal and material prerequisites (Table 14). <?page no="121"?> 122 2 Personal income tax The assessment basis for the elderly allowance is determined using a two-stage process. In accordance with Sec. 24a sent. 1 i.c.w. sent. 2 EStG, the assessment comprises the gross wages (not to be confused with income from non-self-employed work! ) without retirement benefits and the positive total income from the remaining income types (Sec. 2 (1) sent. 1). 1 nos. 1 to 3 and 5 to 7 EStG) without the emoluments listed in Sec. 24a sent. 2 EStG. The excluded income earned by the elderly is already privileged by the above mentioned measures and must therefore not be included in the basis of assessment. The assessment basis is calculated as follows: AB Part 1 Wages (exclusive of pensions and related benefits) + AB Part 2 + Positive sum of the remaining income types (exclusive the renumerations listed in Sec. 24a sent. 2 EStG) = AB of the elderly allowance A separate determination and fixation of the elderly allowance for the rest of the taxpayer`s life occurs here, as is the case when determining the tax allowance for pensions and annuities. The allowance is set in the year following the year in which the taxpayer turns 64 years old. Table 14: Requirements for the deduction of the elderly allowance <?page no="122"?> 2.2 Determination of taxable income 123 In contrast to the allowances mentioned above, the fixation of the elderly allowance does not relate to absolute values. Rather, a constant percentage of the income within the meaning of Sec. 24a EStG is applied because of the extreme fluctuations to which the underlying income can be subject. Otherwise, i.e. if it were fixed to a certain amount, the allowance for the elderly would increase instead of decrease as intended in subsequent years of sinking income. Finally, it must be taken into consideration that, in accordance with Sec. 24a sent. 4 EStG, each spouse is entitled to his/ her own elderly allowance. Example: In the assessment period 2018, the 66 year old Martin received the following earnings and/ or income: • Wages € 29,000 • of which pensions and related benefits amounted to € 3,000 • Earnings from capital assets € 3,000 • Income from rent and lease ./ . € 4,000 Martin’s elderly allowance is calculated as follows: Assessment basis Part 1: Wages € 29,000 Pensions and related benefits ./ . € 3,000 AB Part 1: = € 26,000 Assessment basis Part 2: Earnings from capital assets € 3,000 Lump-sum allowance for income-related expenses ./ . € 801 Income from capital assets = € 2,199 Income from rent and lease ./ . € 4,000 AB Part 1 € 26,000 + AB Part 2 (the sum may not be negative): + € 0 = Assessment basis = € 26,000 The definitive percentage of the elderly allowance was fixed for Martin in the year following the year in which he turned 64 (2017; according to the table in Sec. 24a EStG, the percentage = 20.8 % throughout his life, the maximum amount = € 988 throughout his life). The elderly allowance for 2018 thus amounts to 20.8 of € 26,000 (= € 5,408), at most however € 988. Martin may deduct the elderly allowance of € 988 from the total income (Sec. 2 (3) sent. 1 EStG). <?page no="123"?> 124 2 Personal income tax 2.2.3.2 Tax allowance for single parents Within the scope of the German Concomitant Budget Law (Haushaltsbegleitgesetz), the rules provided for under the old version of Sec. 32 (7) EStG, i.e. the so-called household allowance , in 2004 was cancelled and replaced by a tax allowance for single parents in Sec. 24b EStG. In accordance therewith, single parents may deduct an allowance amounting to € 1,908 per calendar year from the total income if their household includes a child for whom they are entitled to the socalled child allowance within the meaning of Sec. 32 (6) EStG or child benefit. For each additional child within the meaning of Sec. 24b (1) EStG, the aforementioned amount is increased by € 240. The household affiliation includes the responsibility for the material (e.g. care, maintenance) and immaterial well-being (e.g. care and support) of the child and is to be assumed if the child is registered in the home of the single taxpayer. In principle, those taxpayers who do not fulfill the requirements for the splitting method according to Sec. 26 (1) EStG or who are widowed and do not form a household with another person of full age are to be regarded as single persons within the meaning of this provision. The purpose of the tax allowance for single parents is therefore to compensate for the fact that the splitting method is unavailable to single-parent taxpayers. 2.2.3.3 Deduction for farmers and foresters For the sake of completeness, mention must also be made of the deduction provided to farmers and foresters under Sec. 13 (3) EStG. This allowance reduces income from farming and forestry by € 900 provided that the total income does not exceed € 30,700. <?page no="124"?> Summary ► A differentiation is made between the determination of the profit (in the case of business income types) and the determination of the surplus revenue over income-related expenditures (in the case of household income types). ► The profit is generally determined by way of the accrual method in accordance with Sec. 4 (1) and/ or Sec. 5 EStG. Under certain requirements the cash method accounting under Sec. 4 (3) EStG may be used. ► The deduction of a lump-sum allowance for income-related expenditures is possible within the scope of certain surplus income types. ► The shared characteristics of the business income types are independence, sustainability, intention of realizing profit and general economic participation. ► In addition to the general positive requirements, the business income also possess three negative requirements (they may not be from farming and forestry, from self-employment, and may not be merely asset administration). ► The income considered to be income from farming and forestry is listed in Sec. 13 (1) and (2) EStG. ► Income within the meaning of Sec. 15 (1) sent. 1, 16 and 17 EStG is to be subsumed under the business income. ► Income from self-employment presupposed an occupation within the meaning of Sec. 18 (1) EStG. This may consist of income from freelancing, income of recipients of state lotteries, income from other independent-employment, as well as profit from disposals and abandonment. ► Income from dependent-employment can generally only be earned by employees. It includes earnings from existing and previous employment. In the case of pensions and related benefits, the pension tax allowance may be deducted. ► Income from capital assets includes both current income and capital gains on the disposal of capital assets. The taxation of income from capital assets held as private assets is generally settled with the flat-rate withholding tax of 25 %. An amount of € 801 or € 1,602 (saver’s lump-sum) remains tax exempt. ► Taxpayers whose individual tax rate is below 25 % can apply under the so-called assessment option for their income from capital assets to be subject to a collective assessment together with their remaining income. However, even in this case it is not possible to recover the actual income-related expenses incurred (Sec. 20 (9) EStG). ► The option under Sec. 32d (4) EStG to choose the tax assessment method allows to the taxpayer to subsequently claim tax-reducing circumstances that were not taken into account in the context of the capital yields tax deduction in his tax return. ► Income from rent and lease within the meaning of Sec. 21 EStG includes income from real estate, income from the rental of object aggregates, income from the temporary provision of rights, as well as income from the disposal of accounts receivable from rent and lease. ► Other income only includes those earnings explicitly mentioned in Sec. 22 EStG: Income received from recurring payments (basic pension), from retirement benefits, from benefits based on an equalisation of pension obligations under the law of obligations, from private sales transactions, from other benefits, from maintenance payments as well as benefits 2.2 Determination of taxable income 125 <?page no="125"?> 126 2 Personal income tax based on members’ legislation and from pension contracts (Riester pension). ► The German Retirement Income Act (Alterseinkünftegesetz - AltEinkG) provides for an incremental transition to the deferred taxation of life annuity funds from the statutory pension insurance and/ or comparable private retirement insurances. Sec. 23 no longer has priority over Sec. 17 EStG for participations in capital companies of at least 1 % acquired after 01.01.2009. Capital gains then constitute business income within the meaning of Sec. 17 EStG regardless of the retention period. ► The earnings listed in Sec. 24 EStG belong to the income type that they would belong to if they had been attained earlier. Therefore, Sec. 24 EStG does not provide for its own (new) type of income. ► The deduction of the elderly allowance is intended to counteract the privileged position of social security pensions, annuities and related benefits. This allowance will be done away with incrementally by the assessment period 2040. ► The deduction of the tax allowance for single parents is intended to counteract the privileges that married couples have. Questions 1. Why is the allocation of the income to the individual income types so important? 2. Name and explain the basic characteristics of all business income types. 3. How can the business income be characterized and which income is covered by Sec. 15 EStG? 4. What income is included in income from self-employment? 5. Which individuals earn income form dependent-employment? How is the income calculated? Are there any particularities that must be taken into consideration in determining the income? 6. What earnings are included in income from capital assets? To what extent and in what form is capital yields tax levied? Describe the basic system of taxation of capital income depending on whether the income can be allocated to private or business assets? How is this income calculated? 7. What income is included in income from rent and lease? How is this income calculated? 8. What income is included in other income? 9. How do the methods of determining income differ? 10. Briefly explain the determination of income using the accrual method and using the cash method accounting. 11. How is household income determined? What principle is taken into consideration? 12. What income is covered by Sec. 24 EStG? 13. What is the intended purpose in deducting the elderly allowance? What requirements must be fulfilled? How is the assessment basis for the elderly allowance calculated? What must be taken into consideration in the joint tax assessment of married couples? ► <?page no="126"?> 2.2 Determination of taxable income 127 2.2.4 Fiscal treatment of losses The expenditures that are incurred in order to earn income and that possess a direct economic relationship thereto reduce the assessment basis in accordance with the objective net income principle. This principle is fulfilled by Sec. 2 (2) EStG, which stipulates net amounts as income and thus implies that the business expenses and the income-related expenses are fundamentally deductible. The losses must, however, also be compensable with positive earnings because they also negatively affect the taxpayer’s ability to pay. A distinction must be made thereby between the intraperiodic loss compensation (Sec. 2 (3) EStG) and the interperiodic loss deduction with loss carryback (Sec.10d (1) EStG) and loss carryforward (Sec. 10d (2) EStG. Loss compensation Loss compensation is the product in the sense of offsetting of the positive earnings and the negative earnings of the same taxpayer in the same assessment year . A difference is made between horizontal and vertical loss compensation. Figure 33: Loss compensation In accordance with Sec. 2 (3) EStG, positive and negative income in the current year may be set off within an individual income type as well as among different types of income without limitation. Note In the case of innerperiodic loss compensation within the meaning of Sec. 2 (3) EStG, an unlimited amount of positive and negative income from the same assessment period is compensated. <?page no="127"?> 128 2 Personal income tax Example: Franz runs a construction company. He generated losses of € 200,000 in the fiscal year 2018. At the same time, Franz also runs a beverage company, from which he earned a profit of € 150,000 in the same fiscal year. In addition, Franz received income from rent and lease amounting to € 62,000. Special expenses and extraordinary burdens are not taken into consideration for the sake of simplicity. Loss deduction Negative income that cannot be offset in intraperiodic loss compensation (Sec. 2 (3) sent. 1 EStG) is to be deducted from the total income in another assessment period prior to special expenditures, extraordinary burdens and other deductible amounts. This is achieved, on the one hand, by the loss carryback provided for by Sec. 10d (1) EStG and, on the other hand, by the loss carryforward under Sec. 10d (2) EStG. Note The loss compensation has priority over the loss deduction! <?page no="128"?> 2.2 Determination of taxable income 129 a) Loss carryback Sec. 10d (1) EStG If the loss cannot be compensated by income earned in the same year, the taxpayer may retroactively compensate losses of up to € 1,000,000 with the positive total amount of income in the previous year in accordance with Sec. 10d (1) sent. 1 EStG. The maximum amount is doubled to € 2,000,000 for married couples who are assessed jointly. According to Sec. 10d (1) sents. 5 and 6 EStG, the application of Sec. 10d (1) sent. 1 EStG can be waived in whole or in part upon petition by the taxpayer, i.e. the taxpayer has the option of whether and to what extent the loss is carried back. The amount of loss carried back should always be limited to the extent that special expenditures, extraordinary burdens and other deductible amounts have an impact on the tax liability. By doing so, the taxpayer minimizes the tax burden. After the loss is carried over, previously issued tax assessments are to be amended in accordance with Sec. 10d (1) sents. 3 and 4 EStG. Note In the absence of a contrary petition by the taxpayer, the losses will be carried back according to Sec. 10d (1) EStG to compensate up to € 1,000,000 of the total positive income. Example: In the calendar year 2018, Max generated losses of € 2,000,000 with his poultry breeding company. In addition, Max rents out several appartments and generates income from rentals and leases in the amount of € 50,000. In 2017, the total amount of income was € 1,100,000. 1. Intraperiodic loss compensation pursuant to Sec. 2 (3) EStG AP 2018 ./ . Loss under Sec. 15 (1) sent. 1 no. 1 EStG ./ . € 2,000,000 + Income in the meaning of Sec. 21 EStG + € 50,000 = Total income ./ . € 1,950,000 Initially, € 1,950,000 in losses is available to be carried back. 2. Loss carryback pursuant to Sec. 10d (1) EStG AP 2017 Total income € 1,100,000 ./ . Loss carryback (max. 1,000,000) ./ . € 1,000,000 = Income = € 100,000 <?page no="129"?> 130 2 Personal income tax The maximum amount of € 1,000,000 is completely exhausted within the scope of the loss carryback because Max did not file a petition in accordance with Sec. 10d (1) sents. 5 and 6 EStG. Accordingly, as of 31 December 2018 a loss of € 950,000 remains which can be carried forward into 2019 and thereafter. This loss is to be assessed separately by type of income in accordance with Sec. 10d (4) EStG). b) Loss carryforward Sec. 10d (2) EStG Insofar as negative income is neither set off by loss compensation nor by loss carryback, it can be deducted from the total income in the following assessment periods in accordance with Sec. 10d (2) sent. 1 EStG. The loss carryforward is unlimited in time, i.e. remaining losses which cannot be carried forward immediately into the assessment period after their accrual due to limitations described below can still be carried forward in subsequent years, but must be offset as soon as possible. There are, however, limitations with regard to the amount that may be used: Negative income that has not been compensated and that was not deducted in accordance with Sec. 10d (1) EStG (loss carryback) is to be deducted without limitation in the subsequent assessment periods for a total income of up to € 1,000,000 - or the so-called base amount (Sockelbetrag) - and up to 60 % of the total income exceeding € 1,000,000 prior to special expenses, extraordinary burdens and other deductible amounts. The base amount is € 2,000,000 for married couples who are assessed jointly (Sec. 10d (2) EStG). Note If the loss may not be carried back or the loss carry-forward is petitioned for, the losses are to be deducted without limitation in the subsequent assessment periods from a total income of up to € 1,000,000 and up to 60 % of the total income exceeding this base amount. The loss carryforward is limited primarily because of the potentially large loss carried forward by businesses. In stretching the time frame in which deductions can be made (i.e. the carryforward of manageable amounts resulting from the limit on the amount), the calculability of the tax revenue is increased and at the same time a minimum tax is secured. It must be taken into consideration thereby that, in the end, no loss potential is disregarded. The loss carryforward remaining at the end of an assessment period is to be assessed separately in accordance with Sec. 10d (4) EStG. <?page no="130"?> 2.2 Determination of taxable income 131 Example: In the calendar year 2018, Max’s total income amounted to € 2,200,000. In accordance with Sec. 10d (4) EStG, a remaining loss carryforward of € 2,000,000 was assessed separately as of 31 December 2017. 3. Loss carryforward pursuant to Sec. 10d (2) EStG AP 2018 Total income € 2,200,000 ./ . Base amount (unlimited loss carryforward) ./ . 60 % × € 1,200,000 but (in this case) max. € 1,000,000 (limited loss carryforward) ./ . € 1,000,000 ./ . € 720,000 = Income = € 480,000 The loss carryforward of € 2,000,000 assessed as of 31 December 2017 could only be deducted in the amount of € 1,720,000 in 2018. As a result, a loss carryforward of € 280,000 is to be determined separately as at 31 December 2018. The purpose of this regulation is to immediately tax a certain amount of the taxpayer’s income without consideration of the minimum tax, the income would have been € 200,000. Finally, Figure 34 shows how loss offsetting works in its entirety. Figure 34: The tax treatment of losses <?page no="131"?> 132 2 Personal income tax Summary ► An unlimited amount of positive and negative income from the same assessment period is compensated by the loss compensation within the meaning of Sec. 2 (3) EStG. A distinction must be made between horizontal loss compensation and vertical loss compensation. ► If the loss compensation is not possible with income from the same year, the total income in other assessment periods is to be reduced by the loss (loss deduction). A distinction must be made between loss carryback and loss carryforward. ► Within the scope of the loss carryback, the loss is to be compensated with the total positive income in the previous year up to a maximum amount of € 1,000,000 (€ 2,000,000 for couples assessed jointly). ► If loss carryback is not possible or if the loss carryback is not carry out in whole or in part on receipt, the losses are to be deducted from the total income in the following assessment periods. Total income exceeding a base amount of € 1,000,000 (€ 2,000,000 for couples assessed jointly) is subject to a minimum tax. Questions 1. What are the different possibilities of loss compensation? 2. How do the possibilities for loss deduction differ? 3. Explain the method used in loss carryback. 4. Explain the method used in loss carryforward 5. Explain the term “minimum tax”. 6. Which provisions currently ensure minimum taxation in Germany? <?page no="132"?> 2.2.5 Special expenses Concept of special expenses In contrast to income-related expenses and business expenses, there is no legal definition of the term special expenses in the Income Tax Act. A definition can only be given on the basis of the exhaustive lists in Secs. 10, 10a, 10b EStG (enumeration principle). Privately incurred expenses (Sec. 12 EStG) may in principle not be deducted from the total amount of income, as they have no connection with the income generated. However, this principle is broken by the deductibility of special expenses. Thus, certain expenses of private life which burden the taxpayer economically and are permitted by the legislator for economic, social and cultural reasons to reduce the tax base are deductible. Furthermore, expenses of the taxpayer can only be treated as special expenses if they are neither income-related expenses nor business expenses, are based on the taxpayer’s own obligation and are actually paid by the taxpayer. The provisions on special expenses thus take precedence over the prohibition on deducting of private expenses. Example: Ferdinand pays contributions to a private liability insurance in the assessment year. How are these expenses to be taxed? In order to ensure the minimum subsistence level, the legislator has made contributions to certain insurance policies, which also include private liability insurance, deductible (limited) (Sec. 10 (1) nos. 2, 3, 3a EStG). Therefore the insurance contributions are to be considered as special expenses and can in principle be deducted from the total amount of income (subjective net income principle). Special expenses can only be claimed to the extent that the respective individual regulations provide for this. Ultimately, income that becomes negative 1. Income from farming and forestry (Sec. 13) 2. Business income (Sec. 15) 3. Income from self-employment (Sec. 18) 4. Income from dependent-employment (Sec. 19) 5. Income from capital assets (Sec. 20) 6. Income from rent and lease (Sec. 21) 7. Other Income within the meaning of Sec. 22 = Total income = Taxable income (Sec. 2 (5)) ./ . Loss deduction (Sec. 10d) ./ . Special expenses (Secs. 10, 10a, 10b, 10c) ./ . Extraordinary expenses (Secs. 33, 33a, 33b) = Income (Sec. 2 (4)) ./ . Child allowance (Secs. 31, 32 (6)) ./ . Elderly allowance (Sec. 24a) ./ . Deduction for farmers and foresters (Sec. 13 (3)) = Total amount of income (Sec. 2 (3)) ./ . Allowance for single parents (Sec. 24b) 2.2 Determination of taxable income 133 <?page no="133"?> 134 2 Personal income tax due to special expenses does not have a tax effect because only negative income can be taken into account within the framework of the rules on loss deduction. They are divided into expenses with unlimited deductibility and expenses with limited deductibility. • Completely deductible expenses are not subject to any deduction restrictions and can be claimed in full. • Partially deductible special expenses may only be deducted within the limits of maximum amounts. Special expenses are only deductible in the calendar year in which they are paid. The inflow-outflow principle pursuant to Sec. 11 EStG applies. Note Characteristics of special expenses: • Economic burden on the taxpayer • Neither income-related expenses nor business expenses • Personal obligation of the taxpayer • Actual payment and/ or performance by the deduction claimant • Deduction from the total amount of income • The inflow-outflow principle of Sec. 11 EStG applies Unlimited deductible special expenses a) Retirement benefits The main case of application of Sec. 10 (1a) no. 2 EStG are lifelong and recurrent retirement benefits which are provided within the framework of the socalled anticipated succession. In this context, the transfer of agricultural and forestry enterprises, commercial enterprises and business assets of self-employed persons is to be favoured. In addition to sole proprietorships and shares in partnerships, the transfer of 50 % of the shares in a GmbH is also favoured if the transferor was active as managing director and the transferee continues this activity. By this regulation entrainment effects and abusive organizations are to be prevented. Therefor the favoured transfer of private assets, in particular of monetary assets, securities, typically quiet participation and owner-occupied residential property, was excluded. <?page no="134"?> 2.2 Determination of taxable income 135 Figure 35: The different types of special expenses The retirement benefits can be deducted in full as special expenses by the payee if the recipient is subject to unlimited income tax and the retirement benefits are taxed in full as other income within the meaning of Sec. 22 no. 1a EStG (so-called principle of correspondence). Deviating from this, a special expenses deduction must also be granted if the recipient of the service is not subject to unlimited tax liability, but has his residence or habitual abode in the territory of another EU or EEA member state and is thus treated as notionally subject to unlimited tax liability (Sec. 1a (1) no. 1a EStG). Example: In return for the promise of a small pension, Wilhelm receives his father´s sole proprietorship as a gift in accordance with his father's need for care and Wilhelm's economic capacity. Since the pension is not considered to be an adequate payment for the transferred enterprise but is paid on a voluntary basis to support the former owner, it can be claimed as a special expense pursuant to Sec. 10 (1a) no. 2 EStG if the prohibition of deduction under Sec. 12 no. 2 EStG does not apply. <?page no="135"?> 136 2 Personal income tax b) Benefits to avoid pension equalisation To date, the courts have not yet conclusively clarified whether and to what extent compensation payments to avoid pension equalisation are taxable as income for the recipient. This has been clarified by the legislator since 2015. Corresponding payments are deductible by the donor as special expenses, provided that the obligor requests this with the consent of the beneficiary and the beneficiary is subject to unlimited income tax. At the same time, the principle of correspondence has also been laid down by law for these benefits. The deduction entitlement under Sec. 10 (1a) no. 3 EStG is legally opposed to the tax liability under Sec. 22 no. 1a EStG. c) Benefits due to a pension adjustment under the law of obligations Benefits paid on the basis of a pension adjustment under the law of obligations can also be deducted in full as special expenses. Sec. 10 (1) no. 4 EStG therefore also follows the correspondence principle, i.e. a deduction of special expenses is only possible for the person liable for compensation to the extent that the recipient of the compensation subjects the benefits to taxation as other income pursuant to Sec. 22 no. 1a EStG. The same applies to compensation payments to avoid a pension equalisation pursuant to Sec. 10 (1a) no. 3 EStG. The recipient is also taxed according to the correspondence principle pursuant to Sec. 22 no. 1a EStG. Example: If the pension equalisation under the law of obligations is based on a life annuity which, according to Sec. 22 no. 1a EStG, only has to be taxed on the recipient's share of earnings, a special expenditure deduction for the payer according to Sec. 10 (1a) no. 4 EStG is also only possible in the amount of the share of earnings. If, on the other hand, the benefit is based, for example, on pension payments, which in principle are fully taxable for the person liable for compensation pursuant to Sec. 19 EStG, deduction of the compensation payment as a special expense pursuant to Sec. 10 (1a) no. 4 EStG i is fully possible. d) Church tax According to Sec. 10 (1) no. 4 EStG, the church tax paid is deductible as a special expense. It is irrelevant for the inclusion as special expense. It is irrelevant for the inconclusion as special expense whether final payments, advance payments or church tax withheld from wages are concerned. The church tax to be included as special expense is to be reduced by the amount of church tax reimbursements received over the course of the calendar year. Example: In the calendar year 2018, Charlotte pays € 480 to the church tax office as stated in her church tax assessment. In the same year she is reimbursed with € 120 of overpaid church tax. This reimbursement was for the assessment in 2017. In 2018, <?page no="136"?> 2.2 Determination of taxable income 137 Charlotte can claim € 360 (= € 480 ./ . € 120) in special expenses. It is thereby irrelevant from which year the reimbursement of the church tax stems. An exception arises in the context of the final KapEst, according to which church tax cannot be claimed as a special expense, since the special expense deduction was already taken into account when calculating the tax rate for the final KapEst. Since the tax-reducing effect of the church tax has already been claimed in this way, a deduction of the church tax within the scope of the income tax assessment is thus excluded. e) Childcare expenses Since the assessment period 2012, proven costs for the care of children pursuant to Sec. 10 (1) no. 5 EStG can be deducted as special expenses without specifying special circumstances. The prerequisite for this is that the child has not yet reached the age of 14 or is unable to provide for himself or herself due to a disability that occurred before the child reached the age of 25. However, a special expenses deduction is only possible in the amount of two thirds of the care costs incurred, but a maximum of € 4,000 per child. Expenses for lessons, the provision of special skills or for sports or other leisure activities are not eligible. Example: The married mother Judith goes to a gym two afternoons a week. During this time, a babysitter takes care of her five-year-old daughter Chrissi for € 900. Judith also says that her child should be musically encouraged. An appropriately trained teacher receives a further € 1,500 for this. The costs for the babysitter can be deducted according to Sec. 10 (1) no. 5 EStG as special expenses of € 600 (2/ 3 × € 900). However, it is not possible to deduct the costs for music lessons. Note Children are favored in many places of tax law, in particular: • Parental benefit • Child benefit, child allowance • Child care expenses • Allowance for single parents • Certain school/ training costs <?page no="137"?> 138 2 Personal income tax f) Costs of tax consultation As of the assessment period 2006, Sec. 10 (1) no. 6 EStG was deleted, so that the private costs of tax consultation may no longer be deducted as special expenses. However, the deletion of the deduction of special expenses only has a limited effect because the costs of tax consultation are usually related to an income type and thus can be claimed as business expenses and/ or incomerelated expenses. Only the consultation and work that is not performed in connection with the earnings are affected by the prohibition of deduction. Example: The sole proprietor A earned income from commercial operations in the assessment period 2018. In addition, she is also employed part-time in a hair salon from which she earns income from dependent-employment. A has a child. She also has expenses for retirement provisions and medical services. A has her tax return prepared by the tax consultant B. B charges for the following tasks: • Filling out the main tax form (special expenses, extraordinary burdens) • Filling out schedule K (children) • Filling out schedule GSE (business income) • Filling out schedule N (dependent-employment) The costs for filling out schedule GSE represent business expenses, those for filling out schedule N income-related expenses. The costs for filling out main tax form and schedule K, on the other hand, are not eligible for tax purposes. For the simplification of the tax determination a deduction of tax consulting costs is always permissible up to € 100 in its entirety. g) Lump-sum allowance for special expenses If the taxpayer cannot prove that the actual costs were higher, Sec. 10c (1) EStG provides a lump-sum allowance of € 36 and/ or € 72 in the case of joint assessment for special expenses. This covers the special expenses within the meaning of the Secs. 10 (1) nos. 4, 5, 7, 9 and (1a) and 10b EStG. Limited deductible special expenses a) Maintenance payments to the spouse Alimony payments to the divorced or permanently separated spouse who is subject to unlimited taxation may be deducted either as: • Special expenses in accordance with Sec. 10 (1a) no. 1 EStG (so-called real splitting) If the taxpayer chooses the possibility of the deduction as special expenses, he can deduct a maximum amount of € 13,805 per calendar year. If, in addition, contributions to health and long-term care insurance are paid for <?page no="138"?> 2.2 Determination of taxable income 139 the separately living or divorced spouse, these can also be claimed. With the receiver the maintenance is subject to the taxation in the same height (Sec. 22 no. 1a EStG). The prerequisites for the deduction of special expenses are an application by the provider and the consent of the recipient of the maintenance payments. In addition, the identification number issued (§139b AO) of the person providing maintenance must be stated in the tax return of the person providing maintenance if the person providing maintenance is subject to limited or unlimited tax liability. • Extraordinary expenses in accordance with Sec. 33a (1) EStG If the taxpayer chooses to deduct maintenance payments as extraordinary burdens, he can deduct them up to € 9,000. Here, too, the health and nursing insurance contributions can be claimed additionally. The payments remain tax exempt for the recipient. The prerequisite for the deduction of the expenditures is that the person maintained has no or only a low income and the indication of the identification number (§ 139b AO) of the maintained person in the tax return of the maintenance provider if the maintained person is subject to unlimited or limited tax liability. If the payments exceed the respective maximum amount of € 9,000 or € 13,805, the additional amount cannot be claimed as special expenses or extraordinary expenses. b) Provident expenditures With the implementation of the Retirement Income Act (AltEinkG) 12 on 1 January 2005, life annuity funds will no longer be subject to income tax exclusively on their income share, but will be taxed step by step downstream. To compensate for this, the pension expenditures (regardless of whether they are paid for the statutory pension insurance or comparable private insurances) can, in contrast to the previous regulation, be largely deducted as special expenses, limited only by generously selected maximum amounts. For reasons of revenue policy, however, the transition to this subsequent taxation - i.e. the taxation of retirement income in the payout phase with corresponding tax exemption of contributions for retirement provision in the employment phase - cannot be carried out in one step. A number of transitional regulations must therefore be observed. These concern both the oldage provision expenditures and the so-called other old-age provision expenditures, whose separate consideration results as a direct consequence of the changes of the Retirement Income Act. 12 BGBl. I p. 1427. <?page no="139"?> 140 2 Personal income tax Note Since the 2005 assessment period, retirement income is generally fully taxable in the taxpayer's payout phase. Correspondingly, contributions to old-age provision in the acquisition phase remain largely tax exempt (principle of subsequent taxation). The following figure illustrates the different forms of old-age provision and their tax treatment. The basic provision is then explained in more detail. Figure 36: Forms of pensions and their taxation Capital life insurance is explicitly excluded from the range of privileged provision measures. Contributions based on capital policies whose term begins after 31 December 2004 are in no way preferential. If old contracts exist (term commenced before 31 December 2004), the contributions made in this context can in turn be recognised under other pension expenses.  Retirement provisions in accordance with Sec. 10 (1) no. 2 EStG The retirement provisions, the so-called basic pension, include all insurance contributions listed in Sec. 10 (1) no. 2 EStG: <?page no="140"?> 2.2 Determination of taxable income 141 • Contributions to statutory pension insurance in accordance with Sec. 10 (1) no. 2 lit. a EStG. • Contributions to private, capital-backed life annuity insurances (Rürup pension) in accordance with Sec. 10 (1) no. 2 lit. a EStG, whereby the contractual arrangement must fulfill the requirements depicted in Figure 37. Figure 37: Prerequisites for taking private supplementary retirement provision into account It must always be taken into consideration when the term of the private annuity contract begins. Only those retirement contributions within the meaning of Sec. 10 (1) no. 2 double lit. aa EStG may be claimed that are based on contracts beginning after 31 December 2004 . Contributions to private pension insurances that result from so-called “old contracts” may only be claimed within the scope of the other retirement provisions. An important exception is made with respect to the required personal identity. In the case of married couples, it does not matter for the preferential treatment of the retirement contributions if the person paying the contribution and the insured person are not identical. On the other hand, there is a benefit for a pension insurance for child. Supplementary insurances (provisions for occupational incapacity, invalidity, and surviving dependents insurance), which complement supplemental private retirement provisions in accordance with Sec. 10 (1) no. 2 lit. b double lit. aa EStG, are generally not detrimental. They must, however, also fulfill the above-mentioned conditions. In addition, more than half of the contributions for the taxpayer’s own retirement provisions are to be dispensed with. Both pensions and supplementary cover must be governed by a single contract. <?page no="141"?> 142 2 Personal income tax Otherwise it is not a question of supplementary cover to a basic pension contract, but of independent insurances. This means that only coverage against the occurrence of occupational disability or reduced earning capacity is the subject of the contract, but not a lifelong old-age pension. Sec. 10 (1) no. 2 lit. b double lit. bb EStG also allows a deduction of special expenses for such cover under the conditions specified there. Figure 38: Determination of retirement provision expenses deductible as special expenses Step 1: When determining the retirement expenses deductible as special expenses, the actual burden must first be determined by adding the contributions paid within the meaning of Sec. 10 (1) no. 2 EStG. <?page no="142"?> 2.2 Determination of taxable income 143 Step 2: However, it should be noted that Sec. 10 (3) sent. 1 EStG stipulates a maximum amount which doubles in the event of a joint assessment of spouses. The maximum amount (€ 20,000 in absolute terms until 2014) for individually assessed taxpayers in favour of a basic pension in old age has been dynamically linked since 2015 to the income threshold for contributions to the miners' pension insurance (West). The beneficiary contributions of € 23,362 in 2017 (income threshold for pension insurance € 94,200 × contribution rate pension insurance 24.80 %; before 2015 € 20,000) are therefore deductible as special expenses. For 2018, the amount increases to € 23,712 due to changed calculation data (contribution rate 24.7 % or income threshold € 96,000). This maximum amount will again be paid in accordance with Sec. 10 (3) sent. 3 EStG for • Officials and other employees who have acquired an entitlement to a pension, in whole or in part, without paying their own contributions (e.g. professional soldiers), • controlling managing partners of a GmbH and members of the management boards of stock companies under certain conditions, and • Members of Parliament who receive income within the meaning of Sec. 22 no. 4 EStG and who have acquired a pension entitlement in whole or in part without paying their own contributions, reduced by a fictitious total contribution to statutory pension insurance corresponding to the employer's and employee's contributions to the statutory pension insurance. This is calculated by multiplying the earnings from the gross wage (for reasons of simplification in favour of the taxpayer limited to the contribution assessment ceiling: East 2018: € 69,600) with the pension contribution rate (2017: 18.7 %; 2018: 18.6 %). The maximum deduction amount thus amounts to € 12,946. Example: In 2017, the public official B has earnings from civil service amounting to € 50,000. The maximum amount of € 23,362 (€ 94,200 × 24.80 %) is to be reduced by a fictive total contribution to statutory pension insurance in accordance with Sec. 10 (3) sent. 3 EStG. Gross pay € 50,000 × Contributory rate of the statutory pension insurance × 18.7 % = Fictive total contribution to statutory pension insurance = € 9,350 A maximum deduction amount of € 12,946 would be deducted. <?page no="143"?> 144 2 Personal income tax Step 3: Due to the gradual switch to subsequent taxation, the special expenses deduction for the basic pension is reduced in Sec. 10 (3) sents. 4 and 6 EStG during a transitional period. In 2013, 76 % of the lower amount from the actual charge and the maximum amount (i.e. a maximum of € 1 2,000) were therefore initially deductible. Pursuant to Sec. 10 (3) sent. 6 EStG, this share has increased by 2 % p.a. since 2006, so that 100 % of the determined amount (maximum € 20,000) can only be applied from the assessment period 2025 onwards. In the case of employees subject to pension insurance, the deductible portion must then be reduced in accordance with Sec. 10 (3) sent. 5 EStG by the tax exempt employer's contribution to the statutory pension insurance in accordance with Sec. 3 no. 62 EStG or an equivalent tax exempt subsidy from the employer. This takes account of the fact that the employees concerned have already received a benefit in the form of the tax exempt employer's contribution, so that the deduction volume must be reduced by the corresponding amount. The remaining amount represents the pension expenses deductible as special expenses subject to the favourable assessment of Sec. 10 (4a) EStG. Example: The unmarried employee A, liable for pension insurance, asks his tax consultant B whether he should take out a private pension insurance policy. He would like to “take full advantage of the deduction for special expenses amounting to € 23,360 in 2017” thereby. He could like to invest precisely this sum in provident products for this very reason. In 2017 he earned gross wages amounting to € 60,000. What did A forget to take into consideration? The maximum amount of € 23,362 is to be subtracted by the employer's and employee's contribution to the statutory pension insurance in accordance with Sec. 10 (1) no. 2 lit. a and sent. 6 EStG. In the case of A, this means: Maximum amount (Sec. 10 (3) sent. 1 EStG) € 23,362 ./ . Employer’s contribution (50 % of 18.7 %) ./ . Employee’s contribution (50 % of 18.7 %) ./ . € 5,610 ./ . € 5,610 = Margin for supplemental private provisions = € 12,142 Assuming gross pay of € 60,000, A has a margin of € 12,142 for private retirement provisions after taking the statutory amounts into consideration. B must correct A`s faulty assumption: The maximum amount of € 23.362 includes employer and employee contribution! Even if A takes out a supplemental private insurance for € 12,142, this does not mean that it can deduct € 23,362 as special expenses in 2017. <?page no="144"?> 2.2 Determination of taxable income 145 Assessment period 2017 2025 Maximum amount According to Sec. 10 (3) sent. 4 and 6 EStG 84 % × € 23,362 = € 19,624 100 % × € 23,362 = € 23,362 ./ . Employees’ crontribution (Sec. 10 (3) sent. 5 EStG) ./ . € 5,610 ./ . € 5,610 = actual amount deductible = € 14,014 = € 17,715 If A were to invest a total of € 23,362 in 2017 for his retirement, only € 14,014 are deductible as special expenses. Together with the employer's contribution (already exempted in according to Sec. 3 no. 62 EStG), € 19,624 remain tax exempt. A`s second mistake was that he failed to take Sec. 10 (3) sents. 4 and 6 EStG into consideration. The deduction of the lower amount resulting from the actual burden and the maximum amount will finally fall away in 2025. If it is assumed unrealistically that the maximum amount will not change until 2025, the following results. The actual maximum amount of € 23,362 will first be available then. A may not, however, forget that in the future this sum contains the statutory contributions and that the tax free employer`s contribution must always be subtracted in order to arrive at the actual amount that is deductible. Note • Only provident expenditures within the meaning of Sec. 10 (1) no. 2 EStG can be considered as special expenses. • Sec. 10 (3) sent. 1 EStG determines a maximum amount of € 23,362, which is dynamically linked to the income thereshold for the miners’ pension insurance (West). • According to Sec. 10 (3) sent. 3 EStG, the maximum amount must be reduced by a fictitious total insurance contribution for certain occupational groups. • In a transitional period until the year 2025, only part of the determined provident expenditures is to be applied. • The employer’s contribution already constitutes a tax exempt benefit (Sec. 3 no. 62 EStG). It must therefore be deducted in order to receive the actually deductible special expenses.  Other provident expenditures in accordance with Sec. 10 (1) nos. 3 and 3a EStG The contributions named in Sec. 10 (1) nos. 3 and 3a EStG do not serve as retirement provisions and belong to the other provident expenditures. The most important include the following: <?page no="145"?> 146 2 Personal income tax a) Expenses in accordance with Sec. 10 (1) no. 3 EStG • for health insurance • long-term care insurance b) Expenses in accordance with Sec. 10 (1) no. 3a EStG • against unemployment • for disability insurance and occupational accident insurance that does not form part of a life annuity insurance with the meaning of Sec. 10 (1) no. 2 lit. b EStG (Sec. 10 (1) no. 3a EStG) • for casualty and liability insurance • for (pure) term life insurance that only provides for payment upon death, • for retirement insurance within the meaning of Sec. 10 (1) no. 3 lit. a EStG (old contracts) and • for capital insurance (old agreements), if the term of the respective contracts began before 1 January 2005 and the premium payments had already taken place before this date. In these cases Sec. 10 (1) no. 2 sents. 2 to 6 and (2) sent. 2 EStG in the version valid until 31 December 2004 shall continue to apply. From the assessment period 2010 onwards, contributions to health insurance may be claimed as special expenses without limitation, provided that the type, scope and amount of the insurance benefit is comparable to that of statutory health insurance. The legislator has thus reacted to the unequal treatment complained of by the Federal Constitutional Court and the limited deductibility of statutory and private health insurance contributions. Due to the new regulation, both (mandatory) contributions (employee share) to the statutory health insurance, the so-called basic health insurance, and private health insurance contributions after deduction of tax exempt subsidies, which correspond to the basic health insurance, are deductible in unlimited amounts as special expenses. However, contributions for supplementary care (e.g. sick pay, treatment by a chief physician) may not be taken into account. Accordingly, the deductible components of private health insurance contributions must be deducted from the total amount. If the health insurance contribution includes a sickness benefit entitlement or a comparable benefit, the contribution must be reduced by a flat-rate of 4 % (Sec. 10 (1) no. 3 lit. a EStG). Contributions to statutory long-term care insurance are also deductible pursuant to Sec. 10 (1) no. 3 lit. b EStG. Equal to the taxpayer's own expenses and ultimately deductible in an unlimited extent (purely technically in the case of so-called real splitting by increasing the maximum amount pursuant to Sec. 10 (1a) no. 2) 2 EStG or pursuant to Sec. 33a (1) sent. 2 EStG) are the contributions for: <?page no="146"?> 2.2 Determination of taxable income 147 • Co-insured children, • Spouse or registered partner, • Contributions made in addition to maintenance payments to divorced spouses or spouses who are permanently separated and subject to unlimited income tax as part of the so-called real splitting (Sec. 10 (1a) no. 1 EStG) and • Contributions paid for persons legally entitled to maintenance within the meaning of Sec. 33a (1) EStG. In the case of real splitting, the contributions made are taxable by the maintenance recipient as other income within the meaning of Sec. 22 no. 1 a EStG. Together with the new regulation of the special expense deduction, the maximum amounts for taxpayers who bear the expenses for their health insurance and medical expenses entirely from their own resources (in particular self-employed persons) were increased to € 2,800. A maximum amount of € 1,900 (Sec. 10 (4) EStG) has been set for taxpayers who have a claim to full or partial reimbursement or assumption of medical expenses in whole or in part without their own expenses or for whose health insurance benefits within the meaning of Sec. 3 no. 62 or Sec. 3 no. 14 EStG are provided (e.g. employees subject to social insurance for whom the employer makes tax exempt contributions to health insurance or family members insured in statutory health insurance without their own contributions). In the case of spouses assessed together, a common maximum amount is formed in accordance with Sec. 10 (4) sent. 3 EStG, which is made up of the respective maximum amounts of both partners. The health and nursing insurance contributions are given priority. If the health and long-term care insurance costs do not exhaust the maximum amount (e.g. for low-income earners), they can be “replenished” with other provision costs. If the health and long-term care insurance contributions already exceed the maximum amount, the contributions can still be deducted in full from the assessment period 2010 onwards (Sec. 10 (4) sent. 4 EStG). However, a further deduction of other pension expenditures within the meaning of Sec. 10 (1) no. 3a EStG is then excluded. Example: Gustav is a single employee with private health insurance. He pays an annual health insurance contribution of € 1,600, which includes 10 % for supplementary care. The share for the basic health insurance thus amounts to € 1,440. For the statutory long-term care insurance he has paid € 200 and other pension expenses of € 600. The maximum amount pursuant to Sec. 10 (4) sent. 2 EStG of € 1,900 is not fully exhausted by the health and nursing insurance contributions of € 1,640. The other other pension expenses can also be set at € 260. <?page no="147"?> 148 2 Personal income tax If Gustav would pay € 2,300 for his private health insurance, which again includes 10 % for the supplementary care, the share for the basic health insurance would amount to € 2,070. For the statutory long-term care insurance he also spends € 200 this time. The other other pension expenses amount to € 600, analogous to the above example. Already with the health and nursing insurance contributions, Gustav exceeds the maximum amount of € 1,900. According to Sec. 10 (4) sent. 4 EStG, however, a full deduction is possible. However, the consideration of further other pension expenses is excluded. Gustav can therefore claim a special expenditure deduction of € 2,270 (= € 2,070 + € 200). Note • As of the assessment period 2010, both statutory and private health insurance contributions are generally deductible for an unlimited amount (Sec. 10 (1) no. 3 lit. a i.c.w. with (4) EStG. • The statutory long-term-care insurance is also fully deductible (Sec. 10 (1) no. 3 lit. b i.c.w. (4) EStG). • A “replenishment” with other pension expenses within the meaning of Sec. 10 (1) no. 3a EStG is permissible if the maximum amount has not been exceeded. • The maximum amount for employees is € 1,900 and for self-employed persons € 2,800 (Sec. 10 (4) EStG).  Most favourable tax treatment For some taxpayers, the new legal situation entailed by the Retirement Income Act may result in worse treatment compared to the regulations in force in the assessment period 2004. For this reason, Sec. 10 (4a) EStG provides for a most favourable tax treatment for all insured persons ex officio until the assessment period 2019. Note • In a transitional period from 2005 to 2019, it must be examined whether the regulations regarding the amount of pension expenses deductible as special expenses in the old version of the Income Tax Act applicable on 31 December, 2014 are more favourable for the taxpayer than the standards applicable from 2005 onwards • The advance deduction will be reduced from € 2,100 from 2013 to 2020 (€ 4,200 for married couples assessed together) to zero. <?page no="148"?> 2.2 Determination of taxable income 149 Summarizing overview: Tax treatment of an employee With effect from 1 January 2010, the pension lump-sum was abolished within the meaning of Sec. 10c EStG, as only the actual pension expenses paid are taken into account within the scope of the special expenses deduction. The pension lump-sum has recently been applied as part of the income tax procedure (Sec. 39b EStG). <?page no="149"?> 150 2 Personal income tax d) Vocational training and further training costs Pursuant to Sec. 4 (9) and Sec. 9 (6) EStG, expenditures incurred for the first vocational training or a first degree course (undergraduate studies) are not considered income-related expenses or business expenses. They serve to provide for personal existence and are therefore part of the private lifestyle. An exception only arises if the training measure takes place within the framework of an employment relationship, for example within the framework of a dual training system or a part-time first degree course, i.e. if the measure is occupationally induced. Costs for one's own vocational training that are not deductible as incomerelated expenses or business expenses can be deducted as special expenses under Sec. 10 (1) no. 7 EStG up to an amount of € 6,000 per calendar year. Vocational training is defined as the acquisition of initial knowledge and skills, i.e. the acquisition of basic knowledge for the future occupation with the discernible intention of later exercising the profession. In Sec. 9 (6) sents. 2 to 4 of the Income Tax Act, the legislator has specified details in this regard. Vocational training as initial training therefore exists if an orderly training with a minimum duration of 12 months is carried out with full-time training and a final examination. An orderly training course is deemed to exist if it is carried out on the basis of legal or administrative regulations or internal refund from the fiscal authorities 12 months x € 557 ./ . € 6,684 Advance payments of wage taxes € 510 Credit Sec. 32a EStG € 32,618 Taxable income for 2018 € 6,174 Scaled personal income tax for 2018 = ./ . € 600 Church tax paid 12 months x € 50 Sec. 10 (1) nos. 3 and 3a EStG ./ . provisions as special expenses € 3,958 Deduction of other provisions as special expenses Calculation of the annual personal income tax for an employee € 42,000 Annual gross pay Earnings from dependent employment ./ . € 1,000 Lump-sum allowance for deductible under Sec. 9a employees sent. 1 no. 1 EStG ./ . € 3,824 Deduction of retirement Sec. 10 (1) no. 2 EStG <?page no="150"?> 2.2 Determination of taxable income 151 regulations of an educational institution. If the training plan does not provide for a final examination, the training shall be deemed to have been completed at the actual scheduled completion. A person who has passed the final examination of a regulated by law or administrative regulations with a minimum duration of 12 months without having previously undergone the corresponding vocational training has also completed vocational training as initial training. This also applies to first-degree studies, since the degree programmes offered by higher education institutions in accordance with Sec. 10 (1) sent. 1 EStG generally lead to a vocational qualification. The expenses that can be deducted as special expenses include, among other things: • course, school or study fees, work equipment, specialist literature, • travel between home and place of training or work, • additional expenses for meals, • additional expenses due to external accommodation and • costs for a home office. According to jurisdiction, the costs of a first degree course can be recognised as anticipated income-related expenses if it is preceded by vocational training which has already been completed, even if this is not related to the initial training. The Federal Fiscal Court clearly stated its position on this issue in a ruling issued in 2009. 13 The BFH cited the connection with later income from the intended activity as the reason. Thus, the expenses were occupationally induced and deductible as income-related expenses incurred in advance if they were not incurred within the framework of an employment relationship. Since 2004, for fiscal reasons, the expenses for initial training or a first degree course have only been possible as a deduction of special expenses, although these are actually in a sufficiently concrete, objectively ascertainable connection with future taxable income from the aspired professional activity and would thus be professionally induced. In 2011, the Federal Fiscal Court ruled in two rulings that the limitation of the deduction of expenses for initial vocational training and a first degree course is futile due to the legal formulation applicable up to this point in time and that corresponding expenditures must therefore be deductible without limitation as income-related expenses. 14 At the end of 2011, however, the regulations were (unfortunately) revised by the legislator. The old legal situation has thus been reaffirmed, according to which expenses for initial vocational training and a first degree course are only deductible to a limited extent as special expenses. For clarification: A 13 See BFH, 18 June 2009, VI R 14/ 07. BFN/ NV 2009, p. 1875. 14 BFH, from 28 July 2011 - VI R 5/ 10, DStR 2011, p. 1745; BFH, from 28 July 2011 - VI R 7/ 10, DStR 2011, p. 1559. <?page no="151"?> 152 2 Personal income tax loss that can be carried forward within the meaning of Sec. 10d (2) EStG can be created by income-related expenses, but not by special expenses. For this reason, the qualification of education costs as income-related expenses or special expenses is of considerable practical relevance. If, on the other hand, a taxpayer decides, after having completed vocational training or a first degree, to pursue further or continuing vocational training , the costs of which he himself bears, the expenses incurred are income-related expenses (for employees) or business expenses (for self-employed persons). It is decisive that the expenditures are occupationally induced and are thus in a sufficiently concrete, objectively ascertainable connection with future taxable income from the desired occupational activity. Otherwise non-deductible expenditures of the private lifestyle are present. Note Further training is the continuing vocational training in a practiced profession that is not aimed at changing to another profession. There must be an objective link with the profession practiced and the training must be designed to promote that profession. The costs of continuing education and training, however, are not dependent on an employment relationship. Thus, for example, unemployed persons, mothers and fathers on parental leave can also claim income-related expenses incurred in advance if they continue their training in the occupation in which they will be working in the future. Expenditures for a second, supplementary or postgraduate course of study after completion of training or a course of study already completed is in principle deductible, provided that the employee's vocational opportunities are improved in connection with the first course of study by the second course of study. Note A distinction is made between training costs (income-related expenses), training costs (special expenses) and costs of general education (prohibition of deductions). Costs for retraining are also deductible as income-related expenses (incurred in advance), regardless of whether the retrainee is employed or unemployed. A retraining should make it possible to switch from a previously learned occupation to another suitable professional activity. The retraining is therefore <?page no="152"?> 2.2 Determination of taxable income 153 a second vocational training and not a further training in the originally learned occupation. 15 Figure 39: Vocational training and further education costs Examples: 1. Tax assistant Luise, who works in a law firm, prepares for her examination as an accountant in Saturday courses. Since Luise has already completed her vocational training, the training costs she has incurred represent income-related expenses which are fully deductible. 2. Walter is studying at a German university that has introduced study fees to expand its administrative apparatus. Walter can deduct these beside his expenditures for literature as well as for journeys between residence and study place up to a height of € 6,000 per year as special expenses from the total amount of the income. 3. The trained accountant Sabine is studying at a German university as a primary school teacher. Sabine can claim the expenditures she incurs as anticipated income-related expenses in unlimited amounts, as she has already completed her vocational training. e) Tax-privileged benefits The Act on Further Strengthening Citizens' Involvement has comprehensively reformed the regulations on the deduction of special expenses from tax-privileged benefits. Benefits (donations and membership fees) are to be 15 See BFH, 4 December 2002, VI R 120/ 01, BStBl. II 2003, 403. <?page no="153"?> 154 2 Personal income tax subdivided into: • Contributions for the promotion of tax-privileged purposes within the meaning of Sec. 10b (1) EStG, • Donations to the assets of a foundation within the meaning of Sec. 10b (1a) EStG, • and contributions to political parties within the meaning of Sec. 10b (2) EStG. Donations and membership fees within the meaning of Sec. 10b (1) EStG for the promotion of non-profit, charitable and churchly purposes within the meaning of Secs. 52 to 54 AO may be claimed as special expenses up to 20 % of the total amount of income or up to 4 of thousand of the sum of the total turnover and the wages and salaries spent in the calendar year. However, pursuant to Sec. 10b (1) sent. 8 EStG, membership fees to corporations which promote the active cultural activities of their own members (e.g. sports clubs, amateur theatres, associations for the preservation of local traditions, animal breeding, etc.) are excluded from a deduction. If the contributions exceed the permissible maximum limits during a tax assessment period or if contributions cannot be taken into account, they can be carried forward indefinitely and deducted as special expenses in the following tax assessment periods. Figure 40: Maximum amounts for the deduction of benefits within the meaning of Sec. 10 (1) and (2) EStG <?page no="154"?> 2.2 Determination of taxable income 155 In addition to the maximum amounts pursuant to Sec. 10b (1) sent. 1 EStG, donations to the assets of a foundation within the meaning of Sec. 10b (1a) sent. 1 EStG of up to € 1 million may be claimed for tax purposes at the request of the taxpayer. Beneficiaries are not only donations made on the occasion of the establishment of a new foundation, but also so-called endowments into the assets of an existing foundation. The special expenditure deduction can be distributed arbitrarily by the donor within a period of ten years to the individual periods. Sec. 10d (4) EStG is to be correspondingly applied, i.e. a deductible donation amount, which has not yet been taken into account for tax purposes, is to be determined separately and updated in this way for the future. Figure 41: Calculation scheme for political donations The deduction of special expenses for party donations within the meaning of Sec. 10b (2) EStG follows other maximum limitation rules. Contributions to political parties can only be considered as special expenses if the beneficiary political association is a party within the meaning of Sec. 2 of the Political Parties Act. However, only those amounts which have not already been taken into account for tax purposes on the basis of the deductible <?page no="155"?> 156 2 Personal income tax amount pursuant to Sec. 34g EStG can be recognised as special expenses. According to the so-called small donation regulation of Sec. 34g EStG, donation contributions are favoured by a direct deduction from the income tax rate. The reduction amounts to 50 % of the expenses and is limited to a maximum deduction of € 825 (spousal splitting € 1,650). Consequently, at least € 1,650 (spousal splitting € 3,300) must be donated in order to fully utilise the deduction. Only that part of the donation which has not been taken into account in connection with the maximum deduction can therefore be considered as special expenses pursuant to Sec. 10b (2) EStG. However, this deduction of special expenses is also only possible up to an amount of € 1,650 (spousal splitting € 3,300). The two-stage deduction procedure is based on the democratic principle that political decision-making, at least at the first stage, should not depend on the level of income. Example: Single Franz with a total income of € 45,000 donates € 2,400 to the university where his sister is studying. He also donates € 5,000 to his home parish, € 2,600 to the municipal museum and € 2,000 to political parties. Contributions for purposes within the meaning of Secs. 52-54 AO Maximum deductible amount (20 % of € 45,000) € 10,000 ./ . € 9,000 € 9,000 Residual amount that can be carried forward in accordance with Sec. 10b (1) sent. 3 EStG € 1,000 Deductible donation amount according to Sec. 10 (1) sent. 1 EStG € 9,000 Contributions to political parties within the meaning of Sec. 2 of the Political Parties Act € 2,000 Deductible amount according to Sec. 34g EStG 50 % of € 1,650 ./ . € 825 Deductible residual amount according to Sec. 10b (2) EStG ./ . € 350 Franz can claim € 9,000 out of a total of € 10,000 as special expenses within the meaning of Sec. 10b (1) EStG. The remaining amount of € 1,000 will be determined separately pursuant to Sec. 10b (1) sent. 3 i.c.w. Sec. 10d (4) EStG and carried forward indefinitely to the following assessment periods. The amounts not taken into account in the current assessment period will then be considered together with the current benefits in the following assessment periods as special expenses within the limits of the maximum amounts. In addition, he could assert his donation to political parties pursuant to Secs. 34g, 10b (2) EStG in the amount of € 1,175. <?page no="156"?> 2.2 Determination of taxable income 157 f) School fees for supplemental and alternative schools According to Sec. 10 (1) no. 9 EStG, 30 % of the school fees paid to a private school in a calendar year are deductible as a special expense if the taxpayer is entitled to child benefit or the child allowance for the child, up to a maximum of € 5,000 per child and parent. The condition is that the school is resident in an EU/ EEA member state and is recognised by the state. The fees for accommodation, care and meals that may be included in the school fees are not taken into account. Example: Amalia attends a private business school, which is state-recognised as a supplementary school in the German federal state Bavaria. Her parents pay school fees of € 30,000 a year. This includes € 2,000 for drinks and € 7,000 for staying overnight in the school. Amalia`s parents receive child benefit for her. Her parents can claim 30 % of € 21,000 (= € 30,000 - € 9,000) = € 6,300, but not more than € 5,000, as special expenses. 2.2.6. Extraordinary expenses Concept of extraordinary expenses Like special expenses, extraordinary expenses reduce the total income and thus the income subject to taxation and cover the exceptional living needs necessary for survival. Example: After a car accident, Johannes must spend a week in the hospital and makes a co-payment of € 100 per day for his time in the hospital. How are these expenses to be treated fiscally? The costs of medical services are considered private expenditures because they are not directly related to earned income. According to Sec. 12 EStG, private expenses may not reduce the total amount of income. If these expenditures are unavoidable and the taxpayer thus incurs higher <?page no="157"?> 158 2 Personal income tax expenditures than the predominant majority of taxpayers in the same level of income, financial circumstances, and marital status , the legislature characterizes these expenditures in accordance with Sec. 33 (1) EStG as extraordinary expenses and allows their deduction. The expenditures incurred by the taxpayer in accordance with Sec. 33 (2) sent. 1 EStG are unavoidable if the taxpayer is obliged to pay them for legal, factual, or moral reasons, and if the expenditures were necessary and reasonable in light of the circumstances. Example (solution): The costs of medical services resulting from an unavoidable, extraordinary occurrence and which lie outside of the ordinary with respect to the amount and the cause are considered to be extraordinary expenses. The deductibility of the extraordinary burdens gives the income tax its character as a personal tax because the reduction of the taxpayer’s ability to pay, the cause of which lies in the private sphere, is taken into consideration fiscally. Figure 42: The different types of extraordinary expenses Extraordinary expenses are neither incomerelated expenses, business expenses, nor special expenses, and can only be taken into consideration in the year in which the payment of the costs occurred. The inflow-outflow principle of Sec. 11 EStG applies. Extraordinary expenses General cases (Sec. 33 EStG) Standardized cases (Secs. 33a and 33b EStG) Reduced by the reasonable burden (Sec. 33 (3) EStG) Examples: - Medical costs - Treatment costs - Litigation costs to secure his livelihood - Funeral costs etc. Limited by maximum amounts/ lump-sum allowances Maintenance payments (Sec. 33a (1) EStG) Education allowance (Sec. 33a (2) EStG) Disability lump-sum, surviving dependents allowance and care lump-sum (Sec. 33b EStG) <?page no="158"?> 2.2 Determination of taxable income 159 In the case of extraordinary burdens, the legislature differentiates between extraordinary expenses in general cases (Sec. 33 EStG), which are individual and cannot be treated uniformly, and extraordinary expenses in standardizes cases (Secs. 33a to 33b EStG), which, for the most part, can be regulated schematically or uniformly. It must be kept in mind, however, that extraordinary expenses in standardized cases usually have priority over the general cases. Note Characteristics of extraordinary expenses: • Expenses • Unavoidability of the expenses • Economic burden • Unusualness of the expenses • No income-related expenses, business expenses or special expenses • Inflow-outflow principle of Sec. 11 EStG Extraordinary expenses in general cases General cases within the meaning of Sec. 33 EStG predominantly include the costs of medical services, treatment and funeral costs inasmuch as they exceed the value of the estate. Expenses for the conduct of a legal dispute (litigation costs) are excluded from the deduction, unless they are expenses without which the taxpayer would run the risk of losing his livelihood and no longer being able to satisfy his vital needs within the usual framework. The expenditures reduce the total amount of income; this is, however, after deduction of the reasonable burden in accordance with Sec. 33 (3) EStG as extraordinary burdens. The reasonable burden is intended to ensure that the taxpayer bears the expenditures incurred in full or in part to the extent that his or her ability to pay allows. The general population should only have to contribute to the personal expenditures of the taxpayer in question by way of a reduction of the tax liability for burdens that exceed a reasonable volume. The reasonable burden is determined using the statutory percentage in Sec. 33 (3) sent. 1 EStG that is determined by the marital status, number of children and total income. The reasonable burden results from multiplying the total income by the percentage. The reasonable own burden is calculated by multiplying the percentage by the total amount of income, whereby <?page no="159"?> 160 2 Personal income tax income from capital assets subject to the flat-rate withholding tax is not to be taken into account. Contrary to the previous administrative opinion approved by the case-law, the Federal Fiscal Court decided in its judgment of 19 January 2017 - VI R 75/ 14 that the provisions of Sec. 33 (3) sent. 1 EStG should be understood as meaning that the reasonable burden to be taken into account in the case of extraordinary burdens is to be calculated gradually. Example: Juliane is single and has no children. In 2018 she incurred medical costs amounting to € 5,500. Her health insurance reimbursed her with € 2,200. Her total income amounts to € 20,000. Since Juliane has no children, is assessed according to the basic tariff and her total income is between € 15,341 and € 51,130, the reasonable burden is calculated according to a two-stage procedure. Up to a total income amount of € 15,340, the reasonable burden is 5 % of the total income amount, i.e. € 767. For the part of the total income amount exceeding € 15,340, the reasonable burden is 6 %. This part of the total amount of income (€ 4 ,660) results in a reasonable charge of € 280. Juliane therefore faces a reasonable charge of € 1,047. Medical costs € 5,500 ./ . Reimbursement by the health insurance company € 2,200 = Extraordinary expenses € 3,300 ./ . Reasonable burden € 1,047 = Deductible extraordinary expenses € 2,253 Juliane can claim extraordinary expenses of € 2,253 in her personal income tax return. Extraordinary expenses in standardized cases In the case of extraordinary expenses in standardized cases the deductibility of the expenditures is limited by certain maximum amounts and/ or lumpsum allowances. a) Maintenance payments to entitled individuals In the event that the real splitting within the scope of special expenses does not apply, a taxpayer obliged to pay maintenance can, in accordance with Sec. 33a (1) EStG, claim the maintenance payments made by the taxpayer or the other spouse as extraordinary burdens up to a maximum amount of € 9,000 for each person entitled to maintenance. The maximum shall be increased by the health and long-term care insurance contributions assumed within the meaning of Sec. 10 (1) no. 3 EStG, unless they were already deductible as special expenses. It is necessary that neither the taxpayer nor another individual is entitled to the child allowance in accordance with Sec. 32 (6) EStG or to child benefit for the person entitled to maintenance and that the person entitled to maintenance has little or no assets. An appropriate house property is <?page no="160"?> 2.2 Determination of taxable income 161 not considered if it fulfils the requirements set out in Sec. 90 (2) no. 8 of the Twelfth Book of the Social Code. The maximum amount is reduced, however, in accordance with Sec. 33a (1) sent. 5 EStG if the maintenance recipient has received income or benefits exceeding € 624 in that calendar year as well as trainee support or supportive grants meant to finance the recipient’s costs of living. A condition for the deduction of expenses is the indication of the identification number issued to the maintained person in the tax return of the provider of maintenance, if the maintained person is subject to unlimited or limited tax liability. b) Educational allowance The general education costs for a child are already taken into consideration in the family benefit compensation (Familienleistungsausgleich). A separate educational allowance (Ausbildungsfreibetrag) of € 924 is granted in accordance with Sec. 33a (2) EStG if the child has turned 18, is enrolled in vocational training, lives apart from his parents and the parents are entitled to child benefit and/ or the child allowance within the meaning of Sec. 32 (6) EStG. However, the educational allowance is reduced in accordance with Sec. 33a (3) sent. 3 EStG if the child has received subsidies as educational aid from public funds (e.g. BAöG). The income and earning of the person entitled to maintenance do not reduce the training allowance. c) Disability lump-sum, surviving dependents allowance and lumpsum care allowance Disabled individuals incur extraordinary burdens because of their disability which can be compensated with a lump-sum allowance instead of according to the provisions of Sec. 33 EStG. The lump-sum allowance for disabled persons is granted in accordance with Sec. 33b (3) sent. 2 EStG depending on the (continual) degree of the disability. The lump-sum allowance is increased in accordance with Sec. 33b (3) sent. 3 EStG to € 3,700 for helpless disabled individuals and for the blind. Surviving dependents are entitled to a lump-sum allowance amounting to € 370 if current surviving dependent benefits were granted and these are, in accordance with Sec. 33b (4) EStG, paid especially on the basis of the Federal Salary Law (Bundesversorgungsgesetz), the West German Federal Indemnification Law (Bundesentschädigungsgesetz), or the statutory accident insurance. This surviving dependents allowance has no economic justification because the surviving dependents - in contrast to other single individuals - do not incur any additional expenditure. <?page no="161"?> 162 2 Personal income tax Table 15: Disability lump-sums depending on the degree of disability Taxpayers who must bear extraordinary burdens because of having to care for a person who is not just temporarily in need of help may claim a lumpsum care allowance of € 924 per calendar year in accordance with Sec. 33b (6) EStG as an alternative to the provisions of Sec. 33 EStG. The requirement for the deduction is that the taxpayer does not receive compensation for the care given. Note In the case of extraordinary expenses in standardized cases, the deductibility of the expenditures is limited by maximum amounts and/ or lumpsums. An alternative treatment in accordance with Sec. 33 EStG (general cases) may only be selected in the cases provided for under Sec. 33b EStG. No option exists for the other standardized extraordinary expenses Sec. 33a). <?page no="162"?> 2.2 Determination of taxable income 163 Summary ► The deductibility of special expenses and extraordinary expenses represents a violation of the principle codified in Sec. 12 EStG that private expenditures are not deductible. ► A distinction must be made between special expenses that are completely deductible and those that are partially deductible. ► Completely deductible special expenses include, for example, retirement benefits, benefits based on a pension adjustment under the law of obligations and church tax. If no higher expenses are proven, the special expenses lump-sum of € 36 or € 72 is deducted ex efficio. ► Partially deductible special expenses include the following: Pension expenses, maintenance payments to divorced spoueses, childcare costs, vocational training costs, contributions and donations to political parties as well as school fees for supplementary and substitute schools. ► A distinction must be made between retirement provisions and other provident expenditures. ► Since the assessment period 2005, retirement provisions are generally exempted during the earning phase. This corresponds with the full taxation of the retirement income in the payment phase (subsequent taxation). ► The transition to deferred taxation will take place incrementally for fiscal-political reasons. ► Prerequisite for the acceptance of expenses as an extraordinary expense represents a larger burden for the taxpayer than for the predominant majority of taxpayers with the same income, financial situation and marital status. ► A distinction must be made between extraordinary expenyses in general and standardized cases. ► Extraordinary expenses in general cases are above all medical, treatment and care costs. The reasonable burden limit must be taken into account. ► Extraordinary expenses in standardized cases are limited by maximum amounts and/ or lump-sum allowances. These include maintenance payments, separate educational allowance and the disability lump-sum. Questions 1. What are special expenses and how are they treated fiscally? 2. What expenditures are considered to be completely deductible special expenses? 3. What expenditures are considered to be partially deductible special expenses? 4. Explain the system of subsequent taxation. 5. What maximum amounts must be taken into consideration within the scope of the retirement provisions? 6. What should be taken into account for donations in the context of the deduction of special expenses? 7. What are extraordinary expenses and how are they treated fiscally? 8. What expenditures belong to the extraordinary expenses in general cases and what must be taken into consideration thereby? 9. What expenditures belong to the extraordinary expenses in standardized cases? <?page no="163"?> 164 2 Personal income tax 2.2.7 Family benefit compensation According to the German Constitutional Law (Grundgesetz), marriage and family enjoy special protection by the state. Therefore, German social law takes marital status and children into account in order to increase the willingness to lead a life with family and children. German tax law also makes efforts to grant families tax relief. The most important fiscal tool to aid families is the splitting method for jointly assessed marital couples in accordance with Sec. 32a (5) EStG and the equalisation for work performed within the family regulated in Sec. 31 EStG. The latter is intended to compensate financial burdens that result from raising children. German income tax law provides for the possibility of dual privileges as an option model within the scope of the equalisation for work performed within the family. According to Sec. 31 sent. 1 EStG, the parents are entitled to child benefit or a child allowance in addition to a collective allowance. Both measures are two variations of the same equalisation for work performed within the family that may be claimed alternatively by the entitled party. Figure 43: The dual system of family benefit compensation The child benefit is regulated in Chapter X of the German Income Tax Law (Secs. 62 to 78 EStG). The child benefit is not usually paid to the child itself, but rather to those entitled to the child benefit, i.e. usually the parents. According <?page no="164"?> 2.2 Determination of taxable income 165 to Sec. 62 (1) EStG, the necessary prerequisite for an entitlement to child benefit is that the individual(s) entitled to the child benefit is subject to unlimited taxation in Germany or is treated as such. The prerequisite for the claim under sentence 1 is that the beneficiary is identified by the identification number assigned to him (Sec. 139b AO). A foreigner is only entitled to child benefit if he or she possesses a residence authorization or a residence permit. It is primarily the children directly related to the individual(s) entitled to child benefit who give rise to the entitlement to child benefit (Sec. 63 EStG). These include biological and adoptive children. In addition, foster children, step children and grandchildren accommodated in the household are also taken into consideration in the granting of child benefit. A precondition for consideration is the identification of the child by the identification number assigned to this child (Sec. 139b AO). If the child is not liable to tax under a tax law (Sec. 139a (2) AO), it must be identified in another suitable manner. According to Sec. 66 (1) EStG, the child benefit currently amount to € 194/ month (€ 2,328 annually) for the first and second child, and € 200/ month (€ 2,400 annually) for the third child and € 225/ month (€ 2,700 annually) for every additional child thereafter. In accordance with Sec. 67 sent. 1 EStG, the payment by the responsible family insurance fund is made upon written petition by the individual(s) entitled to child benefit. In accordance with Sec. 31 sent. 1 EStG, the child benefit are intended to secure the basic existential needs of the child, including care, instruction, and training. For this reason, the child benefit themselves are not subject to income tax. This is achieved in the law by Sec. 31 sent. 3 EStG which treats the child benefit as a tax refund. As long as the yearly sum of the child benefit exceeds the tax burden of the subsistence level of income, the child benefit serve as help for the family in accordance with Sec. 31 sent. 2 EStG. The amount of the child benefit is based exclusively on the number of children: the individual income circumstances of the recipients do not play a role thereby. The second possibility of securing the basic needs of the child is provided by the child allowance in accordance with Sec. 31 sent. 1 EStG. In addition, a needs-free allowance is granted for the care and upbringing or education of the child ( collective allowance ) in accordance with Sec. 31 sent. 1 EStG. According to Sec. 32 (6) sent. 1 EStG, the child allowance in 2018 amounts to € 4,788 per year for each child taken into consideration for jointly assessed couples and € 2,394 for individually assessed taxpayers. According to Sec. 32 (6) sent. 1 EStG, the collective allowance amounts to € 1,320 for individually assessed taxpayers and is double that for married couples who are assessed jointly for income tax. In contrast to the child benefit, which is independent of the progression, the lump-sum allowances under Sec. 32 (6) sents. 1 and 2 EStG reduce the income in accordance with Sec. 2 (5) sent. 1 and are thus dependent on the progression. The child benefit and the collective <?page no="165"?> 166 2 Personal income tax allowances are, however, not very suited to aid families according to the principle of need because they instead give a higher financial advantage to taxpayers with higher income, contrary to the principle of need. The child benefit are, however, suited to compensate the additional expenditures incurred when compared to those taxpayers who do not have children. The claimants who are generally entitled to child benefit as well as to the allowances under Sec. 32 (6) sent. 1 EStG may not claim both variants of the family benefit compensation under Sec. 31 sent. 1 EStG at the same time. The fiscal authorities automatically determine the most favorable alternative for the taxpayer by way of comparative calculation ( most favourable tax treatment ). If the child allowance and/ or the collective allowances are the more favorable variant, the child benefit already paid are to be returned because they would otherwise be taken into consideration twice. Which of the variants is actually more favorable for the taxpayer depends on the amount of taxable income, as well as the number of children. It can generally be said that the higher the income, the more favourable are the child allowance and collective allowances for the taxpayer than the child benefit because of the higher progression level and the higher tax relief connected therewith. Note The child allowance for spouses is 2018: € 4,788 The collective allowance for spouses is: € 2,640 Alternatively, the child benefit is: € 2,328 Example: Most favourable tax treatment Theresa and Friedrich are married and assessed jointly. Their legitimate child is 5 years old. In 2018, their income amounted to € 150,000. Which variant of the family benefit compensation is most favorable for Theresa and Friedrich? In accordance with Sec. 32 (6) sents. 1 and 2 EStG, the child allowance amounts to € 4,788 per year for jointly assessed couples. The collective allowance amounts to € 2,640 in accordance with Sec. 32 (6) sents. 1 and 2 EStG. Therefore, the sum of the allowances within the meaning of Sec. 32 (6) sent. 1 EStG equals € 7,428. This results in tax relief for Theresa and Friedrich amounting to € 3,120, which is calculated as follows: Personal income tax for 2018 on € 150,000 (without taking the allowances of € 7,428 into consideration) € 45,757 ./ . Personal income tax for 2018 on € 142,572 (= € 150,000 ./ . € 7,428 = € 142,572) ./ . € 42,637 = Savings in income tax after child allowances = € 3,120 <?page no="166"?> 2.2 Determination of taxable income 167 However, in accordance with Sec. 66 (1) EStG Theresa and Friedrich only receive a payment of € 2,328 per year (= 12 × € 194 = € 2,328). The allowances under Sec. 32 (6) sent. 1 EStG are thus more favorable for Theresa and Friedrich than the child benefit. The child benefit that have already been paid in accordance with Sec. 31 sent. 4 EStG are to be returned to the state by way of setting off the child benefit to be returned against the payment of the personal income tax or against the personal income tax refund . The question now arises in which cases the child allowance is more favourable. On the one hand, this depends on the number of children and thus on the amount of child benefit and, on the other hand, on the amount of taxable income. The following chart compares single parents and spouses subject to joint taxation. For the sake of simplicity, it was assumed for single parents that the father of the child pays child support and accordingly receives half of the child benefit. According to H 31 EStH, the most favourable tax treatment is carried out separately for each child, starting with the oldest child. When examining a younger child, the child allowance of the older child is to be deducted from the taxable income if the latter's most favourable tax treatment was in favour of the allowance. Taking into account the increase in child benefit and tax exempt child allowance in 2018, the tax exempt child allowance is more favourable from a taxable income of around € 65,700 for married couples assessed jointly or around € 32,800 for single parents. Figure 44: Most favourable tax treatment for the child allowance 2018 In accordance with Sec. 63 (1) sent. 2 EStG i.c.w. Sec. 32 (3) EStG, the child benefit as well as the child allowance and/ or collective allowance can generally only be claimed for children that have not yet turned 18. This group of <?page no="167"?> 168 2 Personal income tax individuals is expanded in accordance with Sec. 32 (4) sent. 1 no. 1 EStG to include unemployed children who have not yet turned 21 and children under 25 who fulfill the requirements under Sec. 32 (4) sent. 1 no. 2 EStG (i.e. especially in vocational training). Children who have completed vocational training are only taken into account if they are not gainfully employed. However, gainful employment with a regular working week of up to 20 hours, a training employment relationship or a minor employment relationship with a maximum wage of € 450 is harmless. According to Sec. 32 (4) sent. 1 no. 3 EStG, child benefit is paid for physically, mentally or psychologically handicapped children, regardless of their age, if the handicap occurred before the age of 25. Note: Students are taken into consideration within the scope of the equalisation for work performed within the family in accordance with Sec. 32 (4) sent. 1 no. 2 lit. a EStG. Parents are thus entitled to child benefit or the allowances under Sec. 32 (6) EStG until the student child turns 25 years old. After completion of a first degree (e.g. Bachelor’s degree), however, this only applies if the student is not in gainful employment. However, gainful employment is harmless if the weekly working time does not exceed 20 hours, or if the student has an apprenticeship or a minor employment relationship with a maximum monthly salary of € 450. In addition, parents may also deduct the educational allowance of € 924 per calendar year from their total income if the requirements under Sec. 33a (2) EStG are fulfilled. Note Until 2011, the tax benefits were abolished, provided that the child’s income and emoluments were even one euro above the limit of € 8,004 per year (case axe effect). Summary ► Within the scope of the family benefit compensation a distinction must be made between child benefit and child allowance as well as collective allowance. ► Child benefit is paid to the individual(s) entitled to the child benefit. The amount of the child benefit depends of the number of children. ► The child allowance is in 2018 € 2,394 (€ 4,788). In addition, the collective allowance amounting to € 1,320 (€ 2,640) is granted for care and training and/ or education. The allowances named are deducted from the income. Questions 1. How can financial burdens that the taxpayer faces as a result of child-raising be compensated for in fiscal terms? 2. What possibilities of equalization for work performed within the family can be differentiated? Explain the alternatives? <?page no="168"?> 2.2 Determination of taxable income 169 2.2.8 Assessment basis and scale The taxable income According to Sec. 2 (5) sent. 1 half-sent. 1 EStG, the taxable income is the income in accordance with Sec. 2 (4) EStG reduced by the child allowance under Secs. 31, 32 (6) EStG. This represents the assessment basis for the scaled income tax in accordance with Sec. 2 (5) sent. 1 half-sent. 2 EStG. The adjoining scheme is further developed below to arrive at the taxable income for the final payment or refund. Scaled income tax In determining the scaled income tax, the taxable income is to be applied as the assessment basis for the income tax rate. A difference is drawn thereby between normal rates and special rates (e.g. for extraordinary income). In addition, a distinction must be made within the scope of the normal rate between the basic rate and the splitting rate. Generally, no income tax is assessed up to the amount of the fiscal subsistence level (basic tax allowance). The basic tax rate is currently 14 % and increases with more income up to 45 % (top tax rate) for a taxable income amounting to at least € 260,533. The basic rate applies to single individuals or married individuals who are assessed individually. The splitting rate applies to married couples who are assessed jointly. According to Sec. 32a (5) EStG, “for married couples whose income tax is assessed jointly according to Secs. 26, 26b and subject to Secs. 32b, <?page no="169"?> 170 2 Personal income tax 34, 34b and 34c, the scaled income tax amounts to twice the amount of taxes to be paid for half of their mutual taxable income according to subsections 1 to 3 (splitting method)”. The basis tax allowance is doubled thereby to € 18,000. The advantage of the spousal income splitting consists in a reduction of the progression. Accordingly, the largest possible reduction of the progression is achieved if only one of the spouses earns income. The fundamental way in which the mechanism of the splitting method functions can be exemplified using the following example. Example: Individual assessment Husband Wife Total Taxable income € 200,000 € 0 € 200,000 Personal income tax € 75,378 € 0 € 75,378 It would be more favorable for the couple because of the income tax progression if each spouse had to pay taxes on exactly half of the total income amounting to € 200,000, i.e. each on € 100,000. Individual assessment Husband Wife Total Taxable income Personal income tax € 100,000 € 33,378 € 100,000 € 33,378 € 200,000 € 66,756 This would result in € 8,622 (= € 75,378 ./ . € 66,756) of saved taxes because of the progression advantage. The splitting method fictively assumes this half-half division of income resulting in the following calculation: Joint assessment Husband Wife Total Taxable income € 200,000 € 0 € 200,000 Personal income tax € 66,756 € 0 € 66,756 <?page no="170"?> 2.2 Determination of taxable income 171 Note In principle, the normal rate (consisting of the basic rate and the splitting rate) of Sec. 32a EStG applies to the calculation of the income tax. Therefore, the splitting method does not offer any tax advantage in comparison with the individual assessment if both partners earn exactly the same income. The tables for the basic rate and the splitting rate are attached in the annex to the German Income Tax Law (EStG) and can be used to determine the scaled income tax directly - without application of the formula codified in Sec. 32a (1) or (5) EStG. Special rates according to Secs. 34 and 34a EStG The normal rate within the meaning of Sec. 32a EStG does not, however, apply to all types of income. In addition to the special rate as part of the flat-rate withholding tax pursuant to Sec. 32d EStG and the preferential treatment of profits not withdrawn pursuant to Sec. 34a EStG, special regulations must also be observed in the case of the so-called extraordinary income. If extraordinary income within the meaning of Sec. 34 (2) EStG exists, the special rates of Sec. 34 (1) ( one-fifth rule ) or (3) ( reduced average tax rate ) EStG apply. Since the taxable income is often distinctly too high in the case of extraordinary income, undue hardships (caused by a correspondingly high tax burden) from the combined realization of hidden reserves are to be avoided by way of the special rate in accordance with Sec. 34 (1) and (3) EStG. Figure 45: Scope of extraordinary income <?page no="171"?> 172 2 Personal income tax Note The reduced tax rate in the form of the one-fifth rule applies to all extraordinary income within the meaning of Sec. 34 (2) EStG. a) One-fifth rule according to Sec. 34 (1) EStG The one-fifth rule generally applies to all extraordinary income. The rule stipulated a reduced tax rate that is calculated as follows: Step 1 : Determination of the income tax on the taxable income without the extraordinary income (i.e. on the remaining taxable income) Step 2 : Determination of the income tax on the remaining taxable income plus 1/ 5 of the extraordinary income Step 3 : Determination of the difference between the income tax after step 1 and step 2 Step 4 : Scaled income tax = income tax after step 1 plus five times the difference after step 3. b) Reduced average tax rate according to Sec. 34 (3) EStG The following additional requirements must also be fulfilled in order to apply the reduced tax rate within the meaning of Sec. 34 (3) EStG ( reduced average tax rate ): • Capital gains within the meaning of Sec. 34 (2) no. 1 EStG, • application of the taxpayer, • the taxpayer has turned 55 years old or is permanently disabled , and • the reduced tax rate has not already been granted in the past, i.e. it is only granted once in the taxpayer’s lifetime. For profits up to € 5 million the taxpayer can apply to have taxes assessed at the reduced average tax rate instead of the general rate reduction under Sec. 34 (1) EStG. This provision is intended to secure the old-age provision of entrepreneur retiring from working life. According to Sec. 34 (3) sent. 2 EStG, the reduced average tax rate must be at least 14 %. The reduced average tax rate is calculated as follows: Step 1 : Determination of the income tax on the total taxable income (incl. ordinary and extraordinary income) according to the general rate under Sec. 32a EStG Step 2 : Determination of the average tax rate by division of the resulting tax burden by the taxable income <?page no="172"?> 2.2 Determination of taxable income 173 Step 3 : Calculation of 56 % of the average tax rate Step 4 : Application of the reduced average tax rate, but at least 14 % to the extraordinary income Step 5 : Determination of the income tax on the taxable income without the extraordinary income Step 6 : Scaled income tax = sum of the income tax from step 4 plus the income tax from step 5 Note The reduced tax rate in the form of the reduced average tax rate only applies to sales profits within the meaning of Sec. 34 (2) no. 1 EStG earned by a taxpayer who is at least 55 years old or continually disabled. It may only be claimed once in a lifetime. Example: Andreas is 60 years old and single. In 2018, he sells his business for € 412,600. Costs for legal advice within the scope of the sale amount to € 5,000. On the books, the equity capital in the commercial operation amounts to € 250,000. Furthermore, Andreas also earns income from rent and lease amounting to € 25,000 in the same period. The special expenses amount to € 5,000. Determine the scaled income tax. Solution: Andreas fulfills the requirements under Sec. 34 (1) EStG and those under Sec. 34 (3) EStG. It must be determined whether he should choose the privilege provided by the one-fifth rule or by the reduced average tax rate. Calculation of the sales profit: Disposal price € 412,600 ./ . Disposal costs ./ . Book value of the equity capital ./ . € 5,000 ./ . € 250,00 Capital gain = € 157,600 ./ . Tax allowance (Sec. 16 (4) EStG) € 45,000 Less the exceeding amount ./ . € 21,600 (€ 157,600 ./ . € 136,000) € 23,400 ./ . € 23,400 = Taxable capital gain = € 134,200 (I) One-fifth rule (Sec. 34 (1) EStG): Calculation of the tax liability not taking the extraordinary income into consideration: <?page no="173"?> 174 2 Personal income tax Income from rent (not privileged) € 25,000 = Total income = € 25,000 ./ . Special expenses ./ . € 5,000 = Taxable income = € 20,000 Tax without consideration of the capital gain € 2,467 Calculation of the tax liability (according to the basic table) taking the extraordinary income into consideration: Capital gain of € 134,200 to be taxed at a reduced rate: One-fifth thereof € 26,840 + Income from rent (not privileged) + € 25,000 = Total income = € 51,840 ./ . Special expenses ./ . € 5,000 = Taxable income = € 46,840 Tax (according to the table) taking one fifth of the capital gain into consideration € 11,195 Differential tax rate (€ 11,195 ./ . € 2,467) € 8,728 Tax without capital gain = € 2,467 + 5 × differential tax rate on the sales profit ( 5 × € 8,728) + € 43,640 = Total tax = € 46,107 (II) Reduced average tax rate (Sec. 34 (3) EStG) 1. Determination of the income tax for the entire taxable income according to the general rate Business income (sale) € 134,200 + Earnings from rent and lease + € 25,000 = Total income = € 159,200 ./ . Special expenses ./ . € 5,000 = Taxable income = € 154,200 Income tax (Sec. 32a (1) sent. 2 no. 4 EStG) = € 154,200 × 0.42 ./ . € 8,622 = € 56,142 <?page no="174"?> 2.2 Determination of taxable income 175 2. Determination of the average tax rate € 56,142 € 154,200 = 0.3640856 = 36.40856 % 3. Determination of the reduced average tax rate 0.3640856 × 56 % = 0.20388794 = 20.388794 % 4. Determination of the income tax for the privileged portion of the taxable income € 134,200 × 0.20388794 = € 27,362 5. Determination of the income tax for the privileged portion of the taxable income Income tax on € 20,000 : € 2,467 6. Calculation of the scaled income tax € 27,362 + € 2,467 = € 29,829 Comparison of both reduced rates (I) - (II): Scaled income tax with one-fifth rule: € 46,107 Scaled income tax with reduced average tax rate: € 29,829 (Scaled income tax without privilege: € 56,142) The application of the reduced average tax rate results in an income tax liability that is € 16,278 less than results from the application of the one-fifth rule. Therefore, Andreas should be advised to choose Sec. 34 (3) EStG. c) Accumulation privilege according to Sec. 34a EStG Sole proprietorships and partnerships tax their profits on trade tax as independent tax subjects. In the case of income tax, however, partnerships are taxed transparently, i.e. the tax subject is not the sole proprietorship or partnership, but the natural or legal persons who stand behind the company as sole proprietors or co-entrepreneurs (the so-called principle of transparency). Profits can therefore only be reinvested in the company if they have been subject to taxation at the shareholder level as business income at the shareholder's personal income tax rate. For individuals and coentrepreneurs who are natural persons, this can result in a marginal tax burden of up to 45 % (Sec. 32a EStG). Thus, partnerships are clearly disadvantaged in comparison to capital companies, as the latter as independent tax subjects are generally subject to a total tax burden of less than 30 % (15 % corporate income tax + 5.5 % of 15 % = 0.825 % SolZ + 14 % trade tax on average). The following example illustrates the problem. <?page no="175"?> 176 2 Personal income tax Example: Alois is the sole shareholder of a GmbH and at the same time runs a bookstore as a sole trader. Both companies make a profit of € 1,000,000. When viewed from a marginal perspective, Alois is subject to a personal income tax rate of 45 %. The corporate income tax is 15 % and the trade tax a tax factor of 380 % (measured number of 3.5 % x tax factor of 380 % =) is 13.3 %. The trade tax allowance for partnerships pursuant to Sec. 11 GewStG in the amount of € 24,500 and the SolZ are not taken into account. GmbH Sole proprietorship Profit ./ . Trade tax ( 13.3 %) ./ . Corporate income tax (15 %) ./ . Income tax + Trade tax credit according to Sec. 35 EStG 3.8 × ( 3.5 % × € 1 Mio.) € 1,000,000 ./ . € 133,000 ./ . € 150,000 € 1,000,000 ./ . € 133,000 ./ . € 450,000 + € 133,000 ./ . € 317,000 = After tax profit Burden in % = € 717,000 28.30 % = € 550,000 45.00 % If the profits are accumulated in the GmbH and not distributed to the shareholders, this results in a significantly lower burden compared to the individual company. The aim of the special rate pursuant to Sec. 34a EStG is to tax natural persons' income from types of profit income in a comparable way to capital companies (so-called legal neutrality of taxation). This is to be achieved by subjecting undrawn profits (Sec. 34a (1) sent. 1 i.c.w. (2) EStG) to a reduced tax rate at the taxpayer's request. The amount of the special rate of 28.25 % (plus SolZ) is based on the corporate income tax rate of 15 % (Sec. 23 KStG) and the average trade tax rate of 14 %. The SolZ (5.5 %) must also be taken into account, but is neglected in the following explanations. If the taxable income of a taxpayer includes undrawn profits from agriculture, forestry, business operations or self-employment (types of profit income), the taxpayer may request that these be wholly or partly subject to the reduced tax rate of 28.25 % and not included in the collective assessment (Sec. 32a (1) sent. 1 EStG). The necessary request must be made separately for each business or co-entrepreneur share and for each assessment period. The accumulation privilege therefore does not apply at the level of the partnership but at the level of the individual co-entrepreneur. Consequently, each co-entrepreneur is free to choose or waive the preferential treatment. In order to benefit from the accumulation privilege, however, other conditions must be fulfilled cumulatively in addition to the request: <?page no="176"?> 2.2 Determination of taxable income 177 • No preferential treatment of profits through - The tax allowance according to Sec. 16 (4) EStG, - The reduced average tax rate pursuant to Sec. 34 (3) EStG and - By Sec. 3 no. 40 sent. 1 lit. a i.c.w. Sec. 18 (1) no. 4 EStG (remuneration for an investment in a company managing assets). • Determination of profit by the accrual method pursuant to Sec. 4 (1) sent. 1 or Sec. 5 EStG • Profit share of the co-entrepreneur > 10 % or > € 10,000 Example: Anton and Berta each have a 50 % stake in A&B-OHG, which generates a current profit of € 100,000. For its part, A&B-OHG holds a participation in IN-OHG (a socalled two-storey partnership) with a book value of € 10,000. The participation is sold for € 40,000. Anton takes advantage of the benefits of Sec. 16 (4) EStG for his share in the capital gain of € 15,000 [= (€ 4 0,000 ./ . € 10,000) / 2]. Berta waives this claim. Solution: Since Anton claims the benefit of Sec. 16 (4) EStG for the capital gain, he can only claim the accumulation privilege for his share of the current profit in the amount of € 50,000. Berta, on the other hand, has waived any preferential taxation of profits. Berta can therefore claim the special rate of Sec. 34a EStG for her current profit share of € 50,000 and her share of the sale proceeds of € 15,000. Note Prerequisites for the use of the tariff privilege of Sec. 34a EStG are: • Application of the taxable person • No other preferential treatment of profits • Determination of profit through accrual method • For co-entrepreneurships: profit share > 10 % or > € 10,000 <?page no="177"?> 178 2 Personal income tax Figure 46: Determination of the beneficiary profit within the meaning of Sec. 34a EStG The special rate of Sec. 34a EStG can only be claimed for the so-called beneficiary amount. According to Sec. 34a (3) sent. 1 EStG, this is the “profit which is favoured on application in the assessment period in accordance with paragraph 1 sentence 1”. The calculation of the beneficiary amount follows the scheme in Figure 46. The starting point is the profit according to Secs. 4 (1) and 5 EStG determined by the accrual method. This must be reduced by the positive balance from withdrawals (Sec. 6 (1) no. 4 EStG) and contributions (Sec. 6 (1) no. 5 EStG) made during the financial year. Withdrawals flow out of the company and should therefore not be taxed at a preferential rate. However, this only applies to the extent that the withdrawals exceed the contributions. Contributions are taken into account up to the amount of the withdrawals and balance these out within the fiscal year. As a result, the undrawn profit within the meaning of Sec. 34a (2) EStG is received. According to Sec. 34a (1) sent. 1 EStG, the taxpayer has the option of subjecting the undrawn profit to the reduced income tax rate of 28.25 %. The application may also cover only part of the profits not withdrawn. The profit that is not taxed at the request of the taxpayer is subject to the normal rate of Sec. 32a EStG together with the remaining income of the taxpayer. Example: The accounting marketing expert Sepp makes a profit of € 100,000. During the financial year he withdraws € 150,000 and <?page no="178"?> 2.2 Determination of taxable income 179 a) makes a contribution of € 10,000 b) makes a contribution of € 110,000 c) makes a contribution of € 170,000 Case a) Case b) Case c) Profit ./ . Positive balance of withdrawals and deposits € 100,000 ./ . € 140,000 € 100,000 ./ . € 40,000 € 100,000 ./ . € 0 = Undrawn profit ( Sec. 34 a (2) EStG) = € 0 = € 60,000 = € 100,000 In case a), the positive balance of withdrawals and contributions exceeds the annual profit. It is therefore deemed to have been withdrawn in full and cannot therefore be favoured. In case b), the contributions partially compensate the withdrawals, so that only € 40,000 of the annual profit is deemed to have been withdrawn; for the remaining € 60,000, the special rate can be applied. In case c), the entire annual profit can be taxed on a preferential basis, as the contributions fully compensate for the withdrawals. The application of the reduced tax rate is limited to the undrawn profit. The starting point for determining this, is the tax balance sheet profit. However, this must not be confused with taxable income. The non-deductible business expenses were taken into account to reduce the profit when determining the profit. When determining taxable income, however, non-deductible business expenses must be added back to the tax balance sheet profit outside the balance sheet and thus increase the income tax base. In this respect, non-deductible business expenses are not subject to the special rate of 28.25 %, but to the normal income tax rate. Figure 47 illustrates this connection once again. Figure 47: Taxable income vs. tax balance sheet profit <?page no="179"?> 180 2 Personal income tax Example: Otto, the sole proprietor, achieves a tax balance sheet profit of € 100,000. No withdrawals were made during the financial year. As part of the determination of profits, € 20,000 of non-deductible business expenses were recorded as reducing profits. The income tax base is € 120,000, which is made up of the tax balance sheet profit of € 100,000 and the business expenses of € 20,000 to be added outside the balance sheet. The non-deductible profit that is eligible for tax relief pursuant to Sec. 34a (1) EStG is determined on the basis of the tax balance sheet profit and amounts to € 100,000. Otto can therefore apply for this profit to be subject to the reduced tax rate pursuant to Sec. 34a EStG or to the normal rate pursuant to Sec. 32a EStG. However, the non-deductible business expenses of € 20,000 are always subject to the normal income tax rate. Profits for which the accumulation privilege has been claimed can in principle remain in the company for an unlimited period of time. Consequently, partnerships form a pool over time in which the profits subject to preferential taxation are collected (so-called amount subject to subsequent taxation pursuant to Sec. 34a (3) sent. 2 EStG). This must be determined separately for each business and co-entrepreneur share and updated over time. The retained profits, however, only benefit as long as they remain in the company. If in a subsequent financial year the withdrawals exceed the current profit plus contributions, the taxed profits are deemed to have been withdrawn in this amount. The withdrawal is therefore subject to subsequent taxation. The income tax on this so-called subsequent taxation amount amounts to 25 % based on the flat-rate withholding tax of 25 % plus SolZ (Sec. 32a (4) sent. 2 EStG). Note Off-balance sheet additions, such as non-deductible business expenses, are included in taxable income but not in taxable profit. These amounts were actually spent and are therefore not withdrawable. Therefore, an advantage according to Sec. 34a EStG is not possible! Figure 48 illustrates the calculation of the amount subject to subsequent taxation. The starting point is the profit not withdrawn within the meaning of Sec. 34a (2) EStG. This must be reduced by the part of the profit that is not to be favoured at the taxpayer's application. As a result, the so-called benefit amount within the meaning of Sec. 34a (3) EStG is obtained, i.e. the profit which is preferential at the application of the taxpayer pursuant to Sec. 34a (1) sent. 1 EStG. <?page no="180"?> 2.2 Determination of taxable income 181 Figure 48: Determination of the amount subject to subsequent taxation The amount of the benefit must first be reduced by the income tax of 28.25 % (plus solidarity surcharge). The resulting after-tax benefit must then be corrected for various additions and deductions. Example (continuation case b): Sepp would like to claim the benefit of Sec. 34a EStG from the undrawn profit of € 60,000 for € 40,000. The solidarity surcharge is neglected. The benefit amount of € 40,000 is subject to the special rate of Sec. 34a EStG. After deduction of taxes, an accumulation privilege of € 28,700 remains. The remaining € 20,000, together with the part of the profit that was already withdrawn during the financial year and may therefore not be favoured (i.e. the positive balance of withdrawals and contributions amounting to € 40,000), is subject to the normal rate of Sec. 32a EStG. The benefit amount after taxes is increased by the amount subject to subsequent taxation of the previous year determined separately in accordance Undrawn profit ( Sec. 32a (2) EStG) ./ . Profits subject to normal rate € 60,000 ./ . € 20,000 = Benefit amount according to Sec. 34a (3) sent. 1 EStG ./ . Income tax ( 28.25 %) = € 40,000 ./ . € 11,300 = Benefit amount after taxes = € 28,700 <?page no="181"?> 182 2 Personal income tax with Sec. 34a (3) sent. 3 EStG and by the amounts subject to subsequent taxation which are transferred or transferred from the taxpayer's business assets to another business assets of the same taxpayer in accordance with Sec. 34a (5) sent. 2 EStG. Since the assets will continue to be used for business purposes in the latter case, subsequent taxation should be avoided. The consequence of this is that the amount subject to subsequent taxation is mentally removed from one business together with the asset and placed in another business. Example (continued): In the previous year, an amount subject to subsequent taxation of € 31,300 was determined for Sepps' sole proprietorship. In addition, Sepp transfers a special printer with a book value of € 10,000 from his special business assets at X-OHG, in which he also holds a 50 % participation, to his sole proprietorship at book value. The amount subject to subsequent taxation attributable to the co-entrepreneur share in X-OHG amounts to € 15,000. The application within the meaning of Sec. 34a (5) sent. 2 EStG has been submitted. Benefit amount after tax + amount of the previous year subject to subsequent taxation + amount subject to subsequent taxation form the transfer of assets in accordance with Sec. 34 (5) sent. 2 EStG € 28,700 + € 31,300 + € 10,000 = amount subject to subsequent taxation before deductions = € 70,000 <?page no="182"?> 2.2 Determination of taxable income 183 In mirror image to the additions, the amount subject to subsequent taxation is reduced by certain deductions. This is always the case if the positive balance from the withdrawals and contributions of the business year exceeds the profit determined according to Sec. 4 (1) EStG or Sec. 5 EStG. In this case there is an over-withdrawal. If there is an amount subject to subsequent taxation in the corresponding amount, this generally leads to subsequent taxation in the amount of 25 % (Sec. 34a (4) sent. 1 EStG). Example (continuation): The withdrawal of the asset from the special business assets of X-OHG generally leads to subsequent taxation under the conditions of Sec. 34a (4) EStG (over-withdrawal). This is also the case if the asset is transferred to the sole proprietorship (Sec. 34a (4) i.c.w. (5) sent. 1 EStG). However, since Sepp has submitted a corresponding application, in addition to the transfer of the asset there is also a transfer of the amount subject to subsequent taxation (Sec. 34a (5) sent. 2 EStG). The amount subject to subsequent taxation attributable to the co-entrepreneur's share in X-OHG is reduced accordingly from € 15,000 to € 5,000, i.e. exactly to the extent to which the amount subject to subsequent taxation increases at the sole proprietorship. Sec. 34a (6) EStG lists a number of circumstances which, if present, require subsequent taxation of the entire amount subject to subsequent taxation in accordance with paragraph 4: • sale or closure of a business <?page no="183"?> 184 2 Personal income tax • contribution or change of legal form to a capital company • change from the profit determination type to the cash method accounting • taxable person's application In the event of a sale, abandonment or contribution or change of legal form to a capital company, the taxpayer no longer maintains the business or coentrepreneur share. Consequently, there is no entitlement to the tax advantage. However, pursuant to Sec. 34a (6) sent. 2 EStG, the income tax owed in these cases can be deferred without interest for a period of up to 10 years at the taxpayer's application. Determination of the personal income tax to be assessed Sec. 2 (6) sent. 1 EStG stipulates that the income tax to be assessed results from the scaled income tax reduced by the tax abatements and raised by certain increases. The tax abatements especially include the trade tax rate relief allowance in accordance with Sec. 35 EStG and the deductible amount in accordance with Sec. 34g EStG. Furthermore, the child benefit must be added to the scaled income tax in case the child allowance is more favourable (Sec. 2 (6) sent. 3 EStG). If necessary, the income tax must be increased additionally by the tax according to Sec. 32d (3) and (4) EStG. a) The trade tax rate relief allowance within the meaning of Sec. 35EStG <?page no="184"?> 2.2 Determination of taxable income 185 According to Sec. 35 EStG, the scaled income tax is to be reduced • “for income from commercial business within the meaning of Sec. 15 (1) sent. 1 no. 1 by an amount 3.8 times the trade tax index amount” (Sec. 35 (1) sent. 1 no. 1 EStG) • “ for business income as a co-partner within the meaning of Sec. 15 (1) sent. 1 nos. 2 and 3 by an amount 3.8 times the proportional trade tax index amount” (Sec. 35 (1) sent. 1 no. 2 EStG). This is intended to mitigate the double burden on the business income with income tax and trade tax. The tax reduction is limited to the trade tax actually payable (Sec. 35 (2) sent. 5 EStG). For this reason, in the case of co-entrepreneurships, in additon to the trade tax index amount, the actual trade tax to be paid and the share attributable to the individual co-entrepreneurs are also treated separately and uniformly within the meaning of Secs. 179, 180 AO (Sec. 35 (1) sent. 2 i.c.w. (2) sent. 1 EStG). Figure 49: Crediting of trade tax in accordance with Sec. 35 EStG Example: The trade tax index amount for the sole proprietor Christian occupied as a goldsmith is € 2,000 for the assessment period 2018. The trade tax rate relief allowance amounts to € 7,600 (€ 2,000 × 3.8). The scaled income tax for Christian is reduced by € 7,600. Alternative calculation: The municipality Ingolstadt applies its municipal rate of 400 % to the trade tax index amount so that the trade tax liability for Christian equals € 8,000. The trade tax rate relief allowance thus amounts to € 8,000 / 4 = € 2,000 × 3.8 = € 7,600. <?page no="185"?> 186 2 Personal income tax b) Donations to political parties within the meaning of Sec. 34g EStG According to Sec. 34g sent. 1 EStG, the scaled income tax is reduced by the contributions to political parties within the meaning of Sec. 2 of the German Political Party Law and to associations lacking the character of political parties (so-called voters’ associations). The privilege of Sec. 34g EStG is a deductible amount . Contributions within the meaning of this provision are membership fees and donations. Sec. 10b (2) sent. 2 EStG stipulates that the tax abatement in accordance with Sec. 34g enjoys priority over the deduction as special expenses. In this way, the democratic principle of political decisionmaking is realized, regardless of the level income. In accordance with Sec. 34g sent. 2 EStG, the reduction amounts to 50 % of the benefits, maximum € 825 (€ 1,650 in the case of joint assessment). This means that at least twice the amount (€ 1,650 and/ or € 3,300) must have been donated to political parties in order to be able to deduct the full maximum mount from the scaled income tax. If the political donations exceed € 1,650 (€ 3,300 in the case of joint assessment), they are also deductible - also up to a maximum amount of € 1,650 and/ or € 3,300 - as special expenses in accordance with Sec. 10b (2) sent. 1 EStG. Note The maximum reduction of the scaled income tax within the meaning of Sec. 34g EStG: • Individual assessment: € 825 • Joint assessment: € 1,650 <?page no="186"?> 2.2 Determination of taxable income 187 In addition, political donations for which a tax abatement was not granted in accordance with Sec. 34g EStG can be deducted as special expenses (Sec. 10b (2) EStG) up to a maximum amount of € 1,650 (€ 3,300). Example: Elisabeth is single and donates to political parties in 2018: a) € 1,300. According to Sec. 34g sent. 2 EStG, 50 % of the contributions are to be deducted from the scaled income tax. The scaled income tax for Elisabeth is reduced by € 650 (50 % of € 1,300). b) € 2,500. According to Sec. 34g sent. 2 EStG, 50 % of the contributions - at most, however, € 825 - are to be deducted from the scaled income tax. The tax abatement for Elisabeth amounts to € 825 (maximum amount). The remaining amount of donations exceeding € 1,650 is deductible as special expenses in accordance with Sec. 10b (2) sent. 1 EStG, i.e. € 850 (= € 2,500 ./ . € 1,650) can still be claimed as special expenses. c) Crediting the child benefit, if the child allowance is more favourable As was shown in the chapter on the family benefit compensation, the child benefit are to be paid back to the state in accordance with Sec. 31 sent. 4 EStG <?page no="187"?> 188 2 Personal income tax if the child allowance and collective allowance prove to be more favorable for the taxpayer. This is not to be understood as if a transfer is actually made to the fiscal authorities but rather it is simply credited with the higher tax advantage resulting from the allowances stipulated under Sec. 32 (6) sent. 1 EStG. d) Tax according to Sec. 32d (3) and (4) EStG Pursuant to Sec. 2 (6) sent. 1 EStG, the income tax rate is increased by the tax resulting from the application of Sec. 34a (3) and (4) EStG (so-called compensation via assessment). Determination of the final payment and/ or the refund entitlement The advance payments (Sec. 37 EStG) as well as the wage tax and capital yields tax paid (Secs. 38 et seqq., Secs. 43 et seqq. EStG) are to be credited towards the income tax to be assessed (Sec. 36 (2) EStG). This results in the taxpayer’s final payment and/ or final refund entitlement. a) The deduction of income tax paid in advance According to Sec. 37 (1) sent. 1 EStG, the income tax that the taxpayer is likely to owe for the current assessment period is to be paid in advance on 10 March, 10 June, 10 September and 10 December. The amount of the advance payment to be assessed is generally dependent “on the income tax that resulted after = Taxable income (Sec. 2 (5)) Basic tax rate / Splitting rate (Sec. 32a (1),(5)) = Scaled income tax  = Final payment or refund entitlement = Personal income tax to be assessed ./ . Advanced payments of personal income tax (Sec. 36 (2) sent. 1 no. 1) ./ . Withheld wage tax and capital yields tax (Sec. 36 (2) sent. 1 no. 2)  ./ . Trade tax rate relief allowance (Sec. 35) ./ . 50 % of the donations to political parties (Sec. 34g) + Child benefit, if child allowance is more favourable (Sec. 31 sent. 4) + Tax according to Sec. 32d (3) EStG (mandatory assessment) + Tax according to Sec. 32d (4) EStG (assessment option) <?page no="188"?> 2.2 Determination of taxable income 189 crediting the tax deductions [e.g. wage tax, capital yields tax] in the last assessment” (Sec. 37 (3) sent. 2 EStG). The assessment basis for the advance payment is thus the actual income tax paid in the past. The assessment is based on the assumption that the taxpayer’s income situation has not undergone any major changes in the following assessment period. The advance payment calculated is to be divided evenly between the corresponding dates for advance payments. <?page no="189"?> 190 2 Personal income tax Note The income tax is to be paid in advance on 10 March, 10 June, 10 September and 10 December to the tax authorities. b) The deduction of withheld wage tax and capital yields tax  The deduction of wage tax Income tax is assessed directly at the source of the income (so-called wage tax deduction) for income from dependent-employment within the meaning of Sec. 19 EStG. Wage tax is regulated in Secs. 38 to 42g EStG and is not considered to be its own type of tax but rather a special assessment form of the income tax. Note Wage tax is a special assessment form of the income tax and can only be assessed on income from dependent-employment within the meaning of Sec. 19 EStG. Wage tax possesses the character of an advance payment of income tax. Until 31 December 2012, the wage tax card was an indispensable tool for informing the employer of the personal data required for income tax deduction. Every employee with unlimited tax liability was sent a wage tax card by the municipality responsible for him before the beginning of the respective calendar year. Since 1 January 2013, the wage tax card has been replaced by an electronic procedure which is the exclusive responsibility of the tax office. The stored details of the electronic procedure are referred to as Electronic Wage Tax Deduction Features (ELStAM). Instead of the wage tax card, the employer now only needs once the employee's tax identification number (Sec. 139b AO), his date of birth and information as to whether the employment relationship is a main or secondary one. However, the electronic procedure does not result in any changes to the wage calculation or the tax return. Likewise, the tax office only stores the information that was entered on the front of the wage tax card (e.g. tax bracket, number of child allowances or other allowances and religious affiliation). No other personal data is collected. Pursuant to Sec. 39e (4) sent. 1 EStG, the employee must inform each of his employers upon entering into the employment relationship for the purpose of retrieving the ELStAM about his identification number, date of birth and <?page no="190"?> 2.2 Determination of taxable income 191 any tax allowances in accordance with Sec. 39a EStG. In addition, he must inform the employer whether this is the main employment relationship or another employment relationship. In principle, the employer of the main employment relationship has more extensive information possibilities regarding the ELStAM of the employee than an employer of another employment relationship. Only a part of the ELStAM is at the employee's disposal (tax category 6, religious affiliation and, if applicable, an allowance). In general, the employee can, upon application to the competent tax office, decide for himself which employer he grants the right to retrieve the data provided and which employer he excludes from this. The employer requires this data in fulfilment of the legal obligation to calculate and pay the income tax, the solidarity surcharge and, if applicable, the church tax (Sec. 38 (3) sent. 1 i.c.w. Sec. 41a (1) sent. 1 EStG). With regard to the income tax category pursuant to Sec. 38b EStG, a distinction must be made between six tax categories ÷ depending on the marital status and the number of children of the taxpayer (see Table 16): Table 16: Classification of tax categories Assessment period 2010 introduced tax category IV with factor (so-called factor procedure) for spouses who both receive wages. This is intended to offer an alternative to the III/ V tax category combination. The aim is to enable the spouse with the lower wage to earn a higher net wage by applying the advantages of tax category IV to the lower earner. The basic allowance and the tax-reducing effect of the splitting tariff are taken into account on the basis of the factor. <?page no="191"?> 192 2 Personal income tax The other tax categories already take into account the income tax benefits, such as the lump-sum allowance for employees, the basic allowance and the special expenditure lump-sum. The amount of income tax is generally calculated on the basis of the annual salary (Sec. 38a (1) sent. 1 EStG). On the basis of the basic and splitting tables for income tax purposes, the income tax tables were drawn up which show the corresponding income tax amounts for the individual tax categories. In the case of minor and short-term employment relationships, however, the income tax may be flat-rate. Pursuant to Sec. 38 (2) sent. 1 EStG, the debtor of the income tax is the employee. The wage tax becomes due when the wages flow to the employee. However, the employer is obligated to withhold the wage tax and pay it to the fiscal authorities (Sec. 38 (3) sent. 1, Sec. 41a (1) sent. 1 EStG). The wage tax is to be reported and paid by the employer no later than 10 days after the reporting period for wage tax expires (which usually corresponds with the calendar month). In principle, income tax is deemed to be settled by the deduction of income tax (so-called compensation effect of income tax, Sec. 46 (4) EStG). Taxpayers who only receive income within the meaning of Sec. 19 EStG as employees are therefore not assessed for income tax (Sec. 46 (2) EStG). However, an assessment can be made on the basis of the statutory provisions (compulsory assessment under Sec. 46 (2) nos. 1-7 EStG) or on application (voluntary assessment under Sec. 46 (2) no. 8 EStG). The voluntary assessment is carried out if the taxpayer has expenses which are higher than the lump-sum allowances. If income tax was levied in the course of the calendar year, it must be deducted from the income tax to be determined pursuant to Sec. 36 (2) sent. 1 no. 2 EStG. Example: Anton is an employee, but also has a business. According to his wage tax card, the wage tax that was withheld from his wages during the assessment period 2018 amounted to € 1,500. He also paid a total of € 4,000 in advance for his income in 2018. Anton’s total tax liability for 2018 is € 9,000. The final payment Anton must make is calculated as follows: The income tax paid in advance (€ 4,000) and the withheld wage tax (€ 1,500) are to be deducted from the personal income tax to be assessed amounting to € 9,000: Income tax to be assessed ./ . Income tax paid in advance ./ . Wage tax paid € 9,000 ./ . € 4,000 ./ . € 1,500 = Final payment = € 3,500 Anton’s final payment for the assessment period 2018 amounts to € 3,500. <?page no="192"?> 2.2 Determination of taxable income 193  The deduction of capital yields tax For certain income from capital assets, income tax is levied by way of direct assessment at the source of the income (capital yields tax). The capital yields tax - similar to the wage tax - does not form its own type of tax, but rather merely a special way of levying income tax. The capital yields tax is regulated in Secs. 43 to 45e EStG. Capital yields tax is only levied on the domestic capital yields or capital gains named explicitly in Sec. 43 (1) EStG. According to Sec. 44 (1) sents. 1 and 2 EStG, “the obligor of the capital yields tax is […] the obligee of the capital yields. The capital yields tax becomes due when the capital yields flow to the obligee”. The obligor of the capital yield and/ or the paying institution is liable for the deduction of the capital yields tax and/ or its payment to the fiscal authorities by the 10 th of the following month (Sec. 44 (1) sents. 3 and 5 EStG). Furthermore, they are also obliged within the meaning of Sec. 45a (2) sent. 1 EStG to issue the obligee of the capital yields a tax certificate, which contains the capital yields tax that has been withheld and paid, to be presented to the tax authorities. If capital yields tax was levied during the course of the calendar year, this is to be credited to the personal income tax to be assessed in accordance with Sec. 36 (2) sent. 1 no. 2 EStG. A special feature has arisen since the introduction of the flat-rate withholding tax. If capital yields flow into the taxpayer’s private assets, the flat-rate withholding of capital yields tax has a compensatory effect (Sec. 43 (5) sent. 1 EStG). If, on the other hand, the capital yields flow into the business assets or if one of the conditions of Sec. 32d (2) EStG is fulfilled, the capital yields tax merely represents an advance payment on the income tax (Sec. 43 (5) sent. 2 EStG). Note The capital yields tax is a special way of levying the income tax and is only levied on certain income from capital assets within the meaning of Sec. 20 EStG. The capital yields tax - similar to wage tax - possesses the character of an advance payment of taxes. Example: The same assumptions as in the last example apply here. In the assessment period 2018, the paying institution withheld and paid capital yields tax amounting to € 300 on behalf of Anton (for dividend income according to the tax certificate from participation held by Anton in his business assets). The amount of the final <?page no="193"?> 194 2 Personal income tax payment and/ or the refund entitlement is calculated as follows: In this case the advance payments and the withheld wage tax and capital yields tax are deducted from the income tax to be assessed: Income tax to be assessed ./ . Income tax paid in advance ./ . Wagetax paid ./ . Capital yields tax paid € 9,000 ./ . € 4,000 ./ . € 1,500 ./ . € 300 = Final payment = € 3,200 Anton must make a final payment of € 3,200 to the fiscal authorities. Summary ► Sec. 32a EStG contains provisions on the normal rate for income tax. A distinction must be made thereby between the basic rate (Sec. 32a (1) EStG) and the splitting rate (Sec. 32a (5) EStG). ► The reduced rate under Sec. 34 (1) or (3) EStG (one-fifth rule or reduced average tax rate) applies to extraordinary income. ► For the so-called undrawn profit within the meaning of Sec. 34a (2) EStG, the reduced tax rate of 28.25 % can be claimed upon application. If taxed profits are withdrawn again at a later date in the current financial year at a preferential rate, an additional tax rate of 25 % must generally be applied. ► The scaled income tax is to be reduced by the trade tax rate relief allowance and by 50 % of the contributions made to political parties (max. € 825). The income tax to be assessed is to be reduced by the income tax paid in advance and by the withheld wage tax and capital yields tax in order to determine the amount of the final payment and/ or the refund entitlement. Questions 1. The normal rate is regulated by which provision? 2. What advantage results from the joint assessment of married couples? 3. What benefits are eligible for extraordinary income? 4. What is the difference between the subsequent taxation amount and the amount subject to subsequent taxation? 5. How is the so-called amount subject to subsequent taxation determined? 6. How is the income tax to be assessed determined? 7. How high is the trade tax rate relief allowance? 8. What must be taken into consideration with respect to political donations? 9. How is the amount of the final payment and/ or tax refund determined? 10. Which taxpayers must make advance payments? When are advance payments to be paid? 11. Briefly characterize the wage tax. What function does the wage tax card have? 12. Briefly characterize the capital yields tax. How can the taxpayer prove that the capital yields tax has already been paid to the fiscal authorities? <?page no="194"?> 2.3 Partnerships 195 Literature Dietrich Grashoff, Florian Kleinmanns, Aktuelles Steuerrecht 2017 (Current tax law 2017), Munich, 13 th ed. 2017, pp. 30-54, 67-86. Dieter Schneeloch, Stephan Meyering, Guido Patek, Betriebswirtschaftliche Steuerlehre, Bd. 1: Grundlagen der Besteuerung, Ertragsteuern (Business taxation, Vol. 1: Principles of taxation, profit taxes), Munich, 7 th ed. 2016, pp. 58-91, 95-139. Klaus Tipke, Joachim Lang, Steuerrecht (Tax law), Cologne, 22 nd ed. 2015, pp. 321-476. Partnerships As partially independent legal entities, the partnerships occupy an intermediate position between capital companies and sole proprietorships. Capital companies are, as legal entities, legally independent and are thus separately taxable subjects. As a result, the capital company itself is subject to taxation in addition to its shareholders (so-called principle of separability ). In contrast, the operating assets of a sole proprietor are not legally independent. The company result of a sole proprietor is subject to income tax (so-called principle of transparency ). The conclusion of contracts between the sole proprietor and his or her company is neither possible under civil law nor under tax law (so-called self-contracting in accordance with Sec. 181 of the German Civil Code - BGB). In the case of partnerships, it depends on the tax type whether the partnership is a separate taxable entity. For income tax purposes, the determination of the result is initially carried out at the company level. As a result, partnerships acquire a certain partial legal capacity under tax law with regard to taxation. Only in a second step is the result achieved by the partnership distributed proportionately among the shareholders as their own original income and, depending on the capacity of the shareholders as natural persons or legal entities, subject to income tax or corporate income tax. With regard to income tax and corporate income tax, the partnership is therefore not a tax subject , but only a subject of income generation and income determination, i.e. the principle of uniformity applies. Due to the lack of income tax or corporate income tax subject characteristics, the partnership has an influence on the level of the shareholders. This means that not the partnership itself, but the partners are subject to income tax or corporate income tax. Example: After completing their university studies in Munich, Monika and Andrea founded the Glock‘n-OHG, in which they are both equally involved. The OHG achieves a profit of € 200,000 already in the first year. The OHG itself is not taxable, but its <?page no="195"?> 196 2 Personal income tax shareholders with the proportionate income. Thus Monika and Andrea must tax each € 100,000 (1/ 2 of € 200,000) as business income (Sec. 15 EStG). Table 17: Tax subjectivity of the company For other tax types (e.g. trade tax, value-added tax), however, the partnership has tax subject characteristics. In the case of a participation in a partnership, it is not decisive for the income tax treatment of the income whether a partnership exists under civil law, but whether the partner is to be qualified as a co-partner . Since a partnership possesses partial legal capacity (cf. Secs. 124, 161 (2) German Commercial Code - HGB), civil law contracts between the partnership and its partners ÷ in contrast to a sole proprietorship ÷ are possible. 2.3.1 Co-partner income a) Requirements for co-partner status The following requirements must be fulfilled cumulatively in order to qualify the partner of a partnership, e.g. OHG (general partnership), KG (limited partnership), BGB-Gesellschaft (civil-law-partnership) as a co-partner: Figure 50: Cumulative requirements for co-partner status • Shareholder position: The taxpayer must be a partner of a partnership under civil law. • Co-partner risk: The partner must participate in the result of the partner- <?page no="196"?> 2.3 Partnerships 197 ship. In addition to the participation in the profits and losses, this also means participation in the unrealized gains and the goodwill. • Co-partner initiative: The taxpayer must be able to participate in decisions affecting the business (e.g. by way of voting rights, supervisory rights and objection rights). The concept of co-entrepreneur is an “open type concept”, i.e. it cannot be conclusively defined by a list of fixed characteristics, but can only be described by a larger and indefinite number of characteristics. Whether the partner is to be qualified as a co-partner ultimately depends on the overall circumstances. According to R 15.8 (1) EStR, the characteristics can be more or less strongly pronounced in individual cases. b) Determination of profit In spite of not being a taxable subject (with respect to income tax and corporate income tax), the partnership must determine its profits independently. The total profits determined are subject to trade tax for the partnership itself. For the purposes of income tax, the business income of each individual copartner is calculated in accordance with Sec. 2 (2) no. 1 i.c.w. Sec. 15 (1) sent. 1 no. 2 EStG according to their share of the total profits of the partnership. The determination of the total profit is based on the tax balance sheet derived from the commercial balance sheet. A commercial balance sheet may not, however, contain assets that do not belong to the partnership. In other words, only the business assets that are viewed as the collective property of all partners ( joint assets ) are taken into account. Under tax law, however, assets that belong to one of the co-partners are also counted as operating assets under certain circumstances. On the one hand, that is the case if the asset of the partnership serves to carry out the commercial activity and has been provided to the partnership by the co-partner for that purpose (necessary separate business assets I ). On the other hand, the separate business assets include assets that serve as the partner’s share in the partnership (necessary separate business assets II ), i.e. any shares that a limited partner holds in the complementary GmbH (private limited company, Ltd.) of a GmbH & Co. KG (limited partnership with a limited liability company as a general partner). Assets that are objectively suited and subjectively intended to support the operation of the company and/ or the participation in the company may be considered to be voluntary separate operating assets. Note • A commercial balance sheet may only contain so-called joint assets. • Under tax law, assets that belong only to a single co-partner may have to be included in the business assets (separate business assets). <?page no="197"?> 198 2 Personal income tax These “separate” business assets are, however, not accounted for in the balance sheet of the company, but rather in separate balance sheets for the individual partners, i.e. separate balance sheets . This primarily leads to a clear separation in the balance sheet of the assets belonging to the individual partners from that of the company. Secondly, this method allows the identity of the tax balance sheet with respect to the assets accounted for in the commercial balance sheet to be maintained (cf. authority principle). Note Separate business assets are accounted for in the separate balance sheets of the respective partners. The result of these separate balance sheets, which actively and passively account for the separate business assets of the respective partner, also contains so-called special business earnings (Sonderbetriebseinnahmen) in case that these are contracts under the code of obligations between partner and partnership in place. These are booked in the separate profit and loss sheet (Sonder-GuV). The following circumstances in connection with contracts under the code of obligation usually come into consideration (cf. Sec. 15 (1) sent. 1 no. 2 EStG): • Remunerations that a partner has received for work performed in the course of duty; • Interest for loans that the partner has granted the partnership; • Rent for a building that the partner has let to the partnership. Accounts receivable that the partner is entitled to from the partnership in this regard are also accounted for in the separate balance sheet. The determination of the (business) income of a co-partner thus requires a method consisting of two steps: Step 1: The total profit of the partnership is determined according to the provisions under commercial law and tax law. In personal relationships between partnership and partner are to be fully taken into account as an income-statement related expenditure. The total profit determined in this way is to be allocated to the partners according to the profit distribution key (the so-called separate and uniform determination of profit, Secs. 179, 180 AO). Step 2: The special remuneration paid to the partners (for work performed as well as <?page no="198"?> 2.3 Partnerships 199 for the provision of capital and other assets) is added to the partner’s profit share calculated in step 1 (the so-called additive profit determination (additive Gewinnermittlung )). This neutralizes the expenditure that comes from the contracts concluded with the partners. The expenditure related to the realization of special business income ( special business expenses ) is subtracted (e.g. depreciation for a computer provided by a partner). In this way, remuneration that is paid by the partnership for work performed by the partner (so-called special remuneration = special business income of the respective partner) does not reduce the profit. As a result, remuneration on the basis under the code of obligation, which are concluded between the partnership and the partner for work performed, loans granted and/ or assets transferred, are not accepted fiscally. These types of contracts thus do not lead to a reduction of the assessment basis for the trade tax. Figure 51: Determination of the business income of the partner <?page no="199"?> 200 2 Personal income tax Salaries are generally subsumed under income from dependent-employment (Sec. 19 EStG), income from interest under the income from capital assets (Sec. 20 EStG) and rental income under income from rent and lease (Sec. 21 EStG). If, however, income is concerned that is earned within the scope of a co-partnership, it is to be re-qualified as business income in accordance with Sec. 15 (1) sent. 1 no. 2 EStG. The re-qualification, however, only applies with respect to tax law, not commercial law. Therefore, the payments to the partners are still booked as business expenses. Figure 52: Determination of the total taxable profit It must be noted that the Federal Fiscal Court (BFH) decided in its judgment of 6 June 2002 that the remuneration for the work performed by partners of a partnership is subject to value-added tax if it is designed as a separate reward (i.e. the remuneration is independent on the profit) and the requirement of independence of the partner performing the work is fulfilled (which is regularly the case). <?page no="200"?> 2.3 Partnerships 201 Example: Max and Götz are equal partners in the Fürsten-OHG (general partnership). For the sake of simplicity, sales revenue of € 200,000 and other expenditures of € 10,000 are to be assumed. Max receives a salary of € 5,000 per month from the OHG for managerial and representative work performed. Götz rents real estate (with a book value of € 250,000) to the partnership for € 30,000 a year. The salary and the rental payments are correctly booked by the OHG as expenditures. Determine the profit share for Max and Götz as well as the total taxable profit of the OHG. Step 1: First, the result of the commercial balance sheet and/ or tax balance sheet of the Fürsten-OHG must be determined. The resulting profit is to be allocated to the partners according to the profit distribution key: P&L of the OHG Other expenditures € 10,000 Salary € 60,000 Rent € 30,000 Profit € 100,000 Sales revenue € 200,000 € 200,000 € 200,000 Profit according to commercial/ tax balance sheet: € 100,000 Max Götz € 50,000 € 50,000 Step 2: In the second step of determining the profit, the relationship between the performances by the partner and the partnership is drawn up. The remuneration for work performed and the rental payments that were correctly treated as business expenses in the first step of determining the profit are now matched by the special business earnings at the level of the partner. Separate balance sheets are to be prepared that contain the separate business assets of the partnership. The special remuneration paid by the OHG to the respective partner is subsequently added. The expense booked by the OHG is thus neutralized again. Separate balance sheet for Götz Real estate Rents receivable € 250,000 € 30,000 Capital on 1 Jan. + Profit € 250,000 € 30,000 Capital on 31 Dec. € 280,000 € 280,000 € 280,000 <?page no="201"?> 202 2 Personal income tax Separate P&L for Götz Profit € 30,000 Rent € 30,000 € 30,000 € 30,000 It is generally true that the remuneration for work performed that is paid by the partnership to its partners is considered to be deductible business expenses of the partnership within the meaning of Sec. 4 (4) EStG. In the separate accounts for the managing partner, the remuneration owed is booked as revenue and at the same time. a) as a withdrawal within the meaning of Sec. 4 (1) sent. 2 EStG in the event of payment,or b) as a receivable againstthe partnership in the event that it has not been paid or the payment has been postponed. to be booked: 1. 31 Jan Private withdrawal € 5,000 to Special remuneration (revenue) € 5,000 … 11. 30 Nov Private withdrawal € 5,000 to Special remuneration (revenue) € 5,000 12. 31 Dec Receivables € 5,000 to Special remuneration (revenue) € 5,000 A receivable of € 5,000 is to be booked within the scope of Max’s separate accounts because his salary for December is transferred to his bank account in January of the following year. Separate balance sheet for Max Receivables € 5,000 Capital € 5,000 € 5,000 € 5,000 Separate P&L for Max Profit € 60,000 Remuneration for work performed € 60,000 € 60,000 € 60,000 This results in the following separate and uniform profit determination (Secs. 179, 180 AO): Max Götz Profit share Special business earnings € 50,000 + € 60,000 Profit share Special business earnings € 50,000 + € 30,000 <?page no="202"?> 2.3 Partnerships 203 Income within the meaning of Sec. 15 EStG = € 110,000 Income within the meaning of Sec. 15 EStG = € 80,000 A total of € 190,000 (€ 1 10,000 + € 80,000) is subject to taxation as business income within the meaning of Sec. 15 EStG. The contracts of obligation between partnership and its partners (salary and rent) are not accepted fiscally. The expenditure booked by the partnership are neutralized by the addition within the scope of the second step. The resulting amount of € 190,000 is the taxable profit of the co-partnership and is subject to trade tax from the OHG. Therefore, the assessment basis of the trade tax is not reduced by contracts between the partnership and partners. The income of € 110,000 for Max and € 80,000 for Götz are each subject to personal income tax as business income within the meaning of Sec. 15 EStG . It must be taken into consideration that separate balance sheets are not the only special balances that are to be prepared for the partner of a partnership. In addition, so-called supplementary tax balances (Ergänzungsbilanzen) exist that are not to be confused with the formerly mentioned balance and are primarily of importance in the event that there is a change in partners. The tax consequences of a change of shareholder only apply to the selling and the acquiring shareholder, but not to the co-entrepreneurship itself. Together with the company balance sheet, the supplementary balance sheet shows the tax-applicable value of the share in the total assets for the individual co-entrepreneur and must therefore be included in the determination of profits at the first stage, although these are purely personal tax characteristics of the individual shareholder. Special balance sheets, on the other hand, are only relevant for determining income at the second level. Note If the acquisition costs of the co-partner share are higher than the book value of the capital account of the shareholder, the difference is to be recorded in a supplementary balance sheet so that the addition expenditure is not recognized in the overall balance sheet. In accordance with Sec. 6 (1) no. 7 EStG, the acquisition of a co-entrepreneur share must be shown at acquisition cost. It must be taken into consideration that a partnership share is not considered to be a formal economic asset. <?page no="203"?> 204 2 Personal income tax Rather, the newly arriving partner acquires a share of all economic assets belonging to the assets of the company. The costs of acquisition are usually higher than the book values because of the hidden reserves. Since step-up of the assets due to higher purchase price than book value of respective equity portion often shall be avoided, the concerned co-partner has to consider the portion that exceeds the book value in a supplementary balance sheet. On the asset side of the supplementary balance, the surplus expenditure is divided among those assets that cause it because of their immanent hidden reserves. The additional expenditure for the pro rata acquisition of the assets of the partnership is therefore not recognized in the overall commercial balance sheet. The existing capital account of the withdrawing shareholder in the overall commercial balance sheet will be replaced in the same amount by the capital account of the new shareholder. If the additional amount of the acquisition costs were recorded in the company balance sheet, this would have an effect on profits for all shareholders. Supplementary balance sheets thus contain corrective positions specific to the partners that cause the tax shares of the individual partners of a co-partnership to be accounted for correctly. This comes to bear in the following situations: • Resignation of a partner, • Liquidation of the company, and • Divestiture or consumption of the partnership’s assets for which a corrective position is entered into a supplementary balance sheet of a partner, because the valuations booked there are to be liquidated with effect on the income statement. Therefore, if the assets of the partnership for which a corrective position exists in a “supplementary” balance sheet for a partner are sold for a profit, this leads to a reduction of the fiscally relevant profit share of the respective copartner. The profit share of the partner based on the partnership’s balance sheet is to be corrected by the surplus book value according to the supplementary balance sheet because hidden reserves were already subject to taxation when the co-partnership share was acquired. The latter represents the revealed hidden reserves attributable to the corresponding asset when the partners change. The reasons for this systematic lie accordingly in the relevant assessment of tax on the hidden reserves from the partner who - after inclusion of the sales and/ or purchase price of the partnership share - actually netted a profit from the sale of the assets. Example: A and B are equal partners in the S-OHG (general partnership). B sells his copartnership share to C on 1 January 2018 for € 300,000 whereby B’s capital account was accounted for in the company balance sheet with € 200,000. The surplus <?page no="204"?> 2.3 Partnerships 205 expenditure amounting to € 100,000 is to be ascribed to the share of the hidden reserves in the book value of the real estate (€ 60,000) and of a patent (€ 40,000). Tax balance sheet for the S-OHG Assets € 400,000 Capital (A) € 200,000 Capital (C) € 200,000 € 400,000 € 400,000 A supplementary balance must be prepared because the purchase price of the partnership share (and/ or the purchase price for the shares in the assets of the company) exceeds the book value, but C wants to continue with B’s capital account in the balance sheet for the OHG. Supplementary balance sheet for C Surplus value of real estate € 60,000 Surplus value of patents € 40,000 Surplus capital € 100,000 € 100,000 € 100,000 Example (continued): The real estate, which is activated in the balance sheet for the OHG with a book value of € 120,000, is then sold for € 500,000. The profit share for C is determined as follows: Profit share on the basis of the OHG-balance sheet Less the surplus value according to the supplementary balance sheet € 190,000 ./ . € 60,000 Tax-relevant profit share for C € 130,000 The hidden reserves in connection with the real estate that were revealed when the co-partnership share was assumed were already paid by C in the purchase price. This € 60,000 is thus subject to taxation on the part of the leaving partner B. Consequentially, C only pays taxes on his actual profit amounting to € 130,000. 2.3.2 Other partners of a partnership If a co-partnership does not exist, payments made by the partnership to partners are deductible business expenses of the partnership. The partner must then pay taxes on these payments according to the qualification of the underlying source of income. The partners of a typical silent partnership within the meaning of Secs. 230 et seqq. of the German Commercial Code (HGB) are, for example, not co- <?page no="205"?> 206 2 Personal income tax partners. The silent partner necessarily shares in the profits and usually in the losses in return for the payment of a contribution, but only has a claim to have the capital contribution paid back if the company is liquidated. The silent partner participates neither in the hidden reserves nor in the goodwill of the company. Participatory rights other than those of verification are lacking. In the absence of a co-partnership, the profit shares of the silent partners are deductible business expenses at the level of the trade’s owner and result in income from capital assets for the silent partner (Sec. 20 EStG). The optional statutory rules also allow the silent partnership to be formed such that it fulfills the requirements of a co-partnership ( atypical silent partnership ), e.g. by contractually stipulated participatory rights and participation in the hidden reserves. In this case, the atypical silent partner earns business income as a co-partner (Sec. 15 EStG). Summary ► The partnership occupies an intermediate position between the capital company and the sole proprietorship with respect to tax liability and the quality of being a taxable subject. ► The partnership is not a taxable subject with respect to income tax and corporate income tax, but with respect to trade tax and value-added tax. ► The cumulative requirements to be considered a co-partner are shareholder position, copartner risk and co-partner initative. ► Sec. 15 (1) sent. 1 no. 2 EStG names the parts of co-partnership income. ► A commercial balance sheet may only contain so-called joint assets. In tax law, assets that belong to a partner may also belong to the business assets under certain circumstances (separate business assets). ► Separate business assets are accounted for in special balance sheets for the respective partners. ► The profit share from the co-partnership is determined using a two-step process: First, the partnership’s result on partnership’s tax balance sheet level is to be determined and allocated to the partners according to the profit distribution key. Afterwards, the profit share respective remunerations are to be added to the profit share of the shareholders. ► Supplementary balance sheets insure that the partners’s fiscally correct share of the joint assets is accounted for correctly. ► Inasmuch as the requirements for being a co-partner are not fulfilled, Sec. 15 (1) sent. 1 no. 2 EStG does not apply, so that the payments are to be accepted as business expenses of the partnership and are to be subject to taxation from the partner within the scope of that partner’s surplus income. <?page no="206"?> 2.3 Partnerships 207 Questions 1. Is the partnership a taxable subject of income tax and corporate tax? 2. On what attribute does the participation in partnerships depend? What requirements must be fulfilled thereby? 3. What is a separate balance sheet? 4. What parts make up the profit share from the co-partnership within the meaning of Sec. 15 (1) sent. 1 no. 2 EStG? 5. How is the profit share from a co-partnership determined? 6. What is a supplementary balance sheet? 7. How are partners treated fiscally who are not to be qualified as co-partners? Literature Dietrich Grashoff, Florian Kleinmanns, Aktuelles Steuerrecht 2017 (Current tax law 2017), Munich, 13 th ed. 2017, pp. 54-66. Ulrich Niehus, Helmut Wilke, Die Besteuerung der Personengesellschaft (The taxation of the partnership), Stuttgart, 7 th ed. 2015, pp. 20-36, 347-358. Dieter Schneeloch, Stephan Meyering, Guido Patek, Betriebswirtschaftliche Steuerlehre, Bd. 1: Grundlagen der Besteuerung, Ertragsteuern (Business taxation, Vol. 1: Principles of taxation, profit taxes), Munich, 7 th ed. 2016, pp. 92-94. Klaus Tipke, Joachim Lang, Steuerrecht (Tax law), Cologne, 22 nd ed. 2015, pp. 622-655. <?page no="208"?> Corporate income tax Basic principles As legal entities, corporations possess their own legal personality. Corporations are thus independent subjects of corporate income tax, value-added tax, land transfer tax, etc. The corporate income tax is assessed as a profit tax on the income from corporations according to a proportional rate. Since corporations are the most important type of corporate entity in the German economy, the following explanations will mainly focus on capital companies. Their own legal personality gives rise to the separation between the legal sphere of the capital company and the legal sphere of its shareholders (socalled principle of separability). If a corporation retains its profits, the ability of its shareholders to pay does not increase so that a tax liability does not result for them. Dividends are only taxed at shareholder level when they are distributed, so that a double taxation of the same profit is given. Example: For the sake of simplicity, assume that the corporate income tax rate and the personal income tax rate are both 50 %. If the capital company generates profits of € 100,000, it would have to pay € 50,000 in corporate income tax. In the event that the profit is distributed, the shareholder, who is a natural person, receives the remaining € 50,000 as a dividend, which is again subject to taxation as income from capital assets within the meaning of Sec. 20 (1) no. 1 EStG at the personal income tax rate of 50 %, i.e. € 25,000. If the corporate income tax and the personal income tax are added together, the profit tax burden amounts to 75 %. In this scenario, capital companies would only be selected as investment alternatives in the most seldom of cases because sole proprietors and/ or partnerships are not subject to comparable taxation. For this reason, it is necessary to take the corporate income tax paid by the capital company into consideration in the taxation of the shareholders’ dividends and/ or to keep economic tabs on double taxation by ensuring tax privileges at the level of the capital company and that of the shareholder. A distinction can be made between the following corporate income tax systems: a) The classic system: The profits of the capital company are taxed separately. The tax burden can differ in the case of distribution or accumulation. Modern systems, however, generally stipulate a uniform tax rate that is independent of the way the profit is appropriated. In addition, the distributed profits are <?page no="209"?> 210 3 Corporate income tax subject to personal income tax from the shareholders (in the case of a natural person) and/ or corporate income tax (in the case of a capital company). The term definitive burden (Definitivbelastung) of corporate income tax is used because the corporate income tax cannot be credited to the personal tax liability of the shareholder. In order to compensate for the disadvantages of double taxation in comparison to sole proprietorships and partnerships, corporate income tax is kept low on the one hand. And on the other hand, various privileges are provided for the dividend income of natural persons, e.g. the so-called partial-income method (Teileinkünfteverfahren ) according to Sec. 3 no. 40 lit. d EStG and the flat-rate withholding tax according to Sec. 32d EStG . The income from investments (Beteiligungserträge) from capital companies is usually exempt from taxation in order to prevent multiple tax liabilities within the same corporate group, i.e. in the case of distributions between capital companies. However, in Germany this is made dependent on a minimum participation rate, which must directly amount to at least 10 % from the beginning of the calendar year. b) The crediting system: The profit of the capital company is subject to corporate income tax at the level of the capital company. The corporate income tax is, however, considered to be only an advance payment on the personal tax liability of the shareholder. If the shareholder is a natural person, the dividends (including the corporate income tax paid on these) that flow to the shareholder are subject to the shareholder’s individual personal income tax rate, whereby the shareholder may credit the corporate income tax already paid by the capital company to his or her own personal income tax liability. As a result, the share of the capital company’s profit is always taxed at the respective individual tax rate. However, if the shareholder is a capital company, then the corporate income tax to be paid on the dividend received matches the creditable corporate income tax of the distributing capital company. No additional tax burden occurs with corporate income tax. Note The classic system and the credit system are considered to be the fundamental corporate income tax systems. <?page no="210"?> 3.1 Basic principles 211 Additional theoretical approaches, such as the exclusive taxation at the level of the capital company and/ or at the level of the shareholder were not pursued for reasons related to the technical assessment and aspects of tax equality. Up until and including 1976, distributed profits were generally burdened twice by the pure characteristics of the classic system that applied in Germany at the time. This double burden was successfully removed by the introduction of the full-credit system with a split tax rate in 1977. Withheld (retained) profits were finally taxed with a corporate income tax rate of 40 %, distributed profits however only with a corporate income tax rate of 30 %. As of the beginning of assessment period 2001 (in the case of a deviating fiscal year as of assessment period 2002), this crediting method for corporate income tax was replaced by the so-called half-income method (Halbeinkünfteverfahren). This corresponds with the classic system described above with the particularity that if the dividends are distributed to natural persons, only half are subject to taxation, whereas they are not subject to any taxation if they are distributed to capital companies. As of 1 January 2009, the half-income method was again replaced by the partial-income method and the flat-rate withholding tax within the meaning of Sec. 32d EStG. In principle, the partial-income method follows the principles of the half-income method, but it only leads to a 40 percent tax exemption and is only applicable if the relevant profit distributions are attributable to the operating sphere of the recipient. Distributions to capital companies are tax-exempt pursuant to Sec. 8b (1) KStG, but since assessment period 2013 this has mainly been made dependent on a minimum participation rate of 10 % (Sec. 8b (4) KStG). In all other cases, the flat-rate withholding tax rate in accordance with Sec. 32d EStG is applied, which results in an uniform tax burden of 25 % for the recipient of the distribution by deduction at source. Capital yields tax was and is assessed in both corporate income tax systems. The withholding of this tax at the level of the corporation is intended to secure the tax revenue. The capital yields tax can, however, be credited to the tax liability of the shareholder insofar as it has not already been explicitly attributed a compensatory effect by the legislator. In addition, a solidarity surcharge of 5.5 % is levied on the assessed corporate income tax as a supplemental contribution, as is the case with personal income tax. 3.1.1 Characteristic features The corporate income tax is a personal and/ or subject tax, as is personal income tax. It is thus also referred to as income tax for legal entities . The corporate income tax is to be classified as a direct tax as well as a profit tax. <?page no="211"?> 212 3 Corporate income tax The assessment basis of the corporate income tax is the taxable income of the corporation that is determined in accordance with the provisions of German Income Tax Act (Einkommensteuergesetz, EStG) and German Corporate Income Tax Act (Körperschaftsteuergesetz, KStG). In doing so, the net income principle (Nettoprinzip) is taken into consideration. Personal characteristics that can only be had by natural persons (e.g. age, marital status) and the related expenses for the private costs of living (special expenses/ extraordinary burdens) are naturally not taken into consideration. The provisions of income tax act that the fiscal administration considers applicable are named in R 8.1 of the German coporate income tax guidelines (KStR). In particular, these include the following: • the rules on the determination of profit under Secs. 4 et seqq. EStG, • the regulations on the individual types of income (cf. Sec. 8 (2) KStG) as well as • the provisions concerning the loss deduction under Sec. 10d EStG. Note Characteristics of corporate income tax: • Direct tax • Profit tax • “Income tax for legal entities” As a result of the principle of separability , the taxation on the income of legal entities does not depend on the ability of its shareholders to pay the taxes. If, for example, a capital company does not distribute any profits, the shareholder cannot incur a tax liability. A potential loss generated by the capital company can thus not be offset against the positive income of its shareholder. The loss is only taken into consideration at the level of the capital company. An additional consequence of the principle of separability is that contractual relationships such as loans and employment relationships can exist between the corporation and its shareholders and are generally accepted by the fiscal authorities in the same way as are contracts with third parties. Note As a reminder: Contracts concluded between a partnership (co-partnership) and its partners (co-partners) are not accepted by the fiscal authorities (no principle of separability)! <?page no="212"?> 3.1 Basic principles 213 3.1.2 Personal tax liability The tax liability of corporations begins and ends with its capacity as a legal entity. The tax liability begins with the registration in the commercial register (Handelsregister) and ends with the cancellation of the same. Unlimited tax liability In accordance with Sec. 1 (1) KStG, the following corporations, associations of individuals and legal estates that have their management (Sec. 10 AO) or their domicile (Sec. 11 AO) in Germany are subject to unlimited corporate income tax: • capital companies, i.e. European societies (ES), public limited companies (Aktiengesellschaften), partnership limited by shares (Kommanditgesellschaften auf Aktien KGaA), (private) limited companies (Gesellschaften mit beschränkter Haftung), • cooperatives, including European cooperatives, • mutual insurance and pension fund associations • other legal entities under civil law, • unincorporated associations, institutions, foundations and other ad hoc funds under civil law, and • commercial business entertained by legal entities under public law (Sec. 4 KStG). It can be inferred from this conclusive list that a corporate income tax liability does not exist for other legal entities not listed. This applies in particular to legal entities under public law (e.g. regional corporations) and to partnerships, such as the general partnership (OHG), the limited partnership (KG) and the limited partnership with a limited liability company as a general partner (GmbH & Co. KG). As a result of the principle of global income taxation , the unlimited tax liability applies to all domestic and foreign income (Sec. 1 (2) KStG). Note Corporations, associations of individuals and legal estates with domicile or management in Germany are subject to unlimited corporate income tax in Germany (principle of global income taxation). <?page no="213"?> 214 3 Corporate income tax <?page no="214"?> 3.2 Tax assessment basis 215 Limited tax liability The following entities are subject to limited taxation within the meaning of Sec. 2 KStG: • corporations, associations of individuals and legal estates within the meaning of Sec. 1 (1) KStG that have neither their business management (Sec. 10 AO) nor their registered office (Sec. 11 AO), but their earn income in Germany (Sec. 2 no. 1 KStG). Example: Foreign stock companies with operating facilities in Germany. • other corporations, associations of individuals and legal estates which are not subject to unlimited taxation with the domestic income from which a tax deduction is to be effected (Sec. 2 no. 2 KStG). Example: The city Hamburg receives dividend payments on the basis of shares held in a stock company (Aktiengesellschaft). Only domestic income is subject to limited tax liability ( territoriality principle ). 3.1.3 Tax exemption Certain undertakings by the German federal government (e.g. state banks) or legal entities that pursue ecclesiastical, non-profit or charitable aims are exempt in part or in whole (Sec. 6 KStG) from corporate income tax in accordance with Sec. 5 KStG for social and economic-political reasons. Tax assessment basis 3.2.1 Determination of taxable income Like the personal income tax, the corporate income tax is an annual tax (Sec. 7 (3) sent. 1 KStG) and is based on the taxable in come of the corresponding calendar year (Sec. 7 (1) KStG). It is possible to form a fiscal year that differs from the calendar year. According to Sec. 8 (1) KStG, the income is defined in accordance with the German Income Tax Act and the supplemental provisions of the German Corporate Income Tax Act. In Germany corporate entities may generally earn income from all seven types of income in accordance with Sec. 2 EStG. However, as form merchants (Formkaufleute) within the meaning of Sec. 6 of the German Commercial Act (HGB), capital companies are obliged to ensure orderly and adequate bookkeeping in accordance with Sec. 238 HGB, on the basis of which Sec. 8 (2) EStG stipulates as a consequence that all benefits are to be treated as business income within the meaning of Sec. 15 EStG. As a result of the bookkeeping duty <?page no="215"?> 216 3 Corporate income tax under commercial law, they must determine their profit using the accrual method (Betriebsvermögensvergleich) in accordance with Sec. 5 (1) EStG. The basis of the accrual method under Sec. 5 (1) EStG is usually a tax balance sheet that is derived from a commercial balance sheet ( derivate tax balance sheet ). The result of the tax balance sheet does not however correspond with the taxable income. This is adapted to the purposes of corporate income tax by modifications stipulated in the special provisions of income tax law and corporate income tax (Secs. 7 et seqq. KStG). Sec. 9 KStG provides a set of deductible expenditures, while Sec. 10 KStG lists the non-deductible expenditures. Special provisions of the German Income Tax Act to be applied are in particular Sec. 4 (5) and (5b) EStG and Secs. 4h-j EStG. Figure 54: Determination of corporate income tax <?page no="216"?> 3.2 Tax assessment basis 217 Note Corporations can in principle have income from all seven types of income. Capital companies, on the other hand, are limted to income from business income. Question: Why are modifications by special provisions necessary? Why is it possible for the tax balance sheet profit to be different from the taxable income? Answer: The explanation of the crediting provision of Sec. 10 no. 2 KStG is to serve as an example. As a result of this provision, all advance payments of corporate income tax are to be treated as non-deductible expenditure so that these payments, which represent expenditure in the commercial balance sheet of the capital company, lose their effect in the income statement as expenditure and must be added outside of the balance sheet. Advance payments of corporate income tax are treated as non-deductible because “personal” (advance) payments of taxes may not reduce the profit. The payment of the tax must be recorded as an expenditure in the books. However, since a capital company does not have a private sphere, a correction must be made to neutralize the profit effect outside the balance sheet. Figure 54 shows the necessary modifications that must be made to the result of the commercial balance sheet in order to arrive at the taxable income of a capital company. 3.2.2 Adaptations of the commercial balance sheet to the tax balance sheet According to Sec. 60 (2) EStDV, all valuations in the commercial balance sheet that do not correspond to the provisions under tax law are to be adapted thereto by way of additions or comments. Alternatively, an individual tax balance sheet may also be prepared. The special provisions of the fiscal determination of profit can lead to significant differences between the commercial balance sheet and the tax balance sheet. The different provisions on inclusion and valuation are primarily responsible for this. An example of this are the provisions set aside for imminent losses from pending transactions, for which a requirement of full accrual exists under commercial law in accordance with Sec. 249 (1) sent. 1 HGB, but full accrual is proscribed in the tax balance sheet in accordance with Sec. 5 (4a) EStG. <?page no="217"?> 218 3 Corporate income tax In this regard, it should be noted that within the framework of BilMoG, in particular through the abolition of the principle of reverse authoritativeness, there has been an emancipation of the tax balance sheet from the commercial balance sheet, which makes it even more necessary to draw up an independent tax balance sheet. As a result, the adaptations to be made in this regard take those provisions of tax law into consideration that can be accounted for within the scope of transfers and subsequent bookings , i.e. by way of accounting records . For the sake of completeness, this step is to be explained in order to illustrate the difference between the commercial balance sheet profit and that of the tax balance sheet. 3.2.3 Additions and deductions to determine the taxable income outside of the balance sheet All of the adaptations to the tax balance sheet profit made to determine the taxable income and addressed below are corrected outside of the balance sheet , i.e. they are not accounted for with an accounting record , but rather the correction is made in an ancillary calculation to be performed separately. Example: Manuel, the managing director of the Brüder-GmbH (Ltd.) invites his business acquaintances to a dinner costing € 10,000 in the red light district, which he pays via bank transfer in order to procure an assignment absolutely necessary for the survival of the company. The idea was a success and the GmbH actually receives the assignment. <?page no="218"?> 3.2 Tax assessment basis 219 In accordance with Sec. 4 (5) sent. 1 no. 2 and/ or no. 7 EStG, these costs are not considered to be business expenses. The term “business expenses” does not question the commercial character of the expenditures because the expenses were actually necessary for the business in this particular case. However, the general public should not be burdened by the acceptance of the deduction of the expenditure on a visit to the bordello as business expenses. For this reason it is understandable that these expenses may not be deducted . The question is how such a correction is to be made. The payment affected the bank account of the company so that a corresponding contra account would have to be found on the debit side. The entry formula against an account in the private sphere is not possible because capital companies do not possess a private sphere . It can thus only be recognized in the income statement as expenses . This expenditure is added to the result outside of the balance sheet so that no deduction of profit results . The same argumentation applies, for example, to advance payments of corporate income tax. These may not reduce the taxable income at all, but have already reduced the tax balance sheet profit because advance payments were booked in the balance sheet as expenditure. For this reason, Sec. 10 no. 2 KStG provides for an addition outside of the balance sheet to reverse the expenditure that was booked. In principle it can be maintained that only those amounts must be added and/ or reduced outside of the balance sheet that have already been recognized in the income statement as expenditures and/ or income within the scope of the current accounting. Hidden profit distributions Commercial balance sheet profit +/ ./ . Modifications by special provisions of fiscal profit determination (Secs. 4-7i EStG, Sec. 60 EStDV) + Hidden profit distribution ./ . Hidden equity contributions ./ . Tax-exempt income from investments in accord. with Sec. 8b (1) KStG + Non-deductible expenditures in accordance with Sec. 10 KStG • Expenditures for the fulfilment of statutory purposes (no. 1) • Income tax and other personal taxes (no. 2) • Pecuniary penalties (no. 3) • Half of the remuneration for the members of the supervisory board, etc. (no. 4) + Non-deductible expenditures in accord. with Secs. 4 (5), (5b), 4h, 4j EStG, Secs. 8a, 8b (3), (5) KStG = Total income + Donations (Sec. 9 (2) sent. 1 KStG) Tax balance sheet profit <?page no="219"?> 220 3 Corporate income tax The economic purpose of a capital company is generally to generate profits. These profits can then be distributed to the shareholders of the capital company. Profit distributions primarily include dividends from shareholdings or the ownership of shares in a GmbH. In the case of a capital company, profit distributions are part of the appropriation of income and must not under any circumstances reduce the taxable income of the capital company. Pursuant to Sec. 8 (3) sent. 1 KStG, it is therefore irrelevant to the determination of income whether the profit is distributed or not. Profit distributions can be made either as a declared profit distribution or a hidden profit distribution. These two types of profit distributions are explained in more detail below. Figure 55: Distinction between declared and hidden profit distribution A declared profit distribution is a profit distribution which is based on a resolution for an expired financial year in accordance with the provisions of company law. In the so-called profit distribution resolution, the extent to which the earnings generated by the company are to be distributed to the shareholders or allocated to reserves is generally determined after the end of the financial year. <?page no="220"?> 3.2 Tax assessment basis 221 Note A declared distribution is made as a result of a resolution under company law for an expired financial year. Example: The shareholders' meeting of Elisabeth-GmbH decides on 9 June 2018 on a full distribution of the profit for the years 2017 and 2016. A special form of declared distribution of profits is the advance distribution . Advance distributions exist if a profit distribution is made before the annual financial statements are adopted . This means that an advance distribution can be resolved both before expiry , e.g. at the GmbH, and after expiry of the financial year whose profit is to be distributed. Since profit distributions distributed before the end of the financial year are distributions on the expected annual result, advance distributions are always of a provisional nature. The advanced distribution entitlement is therefore subject to the condition that a corresponding distributable profit is shown in the closing balance sheet. If approved annual financial statements and profit distribution resolution do not result in a final dividend in the corresponding amount, the profit already paid out must be repaid by the shareholders. However, the tax effects of the profit distribution remain, i.e. the shareholders receive taxable income from capital assets. In the case of the distributing capital company, the repayment of the shareholder is treated as a contribution. In the case of the stock company (AG), an advance payment on the balance sheet profit can only be made after the end of the financial year, otherwise advance distributions are not possible. Note Declared profit distributions are generally made after the annual financial statements have been approved. Only advance distributions as a special form of declared profit distribution are made prior tot he adoption of the annual financial statements. In contrast to a hidden profit distribution, the declared distribution of profits is posted without affecting net income . Therefore, a correction is not necessary when determining the income. The acounting record (abbreviated and excluding capital yields tax) is: “Per retained earnings to bank”. Pursuant to Sec. 20 (1) no. 1 EStG, declared profit distributions from capital companies to their shareholders, insofar as they are natural persons, gener- <?page no="221"?> 222 3 Corporate income tax ally represent income from capital assets. With regard to the taxation of the declared distribution of profits, a distinction must be made as to whether the distribution is made between • shares held in business assets or • shares held as private assets of the shareholder. Under 3.2.3.3 is explained how taxation takes place when the shareholder is a capital company. a) Shares held in business assets Due to the subsidiarity of income from capital assets pursuant to Sec. 20 (8) EStG, dividends from shares in capital companies that belong to the business assets of sole proprietorships or partnerships are classified as business income and are subject to the partial-income method pursuant to Sec. 3 no. 40 lit. b EStG. The profit distribution is divided into a 40 % share, which remains tax exempt, and a 60 % share, which is subject to taxation at the taxpayer's personal tax rate. In the case of taxation under the partial-income method, 60 % of business expenses are also deductible if they are economically related to the achievement of dividends. b) Shares held in private assets If the shares in capital companies are held in the private assets of the shareholder, the respective capital income is subject to a flat-rate withholding tax of 25 % plus 5.5 % solidarity surcharge pursuant to Sec. 32d (1) sent. 1 EStG. The taxpayer is not permitted to deduct any income-related expenses in connection with such capital income. Pursuant to Sec. 20 (9) EStG, the deduction of a savers’ lump-sum is granted instead. However, the taxpayer has an option under Sec. 32d (2) no. 3 EStG, according to which the application of the flat-rate withholding tax can be waived upon application and the distribution of profits is subject to the regulations of the partial income-method. The exercise of this option requires that the shareholder • holds at least 25 % of the capital of the capital company, or • holds at least 1 % of the capital of the capital compnay and works professionally for it. If the recipient of the dividend is again a capital company, the distribution is tax-exempt in accordance with Sec. 8b (1) KStG if the participation at the beginning of the calendar year amounted to at least 10 % of the share capital (Sec. 8b (4) sent. 1 KStG). <?page no="222"?> 3.2 Tax assessment basis 223 Note Shares held as business assets are subject to the partial-income method pursuant to Sec. 3 no. 40 lit. d EStG, while shares attributable to private assets are subject to a flat-rate withholding tax pursuant to Sec. 32d EStG. Example: The Elisabeth-GmbH (LLC) drew up the following balance sheet as of 31 December 2017: Assets Balance Sheet for the Elisabeth GmbH Liabilities Capital assets € 100,000 Bank € 200,000 Capital stock € 100,000 Retained profit € 180,000 Net income for 2017 € 20,000 € 300,000 € 300,000 On 15 August 2018, the sole shareholder Maria would like to distribute profits of € 100,000. For the sake of simplicity, there were no other business transactions in 2018. The capital yields tax and the solidarity surcharge are also not to be taken into consideration. Maria holds the shares in Elisabeth-GmbH as private assets. No other income or business expenses were incurred. Maria’s personal tax rate is 42 %. The balance sheet thus has the following entries as of 31 December 2018: Balance Sheet for the Elisabeth GmbH Assets as of 31 December 2018 Liabilities Capital assets € 100,000 Bank € 100,000 Capital stock € 100,000 Retained profit € 100,000 Net income for 2018 € 0 € 200,000 € 200,000 At the level of the capital company, the declared distribution of profits leads to a reduction in retained earnings in the amount of € 100,000 (opening balance of retained profits as at 1 January 2018 = balance of retained profits as at 31 December 2017 in the amount of € 180,000 plus net income as at 2017 in the amount of € 20,000 = € 200,000). The bank balance decreases by the same amount. At shareholder level, Maria generates income from capital assets pursuant to Sec. 20 (1) no. 1 EStG, which is taxable accordingly. As Maria holds the shares in Elisabeth-GmbH as private assets, the distribution of profits in the amount of € 100,000 is subject to the flat-rate withholding tax of 25 % pursuant to Sec. 32d (1) sent. 1EStG. After taxation, the sole shareholder's income amounts to only € 75,000. However, Maria holds a 100 % interest in Elisabeth-GmbH. She thus fulfils <?page no="223"?> 224 3 Corporate income tax 75,000. However, Maria holds a 100 % interest in Elisabeth-GmbH. She thus fulfils the requirements of Sec. 32d (2) no. 3 EStG and could make use of the option to tax the distribution of profits in the amount of € 100,000 in accordance with the partial-income method. Accordingly, 60 % of the dividend of € 100,000, i.e. € 60,000, would be subject to the sole shareholder's personal income tax rate of 42 %. In this case, the tax liability would amount to € 25,200. In the case of taxation according to the flat-rate withholding tax, the tax liability would thus be € 200 lower. Therefore, Maria should not apply for taxation according to the partialincome method. The treatment of the hidden profit distributions thus differs from the treatment of the declared profit distribution inasmuch as the entry is not recognized in equity, but rather recognized in the income statement as an expense. It is assumed thereby that contractual agreements between the capital company and its shareholders are generally admissible and that the resulting remuneration is - in contrast to contractual agreements between a partnership and its partners - generally considered to be a deductible expense in the determination of profit for tax purposes. The requirement of the fiscal recognition is that the contracts are concluded under conditions similar to those concluded with third parties (so-called dealing at arm’s length). Inasmuch as the agreements made lie outside the scope of the law of obligations, because they grant the shareholder unreasonable advantages and thus are actually rooted in the relationship under company law, are considered unreasonable and, in this respect, are reassigned as a hidden payment of profits (so-called hidden profit distribution ) in accordance with Sec. 8 (3) sent. 2 KStG. Hidden profit distributions are usually discovered within the scope of a tax field audit and thus after the fact. In contrast to the declared profit distribution, hidden profit distributions are not usually planned or intended to be distributions, but rather reassignments of arrangements considered to be unreasonable from the point of view of the legislature. In accordance with R 8.5 (1) KStR, a hidden profit distribution generally contains the following: • a reduction or prevented increase of the corporation’s assets, • that is occasioned by the company relationship (i.e. if a diligent and conscientious director would not have accepted the reduction or prevented increase in assets from a third party ), • that effects the amount of income (i.e. represents an expense or a revenue not received for the company), and • is not based on a profit distribution resolution passed in accordance with the provisions of company law. <?page no="224"?> 3.2 Tax assessment basis 225 In the case of controlling shareholders, a hidden profit distribution by a capital company can also be assumed if there is no clear agreement, reached in advance, effective under civil law and actually implemented, on whether and to what extent remuneration is paid for the performance of the shareholder (R 8.5 (2) KStR). Figure 56: The concept of hidden profit distribution Examples of hidden distribution of profits thus include the following: • an excessive salary for the managing director, • a loan given by a shareholder for which the company pays excessive interest or a loan that a shareholder is granted by the company with an interest rate that is too low, and • sales, rental and lease agreements, services, pension promises, and the standing of surety under unreasonable conditions detrimental to the corporation. Within the scope of the hidden profit distribution, only theunreasonable portion of the contractual agreement is corrected, not however the reasonable portion, i.e. if the managing director receives an excessive salary, for example, only the portion thereof that is considered unreasonable is qualified as a hidden distribution of profits. However, if there is a so-called hidden distribution of profits on the merits - e.g. in the case of infringements which lead to civil law invalidity in connection with controlling shareholders - the entire part will be corrected, even if parts of the allegedly effective contract under the law of obligations would be entirely appropriate. <?page no="225"?> 226 3 Corporate income tax Example: Anton receives a managing director's salary from his GmbH in the amount of € 100,000 as managing partner. Due to the profit situation of the GmbH, only a salary in the amount of € 80,000 would be considered appropriate. The hidden profit distribution thus amounts to € 20,000. The appropriate portion of the salary is not subject to any tax modifications. If the agreements concluded do not bear the arm’s-length comparison (Fremdvergleich), the transaction is classified as a hidden profit distribution. The company and the shareholder are put in the position they would have been in if they had concluded the transaction to reasonable conditions. The hidden profit distribution was treated as an expenditure in the accounts under review because they - as per definition - had an effect on the amount of income. Therefore, the amount of the hidden profit distribution is to be added back to the tax balance sheet profit outside of the balance sheet in accordance with Sec. 8 (3) sent. 2 KStG. Analogous considerations apply if an unreasonably low amount of revenue is recognized. In this manner, the capital company’s assessment basis for corporate income tax and trade tax is increased by the corresponding amount. Note Declared profit distributions are booked without affecting net income. An off-balance sheet addition to the tax balance sheet profit is not necessary. Hidden profit distributions, on the other hand, must be corrected off-balance sheet as they are expensed in the income statement. Example: Maria is sole shareholder and managing director of the Elisabeth-GmbH and in 2017 she receives an annual salary of € 100,000. During the tax field audit in 2018 the auditor determined that only 20 hours of work per week had been stipulated in the contract. In addition, the financial situation of the Elisabeth-GmbH does not justify a salary that high. The auditor thus considers an annual salary of only € 70,000 to be reasonable and re-qualifies € 30,000 thereof as a hidden profit distribution. Before the discovery of the hidden profit distribution the GmbH accounted for an expenditure decreasing the profit by € 100,000. After the discovery of the hidden profit distribution, the profit is only decreased by € 70,000 because the auditor increased the profit outside of the balance sheet by € 30,000. As a result the assessment basis for corporate income tax and trade tax is increased by the amount of the hidden profit distribution, i.e. by € 30,000. The amount of money in the bank account is actually decreased by € 100,000: € 70,000 thereof is for salary expenditures and € 30,000 for distributed profits. <?page no="226"?> 3.2 Tax assessment basis 227 This reassignment of the payment as a hidden profit distribution for the capital company is reflected at the level of the shareholder: Before the discovery of the hidden profit distribution Maria had income exclusively from dependent-employment in accordance with Sec. 19 EStG amounting to € 100,000. After the discovery of the hidden profit distribution, only € 70,000 is treated as income from dependent-employment. The remaining € 30,000 are treated as income from capital assets in accordance with Sec. 20 EStG. The allocation of shares to business assets or private assets is also relevant for the taxation of dividends in the case of hidden profit distributions. The amount of € 30,000 is subject to the provisions of the partial-income method if the shares of Elisabeth-GmbH are held as business assets, i.e. 60 % (= € 18,000) of the income is taxed. If the shares are allocated to the shareholder's private assets, the flat-rate withholding tax of 25 % is to be applied to the amount of € 30,000. Thus, the hidden distribution of profits at the level of the shareholder is treated like a declared distribution of profits. Since the JStG 2010, hidden profit distributions are only subject to flat-rate withholding tax to the extent that they have increased the income of the performing corporation (Sec. 32d (2) no. 4 EStG). If the hidden profit distribution had actually reduced the income of Elisabeth-GmbH and thus not been subject to corporate income tax, the hidden profit distribution would now be taxed at the individual income tax rate of the shareholder Maria. Question Why are hidden profit distributions so important in practice, although the taxation is merely shifted from the level of the capital company to the level of the shareholder and the shareholder’s tax burden is significantly lower in the case of a declared distribution of profits? In the example above, the GmbH would have incurred an expense of € 100,000 without the legal concept of the hidden profit distribution. In contrast, the shareholder would have had to pay taxes on € 100,000 as income within the meaning of Sec. 19 EStG. What is then the advantage of this type of arrangement and/ or why are the fiscal authorities interested in re-qualifying € 30,000 as a hidden profit distribution? Answer For the capital company, the sum of € 100,000 represents a business expense that reduces the assessment basis not only for corporate income tax but also for trade tax. On the other hand, as a private individual the shareholder’s income from dependent-employment is, for example, not subject to trade tax. As a result, excessive manager salaries, for example, are used in particular to save trade tax: The shareholder does earn a higher income but this is not subject to trade tax, while the capital company saves not only corporate income tax but also trade tax as a result of its higher business expenses. <?page no="227"?> 228 3 Corporate income tax The classification of the hidden profit distribution should under no circumstances be confused with the discovery of fraudulent tax evasion. A hidden distribution of profits is only a question of disclosed, inappropriate agreements under the law of obligations which are conditioned by the company relationship. These are subject to special treatment in order to avoid misuse (in particular deduction of trade tax). Hidden equity contributions Figure 57: Distinction between hidden profit distribution and hidden equity contribution <?page no="228"?> 3.2 Tax assessment basis 229 As a counterpart to the distributions of profit, contributions are economic benefits granted to a company by its shareholder. In doing so, a distinction must be made between declared contributions and hidden equity contributions. This terminological differentiation is, however, irrelevant for tax purposes because both forms of contributions are treated the same under corporate income tax law. • The income that can be earned on the market is to serve as a starting point in determining the corporate income tax. Therefore, only increases in assets related to the business may also increase the profit of the company. Increases in assets that are the result of contributions and are required to company law do increase the equity capital but do not form a part of the taxable profit (Sec. 8 (1) sent. 1 KStG i.c.w. Sec. 4 (1) sents. 1 and 5 EStG) because they have not been earned by the company. According to Sec. 8 (1) sent. 1 KStG i.c.w. Sec. 6 (1) no. 5 EStG, contributions are generally to be accounted for with the net present value. At the level of the corporation an exception is made to this principle of calculating with the net present value, however, in that contributions are to be accounted for with the costs of acquisition or production if one of the conditions of Sec. 6 (1) no. 5 is already fulfilled. Figure 58: Valuation of contributions <?page no="229"?> 230 3 Corporate income tax Under tax law, declared contributions are treated the same as contributions under commercial law, so that a correction is not necessary for tax purposes, whereby hidden equity contributions sporting a different legal designation are often first qualified as such by the fiscal authorities within the scope of tax field audits. The fiscal administration defines hidden equity contributions in accordance with R 8.9 (1) KStR as the grant of a contributable economic benefit to a company by a shareholder or an affiliated individual if the contributions are occasioned by the company relationship. It is deemed to be occasioned by the company relationship if a non-shareholder using the same standard of care as an orderly merchant would not have granted the benefit to the company. The courts have assumed the existence of hidden equity contributions especially if • the shareholder has transferred an asset to the company at no cost or at an unreasonably low price, • the company has sold an asset to its shareholder at an unreasonably low price, • the company has charged too much to a shareholder for services rendered, or • the shareholder has waived a claim against the company for the repayment of a loan. If the agreements made do not bear the arm’s-length comparison, the underlying transactions are classified as hidden equity contributions. The company and the shareholder are put in the position they would have been in if the shareholder had made a declared contribution . Hidden equity contributions must be corrected outside of the balance sheet by a corresponding deduction because they increased the profit in the commercial balance sheet and tax balance sheet. The acquisition costs of the shareholder’s shares in the company increase by the amount of the correction (Sec. 6 (6) sent. 2 EStG). This principle of Sec. 8 (3) sent. 3 KStG, according to which hidden equity contributions do not increase the income of the company, presupposes, however, that the hidden equity contribution does not lead to a deduction in the income of the shareholder making the contribution, either as a business expense or as income-related expenses (Sec. 8 (3) sent. 4 EStG). If this condition is not fulfilled, the hidden equity contribution retains its original profit-increasing effect. <?page no="230"?> 3.2 Tax assessment basis 231 Figure 59: Effects of the hidden equity contribution Example 1: The sole proprietor Hermann operates a cold-storage facility for storing frozen foods. He is also the sole shareholder and managing director of the Wilhelm- GmbH, which manufactures and sells cooling aggregates. In 2017 the Wilhelm- GmbH sells cooling aggregates to the sole proprietorship for € 100,000. During a tax field audit by the fiscal authorities at the Wilhelm-GmbH in 2018, the auditor determines that the cooling aggregates sold in 2017 were usually sold to third parties for € 60,000. As a diligent and orderly merchant, Hermann would not have accepted the excessive price of € 100,000 but rather would have bought them for the market price of € 60,000; the auditor thus determines that a hidden equity contribution of € 40,000 was made to the Wilhelm-GmbH by Hermann. Before the discovery of the hidden equity contribution, the Wilhelm-GmbH accounted for an increase in profit of € 100,000. After the discovery of the hidden equity contribution, the revenue only amounts to € 60,000 because the tax auditors will reduce the tax balance sheet profit outside of the balance sheet by € 40,000. In doing so, the assessment basis for corporate income tax and trade tax will be reduced by the amount of the hidden equity contribution of € 40,000. At the level of the shareholder, the discovery of the hidden equity contribution leads to an increase in the costs of acquiring Hermann’s shares in the Wilhelm- GmbH of € 40,000. In addition the acquisition costs for the cooling aggregates are reduced by € 40,000 yielding smaller depreciation. Hermann and the GmbH are put in the position that they would have been in if a declared contribution had been made. In this case, Hermann would only have paid € 60,000 for the cooling aggregates and would have contributed the remaining € 40,000 to the GmbH. <?page no="231"?> 232 3 Corporate income tax Question Why are hidden equity contributions made at all? What advantages do the shareholder and/ or the company hope to gain? Answer Hidden equity contributions are often made to avoid the realization of profit at the level of the shareholder which would lead to an undesired tax liability. Example 2: Within the scope of field audits performed by the fiscal authorities at the Wilhelm-GmbH an additional hidden equity contribution is discovered in 2017. The sole proprietor sold a truck belonging to his business assets that had a market value of € 15,000 and a book value of € 10,000 to the Wilhelm-GmbH for only € 10,000. In doing so, Hermann would like to avoid the hidden reserves in his truck amounting to € 5,000 being discovered and thus increase his business income. The auditor assesses a hidden equity contribution of € 5,000 because as a diligent and orderly merchant Hermann would have asked for and received a purchase price of € 15,000 on the market. This results in the realisation of the hidden reserves of € 5,000 and a correspondingly higher tax liability for Hermann. In addition, the costs of acquiring Hermann’s shares in the Wilhelm-GmbH increase by the same amount. The GmbH capitalizes the truck at the cost of acquisition amounting to € 15,000. As a result, the declared contribution is assumed: The state of affairs is created that would have existed if Hermann had sold the truck at the “arm’s-length” price of € 15,000 and then subsequently contributed the € 5,000 to the GmbH in cash. Example 1 (continued): In example 1, Hermann purchased the cooling aggregate for € 100,000 although the market price was really only € 60,000. If Hermann had sold the aggregate at a price of € 100,000 directly after having purchased it, this would not have led to a capital gain for Hermann if the hidden equity contribution had not been discovered, because the proceeds from the sale amounting to € 100,000 less the acquisition costs also amounting to € 100,000 would have resulted in a profit of € 0. After the discovery of the hidden equity contribution, however, Hermann must pay taxes on a profit of € 40,000. As with the hidden profit distribution, it must be noted that the classification as hidden contributions is not to be confused with the discovery of fraudulent tax evasion but rather an admissible contractual agreement between the shareholder and the company that is not accepted for tax purposes. <?page no="232"?> 3.2 Tax assessment basis 233 Tax-exempt income from investments in accordance with Sec. 8b (1) KStG As far as bookkeeping and commercial law are concerned, distributions made by other corporations are accounted for under the position income from investments (or also named as investment income) (Beteiligungserträge). If - as is the case for natural persons - 60 % of the distributed amount were subject to taxation, the onward distributed dividends would be consumed by the resulting cumulated taxation (so-called cascade effect). In order to avoid a cumulated tax burden of the same profit distributed more than once in the case of business conglomerates, the income from investments from other companies is exempted from corporate income tax. In doing so, the profit is only burdened once with corporate income tax until the profit leaves the level of corporations and is distributed to a natural person. Figure 60: Treatment of the distribution by the recipient <?page no="233"?> 234 3 Corporate income tax The exemption of the income from investments applies to all earnings from participating interests named in Sec. 8b (1) KStG, i.e. in particular to all declared and hidden profit distributions that are distributed by domestic or foreign capital companies. Since the assessment period 2013, however, the tax exemption pursuant to Sec. 8b (1) KStG only applies if there is a direct minimum participation rate of 10 % since the beginning of the calendar year. For participation quotas below 10 % (so-called free float), the tax exemption of income from investments is not granted. Free float dividends are therefore subject to a cumulative tax burden on the same distributed profit. In addition to income from investments, all profits from the disposal of a share in a domestic or foreign capital company are exempted from corporate income tax in accordance with Sec. 8b (2) KStG. The reasoning for the exemption of the capital gains is that a disposal can be seen as a total distribution ( Gesamtausschüttung ). This transaction must thus be taxed the same as the regular payments within the meaning of Sec. 8b (1) KStG from the same stake. The capital gain must be tax free because the regular payments are exempt from taxation; otherwise, the capital company to be sold would first distribute all profits free from taxation. Subsequently, the shareholders would then dispose of the shares in the - ideally asset-free - capital company. It should be noted that, in contrast to income from investments, no minimum participation quotas or holding periods are assumed in connection with gains from the sale of shares in a domestic or foreign capital company. As part of ongoing accounting, both the income from investments and the capital gains are recognized as income in the income statement. In order to insure the tax exemption of this income, the tax balance sheet profit must be reduced again by the income from investments and the capital gains outside the balance sheet . Example (not taking capital yields tax into consideration): The Wilhelm-GmbH (LLC) holds shares in the Werner-AG (PLC) and received dividends of € 20,000 in 2018 from the latter that were booked as income in the income statement (€ 20,000 debited from the bank and credited to income from investments). In order to exempt this income from participating interest from corporate income tax at the Wilhelm-GmbH, the tax balance sheet profit of the Wilhelm-GmbH is reduced outside the balance sheet. The tax burden in the amount of € 20,000 from partial-income method and/ or the flat-rate withholding tax according to Sec. 32d EStG will first take effect if the Wilhelm-GmbH then makes a distribution to its sole shareholder Hermann as a natural person . <?page no="234"?> 3.2 Tax assessment basis 235 Non-deductible expenditures in accordance with Sec. 10 KStG According to Sec. 10 KStG, the following expenses are not deductible when determining the taxable income: • expenditures for statutory or other purposes (no. 1), • personal taxes (corporate income tax, input tax (set apart from execution) and their related performances such as interest on arrears) (no. 2), • pecuniary penalties, etc. (no. 3), • half of the remuneration for the members of the supervisory board, etc. (no. 4). The tax balance sheet profit is to be increased outside of thebalance sheet because these expenses may not reduce the taxable income but were treated as expenditures in the financial records. It must be taken into consideration that the company must not only bear the expenditure itself but also the corporate income tax, trade tax and the solidarity surcharge as business expenses resulting from the non-acceptance, i.e. the so-called shadow effect (Schattenwirkung). Example: In 2018 the Werner-AG accounted for a pecuniary penalty reducing the profit by € 1,000. What profit must the Werner-AG earn in order to pay the penalty? In order to finance a pecuniary penalty of € 1,000, the company must earn a profit of € 1,425 (! ) before taxes. Assuming a municipal trade tax multiplier of 400 %, the trade tax amounts to € 199; assuming a tax rate of 15 % plus a solidarity surcharge of 5.5 %, the corporate income tax amounts to € 226. <?page no="235"?> 236 3 Corporate income tax Non-deductible expenditures in accordance with Secs. 4 (5), (5b), 4h, 4j EStG, Secs. 8a, 8b (3) and (5) KStG According to Sec. 8 (1) sent. 1 KStG, the income of a capital company is determined in accordance with the provisions of the German Income Tax Act and the German Corporate Income Tax Act. The provisions of the German Income Tax Act thus apply to corporate income tax law inasmuch as the German Corporate Income Tax Act does not contradict the former or contain any special rules itself. In addition to the non-deductible expenditures within the meaning of Sec. 10 KStG, the non-deductible business expenses listed in Sec. 4 (5) EStG as well as the trade tax and the related ancillary services, which according to Sec. 4 (5b) EStG are not business expenses, must therefore also be taken into account when calculating the taxable income of a company. In addition, Sec. 8a KStG, which refers to the regulations of the interest barrier within the meaning of Sec. 4h EStG and Secs 8b (3), (5) KStG, are of great importance. The non-deductible business expenses that have already been dealt with extensively in the chapters on personal income tax and are listed in Sec. 4 (5) sent. 1 EStG include the following: • gifts to individuals who are not employees of the company whereby an tax threshold of € 35 per person receiving a gift is granted for all gifts given during a fiscal year (No. 1), • 30 % of the entertainment expenses occasioned by the business (No. 2), and • bribes (No. 10). <?page no="236"?> 3.2 Tax assessment basis 237 Likewise, pursuant to Sec. 4 (5b) EStG, trade tax and the related ancillary tax payments are also to be allocated to non-deductible business expenses. In addition, the above-mentioned interest barrier within the meaning of Sec. 4h EStG constitutes an additional element for non-deductible business expenses. Pursuant to Sec. 8a KStG, this also applies to capital companies. However, the regulations on the interest barrier for capital companies have additional restrictions. Interest expenditures for capital companies are taken into account in accordance with the principle standardized in Sec. 8a (1) KStG i.c.w. Sec. 4h (1) EStG. Accordingly, interest payments by a company are only fully deductible up to the amount of the interest income of the same financial year. Any additional interest expenditure are subject to a restriction of deduction. For such a remaining net interest expenditure, which results from the netting of the interest income from the interest expenditures (so-called negative interest balance), only a deduction of business expenses up to an amount of 30 % of the taxable EBITDA is permissible. To the extent that the netted EBITDA exceeds the business interest expense less interest income, it must be carried forward to the next five financial years (EBITDA carryforward) and is therefore available for offsetting against future negative interest balances for a period of five years. Any remaining interest expenses must be determined separately and can be carried forward by the taxpayer to subsequent fiscal years in accordance with Sec. 4h (1) sent. 5 EStG (= interest carryforward). In the following assessment periods, these interest carryforwards then increase the amount of interest expenses, but not the relevant profit of the respective financial year in the repeated calculation of EBITDA. Figure 61: Basic principle of the interest barrier Example: In 2018, the Wilhelm-GmbH has liabilities amounting to € 150 million, which bear interest at 5 %. Interest income did not accrue. The tax EBITDA of the Wilhelm- GmbH amounts to € 20 million. Since the Wilhelm-GmbH did not generate any interest income, a deduction of interest expenses of € 7.5 million (5 % of € 150 million) is only permitted up to the amount of the offsetable EBITDA. This amounts to € 6 million (30 % of EBITDA <?page no="237"?> 238 3 Corporate income tax of € 20 million). The remaining interest expenses of € 1.5 million are not deductible in 2018, but can be carried forward by the taxpayer pursuant to Sec. 4h (1) sent. 5 EStG to subsequent fiscal years (= interest carryforward). It increases the interest expense in the following financial years and is deductible within the framework of the interest barrier regulations applicable for the following financial years. The EBITDA for tax purposes must be distinguished from the EBITDA for business purposes, which is prepared on the basis of the figures in the commercial balance sheet. Although both figures are based on the same calculation scheme, the figures contained therein differ from one another. The starting point for determining the tax EBITDA is the relevant profit. However, in the case of corporations pursuant to Sec. 8a (1) sent. 1 KStG, the relevant income takes its place. The use of the relevant income for the purposes of the interest barrier ensures that the provisions of the KStG are also taken into account for corporations (in addition to the provisions of the EStG). The tax EBITDA of a corporation is increased in particular by hidden profit distributions and reduced by hidden equity contributions and tax exempt income from investments within the meaning of Sec. 8b (1) KStG or capital gains within the meaning of Sec. 8b (2) KStG. Based on the commercial balance sheet result, the tax balance sheet profit is calculated in accordance with the regulations for determining taxable income. The relevant income is determined from this in accordance with the addition and deduction provisions of the KStG with the exception of the provisions on the interest barrier pursuant to Sec. 4h EStG, loss compensation pursuant to Sec. 10d EStG and the deduction of donations pursuant to Sec. 9 (1) no. 2 KStG. The result after deduction of interest income and addition of interest expenditures and depreciation represents the tax EBITDA of a capital company. After multiplying the taxable EBITDA by 30 %, the result is the offsetable EBITDA, which determines the maximum interest deduction for this financial year. +/ ./ . Profit according to HGB Rules for determining taxable income (Secs. 4-7i EStG) = +/ ./ . Tax balance sheet profit Additions and deductions according to KStG = + Total income according to EStG/ KStG No consideration of Secs. 4h, 10d EStG Donation (Sec. 9 (1) no. 2 KStG) = + ./ . + Relevant income according to Sec. 8a (1) KStG Interest expenditures Interest income Depreciation according to Sec. 6 (1) sent. 1, (2a) sent. 2 and Sec. 7 EStG <?page no="238"?> 3.2 Tax assessment basis 239 = × Fiscal EBITDA 30 % = Offsetable EBITDA A capital company - analogous to partnerships and sole proprietorships - can only evade the submission to the restrictions of the interest barrier in three exceptional cases: • Pursuant to Sec. 8a (1) KStG i.c.w. Sec. 4h (2) sent. 1 lit. a EStG, an unlimited deduction of interest expenditures is also permissible if the negative interest balance remains below a tax threshold (exemption limit) of € 2,999,999 . With a net interest expenditure of € 3,000,000, the exception no longer applies. The amount is therefore completely non-deductible. By this regulation above all small and medium-size enterprises are relieved. Large concerns, on the other hand, often exceed the exemption limit with their net interest expenditures. • Also with fulfilment of the so-called stand-alone clause in the sense of the Sec. 8a (1) KStG in connection with Sec. 4h (2) sent. 1 lit. b EStG an unlimited deduction of interest expenditures is permitted as business expenses. However, this clause requires that the capital company is not or only proportionately attributable to a concern. In this context, proportionate means that the capital company if at all is only included in consolidated financial statements by proportionate or equity consolidation. According to Sec. 4h (3) sent. 5 EStG, however, a group affiliation exists if a company is or could be fully consolidated with one or more other companies in accordance with the accounting standard underlying the application of Sec. 4h (2) sent. 1 lit. c EStG. • Ultimately, an unlimited deduction of interest expenditures as business expenses is also permitted in the case of group-affiliated companies if these meet the escape clause pursuant to Sec. 8a (1) KStG i.c.w. Sec. 4h (2) sent. 1 lit. c EStG. This presupposes, however, that the equity ratio of the relevant enterprise does not fall below the Group equity ratio by more than 2 %. Note Exceptions to the interest barrier pursuant to Sec. 8a KStG i.c.w. Sec. 4h EStG: • Exemption limit in the amount of € 2,999,999 • So-called stand-alone clause • So-called escape clause <?page no="239"?> 240 3 Corporate income tax The principle of separability states that the capital company and the shareholder are legally independent. Accordingly, shareholder debt financing is also generally recognised in tax law and is not to be treated as a contribution but as debt capital. When setting up a capital company and in the event of subsequent financial requirements, the shareholder can therefore freely decide whether and to what extent the capital company is to be financed with equity or debt capital. The principle of financing freedom applies. The effects of this decision on the performance of the capital company are considerable. Remuneration for borrowed capital is generally deductible as business expenses and thus reduces the amount subject to taxation. On the other hand, remuneration for equity capital does not reduce the economic performance to be recorded for tax purposes under Sec. 8 (3) KStG. At the level of the capital company, the remuneration for equity is fully subject to trade tax, corporate income tax and the solidarity surcharge. As a result, financing through borrowed capital is an attractive alternative to equity financing for shareholders. Shareholders therefore tend to equip the capital company predominantly with debt capital in order to keep the tax burden as low as possible. Due to the increasing debt financing of capital companies by certain shareholder groups, the taxation of dividends is avoided and a considerable tax volume is lost. In order to prevent financing arrangements to the detriment of the German tax authorities through excessive shareholder debt financing of a capital company, the deduction of interest expenses is generally only permitted to a limited extent in accordance with Sec. 4h EStG i.c.w. Sec. 8a KStG. Shareholder debt financing is a popular instrument for reducing the tax burden, especially for capital companies, additional requirements must be observed with regard to the regulations on the interest barrier for capital companies as opposed to the regulations on the interest barrier for partnerships and sole proprietorships. Sec. 8a KStG standardises two additional exceptions for the repayment of harmful shareholder debt financing for capital companies. These considerably restrict the possibilities for making use of the exceptions provided for in the stand-alone clause within the meaning of Sec. 4h (2) lit. b EStG or the escape clause within the meaning of Sec. 4h (2) lit. c EStG. An unlimited deduction of interest expenditures as business expenses justified by these two exceptions is therefore only permissible for capital companies if there is no harmful shareholder debt financing (Sec. 8a (2) or (3) KStG). Such tax-damaging shareholder debt financing exists if the capital company makes payments for debt capital whose share of the interest balance amounts to more than 10 % to: • a shareholder directly or indirectly holding more than 25 % of the subscribed capital, or • a person close to him or her, or <?page no="240"?> 3.2 Tax assessment basis 241 • a third person who may have recourse to the shareholder holding more than one quarter of the subscribed capital or to a person closely linked to that shareholder, can be achieved. Figure 62: Exceptions to the interest barrier regulation pursuant to Sec. 8a KStG in conjunction with Sec. 4h (2) EStG Example: The liabilities of Capitol AG, which bear interest at 5 %, amount to € 120 million in 2018. Interest income amounted to € 2 million and depreciation to € 1.5 million, all of which are included in the 2018 net income of € 4.5 million. The exceptions of Sec. 8a KStG i.c.w. Sec. 4h (2) EStG do not apply. ./ . Interest expenditures (5 % of € 120 Mio.) Interest earnings € 6 Mio. € 2 Mio. = Negative interest balance / net interest expenditure € 4 Mio. The interest expenses of Capitol AG are initially deductible only up to the amount of the interest income of the same financial year in the amount of € 2 million. A deduction of the remaining net interest expense of € 4 million is only permissible up to the amount of the offsetable EBITDA. Calculation of the tax EBITDA: ./ . + + Taxable profit 2018 Interest earnings Interest expenditures Depreciation € 4,5 Mio. € 2 Mio. € 6 Mio. € 1,5 Mio. = EBITDA € 10 Mio. The offsetable EBITDA amounts to € 3 million (30 % of the EBITDA of € 10 million). Accordingly, an interest deduction of € 5 million (€ 2 million interest income + € 3 million offsetable EBITDA) is possible in fiscal year 2018. After deduction of <?page no="241"?> 242 3 Corporate income tax interest expenditures of € 6 million, the difference amounts to € 1 million. Therefore, the remaining interest expenditures of € 1 million are to be reclassified as non-deductible business expenses. The taxpayer can carry forward these nondeductible interest expenditures in 2018 pursuant to Sec. 4h (1) sent. 5 EStG to subsequent fiscal years (= interest carryforward). The interest carryforward increases the interest expenditure in subsequent financial years and can be claimed in subsequent years under the conditions of the interest barrier. A weakness of the interest barrier is that the maximum amount of deductible interest expenditures is dependent on earnings. This means that if the economic development of the company is poor, EBITDA decreases and thus the deductible interest amount also decreases. Consequently, in times of economic crisis, the tax burden on companies could increase because their interest is no longer tax-deductible. In times of losses, the interest barrier could therefore contribute to a worsening of a corporate crisis. The introduction of a so-called EBITDA carryforward has defused the interest barrier in times of crisis. This prevents companies that have not used the full interest deduction in the past from being affected by the interest deduction restriction in an economically bad year with a slump in earnings. Note The application of the EBITDA carryforward requires: • Offsetable EBITDA > Interest balance • No use of the exemptions according to Sec. 4h (2) EStG Figure 63: Basic principle of the EBITDA carryforward The EBITDA carried forward is calculated if, in economically successful years, the offsetable EBITDA exceeds the negative net interest expenditure (interest expenditures ./ . interest earnings) and the net EBITDA is therefore not fully utilized. The interest expenditures are therefore not only fully deductible, but more than the actual interest expenditures incurred could have been deducted. The resulting positive difference between the maximum amount of deductible interest expenditures and the actual interest expend- <?page no="242"?> 3.2 Tax assessment basis 243 itures must be determined separately and can be carried forward by the taxpayer into the next five fiscal years. If in the future the interest expenditures exceed the maximum amount in the following five fiscal years, more interest expenditures than 30 % of the relevant EBITDA can be deducted by using the EBITDA carryforward. By using the EBITDA carryforward in this way, a restriction on the deduction of interest in subsequent years can be limited or completely avoided. However, it should be noted that the EBITDA carryforward cannot arise in the financial years in which the taxpayer has to make use of the exemption limit, the concern clause or the escape clause pursuant to Sec. 4h (2) EStG in order to escape the interest barrier. Example: In 2018, the Helios-GmbH had liabilities of € 80 million. The liabilities bear interest of 5 %. Depreciation amounts to € 2 million. Interest income did not accrue. In 2018, the Helios-GmbH will generate an annual tax surplus of € 12 million. The exceptions under Sec. 8a KStG i.c.w. Sec. 4h (2) EStG do not apply. Calculation of the net interest expenditures: ./ . Interest expenditures Interest earnings € 4 Mio. ---------- = Interest balance / net interest expenditure € 4 Mio. Calculation of the tax EBITDA: + + Taxable profit in 2018 Net interest expenditure Depreciation € 12 Mio. + € 4 Mio. + € 2 Mio. = EBITDA = € 18 Mio. In 2018, the offsetable EBITDA amounts to € 5.4 million (30 % of EBITDA in the amount of € 18 million). Since no interest income was generated, an interest deduction of € 5.4 million is permitted in this financial year. However, only € 4 million in interest expenditures were incurred. After deduction of these interest expenditures of € 4 million, a positive difference of € 1.4 million remains. This difference represents the EBITDA carried forward, which will be carried forward to the following financial years. In 2018, the Helios-GmbH will therefore not only avoid a restriction on interest deduction, but will also have a credit balance of € 1.4 million for the following five financial years, which will guarantee a higher interest deduction in the following years. However, international concerns are trying not only to shift profits from high-tax countries to low-tax countries through financing arrangements, but also through the collection of license fees. In particular, companies with high intangible assets such as license and patent rights have in the past transferred <?page no="243"?> 244 3 Corporate income tax these rights to group units in low-tax countries, which have subsequently demanded license fees from the group units in the high-tax countries (e.g. Germany). Through this tax structure, well-known Internet companies have apparently legally managed to pay only extremely low tax burdens in the high-tax countries despite high profits. In order to limit this construction, which is perceived as abusive, the German legislator introduced the provision of Sec. 4j EStG with effect from 1 January 2018, whereby the expenditures for the transfer of rights in Germany may not be deductible as business expenditures or only to a limited extent. If expenses for the transfer of rights from a German company to a group unit abroad are incurred and these expenditures are subject to low taxation abroad, the expenses are only permitted to be deducted within the scope of Sec. 4j (3) EStG. The formula mentioned there assumes that the non-deductible portion is the higher the lower the taxation of license fees abroad is. In addition to the interest and license barrier, the non-deductible fictitious business expenses pursuant to Sec. 8b (3) and (5) KStG are of great importance in practice. Accordingly, a flat rate of 5 % of the earnings from tax exempt income from investments within the meaning of Sec. 8b (1) KStG and from tax exempt capital gains within the meaning of Sec. 8b (2) KStG are considered as non-deductible business expenses. It must be taken into consideration that non-deductible business expenses are recognized as expenditures in the income statement. The tax balance sheet profit must thus be corrected by an addition outside of the balance sheet. This also applies to the fictive 5 % portion , whereby the actual expenditures (e.g. interest expenditure resulting from a loan-financed purchase of shares) are irrelevant for the addition . The 5 % addition is also carried out if no actual expenses exist. The provision thus represents an exception to the principle that only those amounts are added back to the profit outside of the balance sheet that were already recognized in the regular books as expenses. In return, Sec. 8b (5) sent. 2 KStG stipulates that the provision Sec. 3c (1) EStG does not apply to tax-exempt income from capital companies within the meaning of Sec. 8b (1) and (2) KStG. Therefore, all - with the exception of the fictive portion of 5 % of the tax free benefits - business expenses related to the tax exempt income are deductible in full. Example: The Wilhelm-GmbH took out a loan to refinance their stake in the Werner-AG. In 2018, there was not only a tax exempt income from investments of € 20,000 but also the business expenses directly related to these in the form of loan interest of € 10,000. These costs of financing are recognized in the financial income statement (€ 10,000 per interest expense to bank). The other revenue of the Wilhelm-GmbH amounts to € 200,000. <?page no="244"?> 3.2 Tax assessment basis 245 In the balance sheet: Regular revenue € 200,000 +./ . Dividends Business expenses (interest expenditures) + € 20,000 ./ . € 10,000 = (tax) balance sheet profit = € 210,000 The actual business expenses related to the dividends and amounting to € 10,000 are accounted for in the balance sheet. The business expenses (interest expenditures) continue to reduce the profits by 100 % because they are claimed within the balance sheet and may not be added outside of the balance sheet again in accordance with Sec. 8b (5) sent. 2 KStG i.c.w. Sec. 3c (1) EStG. Outside the balance sheet: ./ . + Tax balance sheet profit Dividends according to Sec. 8b (1) sent. 1 KStG Non-deductible business expenses according to Sec. 8b (5) KStG (5 % ×€ 20,000) € 210,000 ./ . € 20,000 + € 1,000 = Taxable income € 191,000 The dividends are to be deducted outside of the balance sheet to avoid taxation. However, a lump-sum of 5 % of the benefits are to be added back in accordance with Sec. 8b (5) KStG. In other words, only 95 % of the dividend benefits are exempted. If no expenditures had actually been incurred in relation to the tax exempt income from investments, nevertheless 5 % of € 20,000 = € 1,000 would have had to be added back outside of the balance sheet regardless in accordance with Sec. 8b (5) KStG. Note • 5 % of the income from tax-exempt income from investments and capital gains is considered to be non-deductible business expenses. • In the financial accounts, non-deductible business expenses within the meaning of Sec. 4 (5), (5b), Sec. 3c EStG, Sec. 8b (3) and (5) KStG are recognized as expenditures in the income statement. The tax balance sheet profit has thus to be corrected by an addition outside of the balance sheet. <?page no="245"?> 246 3 Corporate income tax Donations In contrast to the deductibility of donations of a natural person as special expenses according to Sec. 10b EStG, the deductibility of capital companies as business expenses is regulated separately according to Sec. 9 (1) no. 2 KStG for lack of a capital company´s private sphere. The amount of this deductibility is also limited as it is in the case of the personal income tax and is only allowed for certain purposes. A two-step method of determining the deductible donations must be used because the donations are only deductible within the scope of a maximum amount: In accordance with Sec. 9 (2) sent. 1 KStG, all donations - including donations to political parties - are to be added to the tax balance sheet profit outside of the balance sheet in order to determine the total income. The resulting sum forms the assessment basis for the deduction of donations. After determining the deductible portion, this is to be subtracted from the total income again in the second step. The determination of the intermediate result “total income” only serves to calculate the deductible portion of the donations. <?page no="246"?> 3.2 Tax assessment basis 247 Note The deduction of donations is limited with respect to amount and purpose. Pursuant to Sec. 9 (1) no. 2 KStG, benefits for the promotion of non-profitable, charitable or churchly purposes within the meaning of Secs. 52-54 AO are deductible as business expenses up to a general maximum amount of 20 % of total income or up to 4 % of the sum of the total turnover and the wages and salaries paid in the calendar year. Income is defined in Sec. 9 (2) sent. 1 KStG especially for the purpose of deducting donations. As a result, the assessment basis for the maximum donation amount is the total income shown in the scheme. For amounts which exceed the maximum rates, there is also the possibility of a deduction within the framework of the maximum amounts in subsequent periods (donation carryforward) in accordance with Sec. 9 (1) no. 2 sent. 2 KStG. However, pursuant to Sec. 9 (1) no. 2 sent. 9 i.c.w. Sec. 10d (4) EStG, this presupposes that the relevant amounts have been determined separately beforehand. Because of the possible additional influence that could be exerted on political parties by the natural persons behind the capital company, donations made to political parties are - in contrast to the rules of personal income tax for natural persons (Sec. 10b (2) EStG) - not deductible (Sec. 4 (6) EStG). The non-deductible portion of the donations increases taxable income due to the addition of all donations in the first stage and the limited deduction of deductible donations. Example: In 2018, the Wilhelm-GmbH generated a total turnover of € 4,000,000; € 2,500,000 in wages and salaries were paid. The tax balance sheet profit appearing in the profit and loss (P&L) amounts to € 300,000. The following are to be taken into consideration as business expenses: Advance payments of corporate income tax Donation to the German Federation of Blind Veterand e.V. (registered association) Donation to the Catholic University of Eichstätt-Ingolstadt Donation to a political party € 300,000 € 25,000 € 200,000 € 5,000 Taking the deductible donations into account, the taxable income is calculated as follows: Tax balance sheet profit € 300,000 + Advance payments of corporate income tax € 300,000 + Total amount of donations € 230,000 = Total income € 830,000 <?page no="247"?> 248 3 Corporate income tax Calculation of the maximum amounts: 20 % of € 830,000 € 166,000 0.4 % of € 6,500,000 (= ∑ of the turnover, wages, and salary) € 26,000 The deductible maximum amount for donations to charitable and scientific purposes thus amounts to € 166,000. This amount is higher than the amount of € 26,000 calculated on the basis of the alternative calculation using the sum of turnover, wages and salaries. ./ . Total income Deductible portion of the donations € 830,000 € 166,000 = Taxable income € 664,000 The donation to the political party is not deductible. The proportion of deductible donations exceeding the maximum permissible amount of € 166,000 and amounting to € 59,000 is to be determined separately and deducted from income in subsequent periods within the limits of the respective permissible deductions. 3.2.4 From the total amount of income to the remaining corporate income tax payment/ refund The assessment basis of the corporate income tax is not the total income, but rather the taxable income , as is also the case with personal income tax. • Loss deduction In order to determine the taxable income, the first step is to deduct any (interperiodic) losses in accordance with Sec. 8 (1) sent. 1 KStG i.c.w. Sec. 10d <?page no="248"?> 3.2 Tax assessment basis 249 EStG. The vertical loss compensation does not apply to capital companies because they only have business income within the meaning of Sec. 15 EStG. Within the scope of the interperiodic loss deduction, negative income is offset against the total income in other assessment periods. This rule corresponds to the approach for personal income tax. First, within the scope of the loss carryback in accordance with Sec. 8 (1) sent. 1 KStG i.c.w. Sec. 10d (1) sent. 1 EStG, up to € 1,000,000 are deducted from the total amount of income in the assessment period preceding this assessment period. Upon application in accordance with Sec. 8 (1) sent. 1 KStG i.c.w. Sec. 10d (1) sents. 5 and 6 EStG, however, such a loss carryback is forgone in full and in part so that an option exists with respect to the loss carryback. Within the scope of the loss carryforward in accordance with Sec. 8 (1) sent. 1 KStG i.c.w. Sec. 10d (2) sent. 1 EStG, remaining negative income is deducted from the total amount of income as soon as possible in the following assessment period. Pursuant to Sec. 10d (2) EStG, a minimum taxation requirement must also be observed for capital companies. Accordingly, losses up to an income amount of € 1 million that could not be offset so far can be deducted without restriction. If this amount is exceeded, an amount of 60 % of the income is deductible. The total income in an assessment period is thus reduced in this case by the loss carryback and/ or loss carryforward from the following and/ or previous period(s). • Tax allowances After the loss deduction has been carried out, the income for certain corporations calculated in this manner is reduced by the personal allowances, however at most by the amount of income. The tax allowance of € 5,000 in accordance with Sec. 24 KStG is granted to corporations, associations of individuals or legal estates that are neither associations within the meaning of Sec. 25 KStG nor corporations and/ or associations, the performances of which are considered to be income within the meaning of Sec. 20 (1) no. 1 or 2 EStG. All capital companies are excluded from the application of the tax allowance because dividends and profit shares in particular belong to this income. The tax allowance of € 15,000 in accordance with Sec. 25 KStG is only granted to co-operative societies as well as industrial and provident societies that deal exclusively in farming and forestry. max. compensable amount = € 1 Mio. + 60 % x (total income ./ . € 1 Mio.) <?page no="249"?> 250 3 Corporate income tax • Rate of taxation The resulting taxable income after any deductions of loss or any tax allowances are taken into consideration is subject to scaled taxation. According to Sec. 23 (1) KStG, the tariff tax rate amounts to 15 %. The fiscal authorities assess corporate income tax by applying the respective tariff tax rate. The corporate income tax to be assessed is usually not to be paid by the respective corporation because it has already been settled to a certain extent: On the one hand, quarterly advance payments are to be made (on 10 March, 10 June, 10 September and 10 December respectively) towards the estimated corporate income tax liability for an assessment period in order to secure the regular income of the regional corporations in accordance with Sec. 8 (1) sent. 1 KStG i.c.w. Sec. 37 (1) EStG. On the other hand, capital yields tax is withheld as in the case of personal income tax in order to secure the tax revenue from direct investment and interest in accordance with Sec. 8 (1) sent. 1 KStG i.c.w. Secs. 43 et seqq. EStG. These source taxes are - as is also the case with personal income tax - merely a form of assessing corporate income tax. • Creditable corporate income tax and capital yields tax It must be taken into consideration that in spite of its subsequent exemption from corporate income tax, income from investments is subject to the capital yields tax deduction upon distribution. Since the advance payments, the withheld capital yields tax, are advance payments on the corporate income tax debt, the corresponding amounts must be credited against the corporate income tax debt to be determined pursuant to Sec. 8 (1) sent. 1 KStG i.c.w. Sec. 36 (2) sent. 1 nos. 1 and 2 EStG. The remaining corporate income tax liability then leads either to an additional payment or to a refund of corporate income tax. Example: In 2018, the total amount of income of the Wilhelm-GmbH amounts to € 100,000. The Wilhelm-GmbH has received a dividend payment of € 15,000 from the Werner-AG, in which Wilhelm-GmbH has held an interest of more than 20 % for years, from which capital yields tax of € 5,000 (= 25 % of the gross dividend of € 20,000) has already been correctly withheld. The total amount of income already takes into account the tax exemption of the dividend due to the deduction provision of Sec. 8b (1) KStG. In 2017, the GmbH generated a negative taxable income of ./ . € 50,000. Accordingly, no advance payments of corporate income tax were made in 2018. No losses were carried back in assessment period 2016. The corporate income tax for 2018 is calculated as follows: <?page no="250"?> 3.2 Tax assessment basis 251 ./ . Total amount of income Loss deduction (Sec. 8 (1) KStG i.c.w. Sec. 10d EStG) € 100,000 ./ . € 50,000 = ./ . Income Tax allowance for certain corporations (Secs. 24, 25 KStG) = € 50,000 -------- = × = ./ . ./ . Taxable income Corporate income tax rate in accordance with Sec. 23 KStG Corporate income tax to be assessed Creditable corporate income tax (e.g. advance payments) Creditable capital yields tax = € 50,000 × 15 % = € 7,500 ./ . € 0 ./ . € 5,000 = Remaining corporate income tax to be paid = € 2,500 After the loss deduction in accordance with Sec. 10d (2) EStG, the income of the Wilhelm-GmbH amounts to € 50,000 in 2018. No allowance is granted to the Wilhelm-GmbH in accordance with Sec. 24 KStG or Sec. 25 KStG because the distributions to the shareholders represent income within the meaning of Sec. 20 (1) no. 1 EStG and the Wilhelm-GmbH does not deal in farming or forestry. Upon applying the tariff tax rate of 15 % in accordance with Sec. 23 (1) KStG, corporate income tax of € 12,500 is to be assessed. Capital yields tax of 20 %, i.e. € 5,000 was withheld and paid to the fiscal authorities by the Werner-AG in accordance with Sec. 43a (1) no. 1 EStG that can be credited correspondingly to the corporate income tax liability of the Wilhelm-GmbH. An amount of corporate income tax equaling € 2,500 remains to be paid by the Wilhelm-GmbH. <?page no="251"?> Summary ► In principle, two systems of corporate income tax can be distinguished: The classic system and the crediting system. ► In Germany, the partial-income method applies in the business sphere and the flat-rate withholding tax applies in principle in the private sphere. In both procedures, taxation takes place in two independent steps - at the level of the corporation (corporate income tax burden) and the level of the shareholder (income tax burden) in the event of a distribution. ► The corporate income tax is a personal tax; legal entities are the subject of taxation, while the object of taxation is the income. ► A distinction must be made between the unlimited and limited corporate income tax liability. Certain legal entities are exempted from corporate income tax for economic or sociopolitical reasons. ► The provisions of the German Income Tax Act and the German Corporate Income Tax Act apply when determining the taxable income as the assessment basis for corporate income tax. ► The profit on the commercial balance sheet forms the starting point for the determination of the taxable income for corporate income tax. ► First, the commercial balance sheet is to be adopted to the tax balance sheet profit. ► The profit on the tax balance sheet is to be corrected by way of an ancillary calculation (outside of the balance sheet). In doing so, revenue is to be reduced and expenses added that were recognized inside the balance sheet. ► The additions include the following: • Hidden profit distributions • Non-deductible expenses within the meaning of Sec. 10 KStG • Non-deductible expenses within the meaning of Sec. 4 (5), (5b), Sec. 4h and 4j EStG and Sec. 8a, 8b (3), (5) KStG • Donations within the meaning of Sec. 9 (2) sent. 1 KStG. ► The deductions include the following: • Hidden equity contributions and • Tax free distributions within the meaning of Sec. 8b (1) KStG. ► The corporate income tax rate is uniformly 15 %, irrespective of whether the profits are retained or distributed. ► Pursuant to Sec. 8b (1) i.c.w. (5) KStG, 95 % of dividend income earned by corporations is tax-exempt, provided no free float dividends within the meaning of Sec. 8b (4) KStG exist. ► If corporations sell participations in domestic or foreign capital companies, 95 % of the profit thereby generated is tax exempt (Sec. 8b (2) i.c.w. (3) KStG). 252 3 Corporate income tax <?page no="252"?> 3.2 Tax assessment basis 253 Questions 1. Who is subject to the corporate income tax liability? Are there any particularities and/ or exceptions to be taken into consideration? 2. What is the assessment basis of corporate income tax and how is it calculated? 3. What modifications must be made to the tax balance sheet? How are these modifications carried out? 4. What is the difference between declared and hidden profit distribution? 5. How can hidden profit distributions occur? Why are hidden profit distributions of such practical importance? 6. What are hidden equity contributions? How are they usually treated in the determination of the taxable income? 7. How are distributions of profits to shareholders taxable if the participation in the capital company is held as business assets on the one hand respectively as the shareholder’s private assets on the other hand? 8. Why are distributions of profits by a capital company to a capital company which do not constitute free float dividends within the meaning of Sec. 8b (4) KStG exempt from taxation? What must be considered with regard to business expenses? 9. What non-deductible expenditures can be distinguished? Provide three examples of each. 10. What has to be considered with donations from capital companies? Literature Dietrich Grashoff, Florian Kleinmanns, Aktuelles Steuerrecht 2017 (Current tax law 2017), Munich, 13 th ed. 2017, pp. 87-119. Dieter Schneeloch, Stephan Meyering, Guido Patek, Betriebswirtschaftliche Steuerlehre, Bd. 1: Grundlagen der Besteuerung, Ertragsteuern (Business taxation, Vol. 1: Principles of taxation, profit taxes), Munich, 7 th ed. 2016, pp. 151-184. Klaus Tipke, Joachim Lang, Steuerrecht (Tax law), Cologne, 22 nd ed. 2015, pp. 669-716. <?page no="254"?> Trade tax Basic principles 4.1.1 Characterization of trade tax According to Sec. 3 (2) AO the trade tax is a real and/ or object tax. The subject of real taxes are things and/ or object aggregates and objects. In the case of the trade tax, the subject of taxation is the business. In contrast to personal and/ or corporate income tax, trade tax does not take any personal aspects of the tax-subject into account because the trade tax is intended to tax the - objective - earning capacity of the business establishment. This earning capacity is to be kept strictly apart from the personal ability of the person behind the business to pay. The municipalities are authorized to assess trade tax as a municipal tax in accordance with Sec. 1 of the German Trade Tax Act (GewStG). According to article 106 (6) sent. 1 of the German Constitutional Law (GG), the municipalities are entitled to a large portion of the trade tax revenue. The German federal government and the German federal states, however, also take their share of the trade tax by way of cost allocation in accordance with article 106 (6) sents. 4 and 5 GG. Note Characteristics of trade tax: • Real / object tax • Profit tax • Municipal tax • Domestic tax • Annual tax All domestic business operations are subject to trade tax in accordance with Sec. 2 (1) sent. 1 GewStG, from which its domestic character can be inferred. Foreign business establishments of domestic taxpayers are not subject to trade tax. After the German trade tax on capital (Gewerbekapitalsteuer) was abolished on 1 January 1998, only the trade tax is assessed as a trade profit tax (Gewerbeertragsteuer) . The trade income forms the assessment basis (Sec. 6 GewStG). <?page no="255"?> 256 4 Trade tax The trade tax is an annual tax. According to Sec. 14 sents. 2 and 3 GewStG the assessment period is the calendar year. The formation of a fiscal year deviating from the calendar year is also possible for trade tax (Sec. 10 (2) GewStG). In this case, the trade income is deemed to have been received in the survey period in which the business year ends. On the basis of the trade tax return (Sec. 14a GewStG), the fiscal authorities determine the tax index amount for fiscal purposes and then issue the notice of trade tax assessment basis (Gewerbesteuermessbescheid). The trade tax assessment is prepared by the municipality by multiplying the tax index amount for fiscal purposes with their municipal rate (Hebesatz). The trade tax is politically very controversial. Neither the ability-to-pay principle nor the equivalence principle is able to provide sufficient justification for the trade tax. The ability-to-pay principle is unable to justify the trade tax, for example, because of the following: • The net income principle is not taken into consideration, i.e. the deduction of certain business expenditures such as debt interest or rental expenditures is only partially possible. • The trade tax is a special tax for business establishments because neither farmers and foresters nor freelancers are taxed. • The burden on the company depends on where the company is located because the municipal multiplier is set by each individual municipality independently. The justification provided by the equivalence principle is not free of contradictions: • It is very difficult to demonstrate how business establishments pose a burden to the municipalities that would justify a special tax. • There is no relationship between the trade profit and the burden of business establishments on the municipality. • Freelancers and agricultural and forestry operations also take advantage of the services rendered by the municipalities but are not subject to trade tax. In the past, this criticism continually led to discussions revolving around the trade tax, the revenue of which amounted to € 50.1 billion in 2016 according to the official estimate. 4.1.2 Subject of taxation The business establishment is the subject of trade tax. Two types of business establishments are known to the German Trade Tax Act (Gewerbesteuer- <?page no="256"?> 4.1 Basic principles 257 gesetz). The trade tax applies on the one hand to all stationary business establishments (Sec. 2 (1) sent. 1 GewStG) and to mobile business establishments (Sec. 35a (1) GewStG). According to Sec. 1 GewStDV, all business establishments are considered to be stationary inasmuch as they are not deemed to be a mobile business establishment within the meaning of Sec. 35a GewStG. Mobile business establishments are unique in that no fixed establishments are kept and it is thus unclear which municipality may demand the trade tax. According to Sec. 35a (3) GewStG, the tax is assessed by the municipality in which the main emphasis of the commercial activity of the mobile business establishment is located. Figure 64: The types of business establishment If both a stationary business establishment and a mobile business establishment are operated, a distinction must be made between a single enterprise or two independent enterprises. In the context of a single commercial enterprise, the entire enterprise, consisting of a mobile business establishment and a stationary business establishment, is to be treated as a stationary business establishment in its entirety. The special regulations on the mobile business establishment do not apply. In addition, three forms of stationary business establishments can be differentiated: • A business establishment by virtue of commercial activity (Sec. 2 (1) sent. 2 GewStG) exists if a commercial enterprise within the meaning of the Income Tax Act is present, i.e. if an independent, sustainable activity undertaken with the intention of realizing profits, which presents itself as <?page no="257"?> 258 4 Trade tax participation in general commercial transactions, is carried out (R 2.1 (1) GewStR, H 2.1 (1) GewStH). This may not be an agricultural or forestry activity, the exercise of a liberal profession or pure asset management. A business enterprise by virtue of commercial activity includes, for example, partnerships which carry out an activity within the meaning of Sec. 15 (1) sent. 1 no. 2 EStG and whose shareholders are to be regarded as co-entrepreneurs. • A business establishment by virtue of legal form is always given in the case of capital companies (Sec. 2 (2) GewStG). It is no longer necessary to examine whether the activity represents a trade because the trade tax liability is dependent on the legal form. • Business establishments by virtue of economic business operations (Sec. 2 (3) GewStG) include other legal entities (such as incorporated associations) and non-incorporated associations (such as consortia) which perform economic business operations within the meaning of Sec. 14 AO. This is the case if it is an independent and sustainable activity with which income is earned and which represents more than the mere administration of assets. The intention to make a profit and the participation in general economic transactions are not important in this context. Example: The tax-exempt, charitable soccer club DJK Ingolstadt also has a clubhouse restaurant. The precondition of the assessment of trade tax is that the business establishment is located domestically (Sec. 2 (1) sent. 1 GewStG). This means that a permanent establishment must be held in the country. A permanent establishment is any fixed facility or system that serves the activity of the company (Sec. 12 AO). These include primarily: • the place of the business management, • branches, • offices, • factories or workshops, • purchasing offices or sale outlets. Not all business establishments are subject to trade tax. Sec. 3 GewStG names several businesses that are exempt from trade tax, e.g. non-profit corporations, associations of persons and property masses. This rule corresponds to Sec. 5 KStG. A charitable corporation within the meaning of Secs. 51 et seqq. AO is, for example, exempted from trade tax in accordance with Sec. 3 no. 6 GewStG. <?page no="258"?> 4.1 Basic principles 259 Note Requirements for taxation: • Business establishment within the meaning of Sec. 2 (1) sent. 1 or Sec. 35a (1) GewStG • Business establishment is located within the country. If co-partnerships and capital companies maintain several commercial enterprises, these are always to be regarded as a single commercial enterprise, even if different lines of business are combined. Accordingly, co-entrepreneurships and capital companies can each have only one single business enterprise. Example: The blue wonder AG runs a designer outlet shop in Dresden, a delicatessen restaurant in Leipzig, a carpenter's workshop in Chemnitz and an electronics shop in Freiberg. The blue wonder AG operates a single business with four branches. In the case of natural persons, on the other hand, there is only one single commercial enterprise, insofar as the various commercial activities of the individual enterprise are to be regarded as parts of a single commercial enterprise according to the public perception and operating conditions. Accordingly, similar and factually (in particular economically, financially and organizationally) internally connected enterprises form an unit and represent only one tax object. Example: The sole proprietor Fritz runs a butcher's shop in Ilmenau and a restaurant connected to it. The butcher's shop and the restaurant of the sole proprietor Fritz are to be regarded as the only business enterprise. If, due to the diversity of the businesses, there are several economic units, each of these units is regarded as a separate tax object. Example: The sole proprietor Kalle runs an ice hockey fan article shop in Erfurt and a chemical factory in Jena. Note In the case of several commercial activities of co-entrepreneurships and capital companies, it is always to be assumed that there is a single commercial enterprise. In the case of sole proprietorships, the operating <?page no="259"?> 260 4 Trade tax conditions and the opinion of the public are decisive for whether one or more tax objects exist. 4.1.3 Personal tax liability The personal tax liability is substantiated in the case of trade tax as a real tax by the tax debt. The obligor of the trade tax is the business person (Sec. 5 (1) sent. 1 GewStG). A business person is deemed to be an individual on whose account the business is operated (Sec. 5 (1) sent. 2 GewStG). Within the scope of the trade tax, a partnership itself - in contrast to its treatment with respect to income tax - is the obligor of the tax (Sec. 5 (1) sent. 3 GewStG). This can be explained by the partial legal capacity of the partnership. In the case of sole proprietorship, it is the owner who is the obligor of the tax; in the case of a capital company it is the company itself. Note According to Sec. 5 (1) sent. 3 GewStG, the partnership itself is the obligor and thus liable for trade tax. Business profit According to Sec. 7 sent. 1 GewStG, the starting point for the calculation of the assessment basis for trade tax is the business profit that is determined in accordance with the provisions of the German Income Tax Act or the German Corporate Income Tax Act. Therefore, only the income within the meaning of Sec. 15 EStG is subject to trade tax. In particular, income from selfemployment in accordance with Sec. 18 EStG is thus not subject to trade tax. It can be inferred from the language of Sec. 7 sent. 1 GewStG, which reads, “which was determined in accordance with the provisions of the German Income Tax Act or the German Corporate Income Tax Act” that the German Trade Tax Act first assumes all adaptations of expenditures and revenue made in accordance with the provisions of the German Income Tax Act or the German Corporate Income Tax Act (e.g. Sec. 4 (5) EStG, Sec. 10 KStG) . However, the German Trade Tax Act stipulates that its own provisions concerning addition and deduction be applied in a second step. The act’s own adaptation provisions appearing in Secs. 8 and 9 GewStG apply expressly to trade tax only and are thus not to be included in the assessment basis for personal and/ or corporate income tax. The aim of the addition and deduction <?page no="260"?> 4.2 Business profit 261 provisions is to account for the character of trade tax as a real and/ or object tax - by determining the “objective” earning capacity of the business - as well as to provide for the domestic character of trade tax. These corrections must always be made outside of the balance sheet because all of the adaptive provisions under trade tax law are only related to trade tax. For sole proprietorships, the business income is the profit in accordance with Sec. 15 (1) sent. 1 no. 1 EStG. In the case of partnerships, the starting point for the determination of the trade tax is the profit of the co-partnership in accordance with Sec. 15 (1) sent. 1 no. 2 EStG. The profit of the co-partnership includes not only the profit shares in the partnership but also the special remuneration paid to the partners within the meaning of Sec. 15 (1) sent. 1 no. 2 EStG. For capital companies, the business profit is deemed by Sec. 8 (1) KStG to be the income for purposes of corporate income tax. Figure 65: Objectives of the trade tax modifications <?page no="261"?> 262 4 Trade tax Because the determination of the profit is independent, neither the loss deduction in accordance with Sec. 10d EStG nor the tax allowances in accordance with Secs. 24, 25 KStG may reduce the business profit (R 7.1 (4) GewStR). In the case of sole traders and partnerships, only current profits belong to trade income, while one-time profits are not subject to trade tax. Current profits are determined by the transactions belonging to “normal” business activities. Extraordinary profits pursuant to Sec. 16 EStG, such as profits from the sale or abandonment of the business, are therefore excluded from the trade tax assessment base. For this purpose, however, it is assumed that the profit is directly attributable to natural persons. Sec. 7 sent. 2 GewStG, on the other hand, provides for an exception under which trade tax is payable if the profits from the sale or abandonment of • the entire business or a part of a business of a co-partnership, • a co-entrepreneur share, • the share of a general partner of a partnership limited by shares are not attributable to natural persons as directly involved co-entrepreneurs, but to directly involved partnerships or capital companies. These profits must therefore be included in the trade income. Note The profit under the EStG or KStG is the starting value for determining the trade tax base. In addition, the calculation must take into account the addition and deduction rules laid down in the trade tax law. 4.2.1 Additions under Sec. 8 GewStG In Sec. 8 GewStG, the German Trade Tax Act provides its own addition provisions. In doing so, those business expenses that have already been claimed are excluded from deduction for the purpose of trade tax . The additions increase the assessment basis for trade tax but do not have an effect on the assessment basis of personal income tax or corporate income tax. The most important additions of trade tax law under Sec. 8 no. 1 GewStG are examined more closely below. This regulation requires an addition of 25 % of the sum of all individual amounts within the meaning of Sec. 8 no. 1 lits. a-f GewStG. The following facts are included: <?page no="262"?> 4.2 Business profit 263 + All charges for debts economically connected with the business enterprise (Sec. 8 no. 1 lit. a GewStG). The term “charges for debts” refers in particular to interests, but also profit-related interest surcharges, damnum or discount (R 8.1 (1) GewStR). A prerequisite for the addition of interests on borrowed capital is that the corresponding business expenses were previously deductible when determining the profit. When adding interests or licenses, it should therefore be noted that their deductibility was not limited by the regulations on the interest barrier pursuant to Sec. 4h EStG i.c.w. Sec. 8a KStG or by the regulations on the expenses for transfer of rights pursuant to Sec. 4j EStG. Customer rebates and discounts granted as well as similar economic benefits in connection with the fulfilment of trade receivables prior to maturity, however, are only recorded as charges if they do not correspond to normal business transactions (e.g. in the case of unusually long payment terms for discounts). The aim of this addition is to determine a trade tax burden that is largely neutral in terms of financing. For trade tax purposes, it should not make any difference whether the business is financed with equity capital or with borrowed capital. If the business is financed with equity capital, there are no debt interests. For this reason, 25 % of the debt interest is treated as non-deductible in the event of debt financing and is thus added back to the business profit. In this way, the two types (equity financing and debt financing) of financing are aligned. <?page no="263"?> 264 4 Trade tax Figure 66: Additions pursuant to Sec. 8 no. 1 GewStG + All pensions and permanent burdens are to be added to the trade tax base in accordance with Sec. 8 no. 1 lit. b GewStG. Only components affecting expenditures, such as the interest portion, are to be taken into account in the addition. This corresponds to the principle that only the portion needs to be corrected (off the balance sheet) that has already been charged to expenditures in the income statement. In addition, pursuant to Sec. 8 no. 1 lit. b sent. 2 GewStG, pension obligations from direct commitments by an employer to its employees are not added. As with the addition pursuant to Sec. 8 no. 1 lit. a GewStG, the reason for this addition is to determine a trade tax burden that is as financially neutral as possible. + The profit shares of silent partners within the meaning of Sec. 230 HGB are to be added to the business profit in accordance with Sec. 8 no. 1 lit. c GewStG. In this context, a distinction must be made between typical and atypical silentt partners. If someone participates as a typical silent partner, i.e. he is not a co-entrepreneur, but earns income from capital assets in accordance with Sec. 20 EStG. In the trading business of a third party, the profit share of the silent partner reduces for income tax purposes the profit from the trading business of the owner of the trading business as a deductible business expense. In order to ensure the neutrality of the financing and thus the object character of the trade tax, the profit shares must be added, since the typical silent partnership is to be qualified as a form of external financing. The atypical silent partner, on the other hand, is a co-entrepreneur. His profit share therefore does not reduce the profit <?page no="264"?> 4.2 Business profit 265 of the co-entrepreneurship, which is subject to trade tax. An addition in accordance with Sec. 8 no. 1 lit. c GewStG is therefore not necessary. Example: Mr. Max is a typical silent partner in Mr. Moritz's trading business. Mr. Max holds the investment as a private asset. In 2018, Mr. Max's profit share amounts to € 20,000. Mr. Moritz records the full amount as a business expense. The profit share achieved in the amount of € 20,000 represents Mr. Max's income from capital assets in accordance with Sec. 20 EStG and is therefore not subject to trade tax. Since Mr. Moritz recorded the profit share as a business expense, his income taxable profit and thus the starting point for calculating the trade tax assessment base was reduced. Therefore the addition regulation of the Sec. 8 no. 1 lit. c GewStG with regard to the profit portion booked as expenditure in the amount of € 20,000 applies. + According to Sec. 8 no. 1 lit. d GewStG, the additions include “one fifth of the rent and lease payments (including leasing payments) for the use of movable fixed assets owned by another”. Examples of this are charges for rented or leased machinery or cars. This provision is intended to preserve the object tax character of trade tax by ensuring that trade tax is independent of whether the entrepreneur liable to trade tax is the owner of the assets himself or whether the assets are made available in return for payment of rental and lease interests. For this reason, 20 % of the rental and leasing interests booked as expenditures must be added back to the trade tax assessment base. The effective rate of addition for rental and leasing interest for the use of movable fixed assets is thus 5 %. + In addition, Sec. 8 no. 1 lit. e GewStG requires an increase of the trade tax assessment base by 50 % of the rental and lease interests (including leasing payments) for the use of immovable fixed assets owned by another party. Examples of this include charges for rented premises. This regulation also serves to preserve the object tax character of trade tax. The effective additional rate for rental and leasing interest for the use of immovable fixed assets is thus 12.5 %. + Furthermore, pursuant to Sec. 8 no. 1 lit. f GewStG an addition of 25 % of the expenditures for the temporary transfer of rights is to be made (effective addition rate 6.25 %). This applies in particular to expenditures for concessions and licences, which must be added to the assessment basis for trade tax. However, an exception in this regard are license agreements which only have the right to make derivative rights of the licensor available to third parties (so-called intermediate licenses). Such agreements correspond to a pure distribution agreement and are not covered by Sec. 8 no. 1 lit. d GewStG. <?page no="265"?> 266 4 Trade tax Pursuant to Sec. 8 no. 1 GewStG, the individual amounts of lit. a to f are to be added up in order to subsequently add 25 % to the determined sum of the trade tax assessment base. Before this, however, the sum of the individual amounts must be reduced by an allowance of € 100,000 (Sec. 8 no. 1 GewStG). Moreover to Sec. 8 no. 1 GewStG, other additions must also be taken into account when determining the trade tax assessment base: + Pursuant to Sec. 8 no. 5 GewStG, dividends that are 40 % tax-exempt pursuant to Sec. 3 no. 40 EStG or fully tax-exempt pursuant to Sec. 8b (1) KStG are added back to the business profit if the requirements for the so-called intercorporate privilege for trade tax law (gewerbesteuerliches Schachtelprivileg) pursuant to Sec. 9 no. 2a, 7 GewStG cannot be met. For this reason, the advantages granted by the partial-income method are revoked for trade tax purposes both for natural persons (only 60 % taxable) and for capital companies (tax exemption in full if no free float dividends are available), if the prerequisites of the corresponding deduction provision pursuant to Sec. 9 no. 2a, 7 GewStG are not met. Expenditures which have been incurred in connection with these dividends and which have not yet been recognised in full or in part may be recognised in the income statement. According to Sec. 9 no. 2a GewStG, a deduction must be granted for dividend distributions by domestic capital companies if the shareholder holds at least 15 % of the shares at the beginning of the assessment period (national intercorporate privilege for trade tax). According to Sec. 9 no. 7 GewStG, in the case of dividend distributions by foreign capital companies, an uninterrupted participation of at least 15 % since the beginning of the assessment period is a prerequisite for tax exemption. In addition, the foreign capital company must also be active within the meaning of Sec. 8 (1) AStG, i.e. it may not, for example, be a letterbox company (international intercorporate privilege for trade tax). The intercorporate privilege for trade tax pursues the same aims as the deduction of profit shares in partnerships: The taxation should be carried out by the legal entity that has achieved the results. This is, however, contradicted by the fact that the shares are subject to multiple assessments of trade tax in the case of holdings equaling less than 15 % as the shares in the capital company belong to the business operations of the shareholder. Note The intention of the intercorporate privilege for trade tax is that only the legal entity that generated the results is to be subject to taxation. <?page no="266"?> 4.2 Business profit 267 Example: The shareholder of the domestic Kerner AG by 12 % share is a) the Heisterkamp GmbH b) the sole proprietor Martin for several years. The investment in Kerner AG is held as business assets. In 2018, a dividend of € 50,000 is paid on this 12 % share. There is a direct economic connection with this dividend in the form of interests of € 7,000, which were used to finance the investment. a) Pursuant to Sec. 8b (1) KStG, the dividend income of € 50,000 is tax-exempt in the context of determining corporate income tax. However, pursuant to Sec. 8 (5) KStG, 5 % of this income, i.e. € 2,500 (5 % of € 50,000), is considered as nondeductible business expenses, so that only 95 % of dividend payments are exempt. Accordingly, the profit adjustment ultimately amounts to € 47,500. The actual expenditures of € 7,000 are fully deductible. As Heisterkamp-GmbH only holds 12 % of Kerner AG, the conditions for the intercorporate privilege for trade tax are not fulfilled. According to Sec. 8 no. 5 GewStG, the correction amount of € 47,500 must be added to the trade income calculation. The non-deductible business expenses in the amount of € 2,500 have already increased the starting amount for determining trade tax. The corporate income tax exemption is thus reversed for trade tax purposes. After deduction of the expenditures amounting to € 7,000, € 43,000 are ultimately subject to trade tax. In addition, 25 % of the interests in the amount of € 7,000 are to be added after Sec. 8 no. 1 lit. a GewStG as charges for debts, since they have reduced the starting amount for determining trade tax. b) Dividend income is set at 60 %, i.e. € 30,000, when determining the profit for income tax purposes in accordance with Sec. 3 no. 40 lit. d EStG. In addition, 60 % of the interests, i.e. € 4,200, are deductible. The requirements of Sec. 9 no. 2a GewStG are also not fulfilled in the case of the sole proprietor Martin. Consequently, an addition must be made in accordance with Sec. 8 no. 5 GewStG. The starting amount for trade tax so far only includes 60 % of the dividend income. The tax exempt 40 % share of the dividend in the amount of € 20,000 must therefore be added, so that the dividend income is fully included in the trade tax assessment base. The addition will be made after deduction of the interest expense of € 2,800 (40 % of € 7,000), which has so far not been recognised. In the end, an amount of € 17,200 has to be added. In total, income from the free float dividend in the amount of € 43,000 is subject to trade tax. Also here 25 % of the interests at a value of € 7,000 are to be added according to Sec. 8 no. 1 lit. a GewStG as charges for debts. + The loss shares in a domestic or foreign partnership (co-partnership) must be added back to the result in accordance with Sec. 8 no. 8 GewStG. With regard to the addition of loss shares in domestic partnerships, the <?page no="267"?> 268 4 Trade tax purpose is that both a profit and a loss may only be taken into account for trade tax purposes at the level of the partnership. It should not have an impact on the individual co-partner. The loss of a partnership, which is proportionately attributable to the shareholder, must be added back for trade tax purposes so that the loss of the partnership does not have an impact on the trade tax to be paid by the partner. With regard to the addition of loss shares in foreign partnerships, the purpose of the provision is to ensure that the domestic character of the trade tax remains guaranteed. As a result, losses from foreign partnerships - as well as loss shares in domestic partnerships - have no effect on the trade tax of the shareholder. This provision corresponds to the deduction of profits of a domestic or foreign partnership (Sec. 9 no. 2 GewStG). + According to Sec. 8 no. 9 GewStG, capital companies must add all donations within the meaning of Sec. 9 (1) no. 2 KStG back to the business income as these have affected the income subject to corporate income tax. Subsequently, in accordance with Sec. 9 no. 5 GewStG, the deductible part of the donations that may reduce the trade tax assessment basis is determined. This procedure corresponds with that of the German Corporate Income Tax Act, since here also all donations considered as expenditures are firstly completely added back (Sec. 9 (2) sent. 1 KStG) and then after the deductible portion has been determined, a corresponding deduction is made (Sec. 9 (1) no. 2 KStG). Note Additions within the meaning of Sec. 8 GewStG are: • A quarter of the debt interests, • A quarter of the annuities and permanent burdens, • A quarter of the profit shares of typical silent partners, • 5 % (=25 % x 20 %) of rent and lease payments for movable assets, • 12,5 % (=25 % x 20 %) of rent and lease payments for immovable assets, • 6,25 % (=25 % x 25 %) of expenses for the temporary transfer of rights, • Pro rata and fully tax exempt dividends if the requirements of the intercorporate privilege for trade tax are not met, • Loss shares in partnerships, • Donations from capital companies. <?page no="268"?> 4.2 Business profit 269 4.2.2 Deductions under Sec. 9 GewStG The most important requirements for a deduction in accordance with Sec. 9 GewStG are explained below. As was made clear in the previous chapter, the provisions on the deduction often correspond with the addition provisions of Sec. 8 GewStG. It should be emphasized again that, like the additions, the deductions are only applicable to trade tax and thus do not have an effect on the assessment basis for personal income tax and/ or corporate income tax. The deduction of certain sums from the business profit predominantly counteracts the double and/ or multiple assessment(s) of trade tax. Furthermore, it is intended to secure the character of the trade tax as an object tax and domestic tax. ./ . The business profit is to be reduced by 1.2 % of the ratable uniform value of the real estate belonging to the business assets in accordance with Sec. 9 no. 1 GewStG. The deduction serves to avoid a double burden of two real taxes and/ or two taxes that are due to the municipalities, i.e. land tax and trade tax. Whether the real estate belongs to the business assets depends on the provisions of the German Income Tax Act and the German Corporate Income Tax Act. If, for example, a property is sold in the course of the calendar year, it must be reduced. However, if a property is acquired in the course of the year, there is no deduction. Thus, the status at the beginning of the calendar year is decisive. A value equaling 1.4 times the ratable uniform value based on the uniform values existing on 1 January 1964 is taken as the assessment basis for the deduction in accordance with Sec. 121a of the German Valuation Act (BewG). Furthermore, with regard to this deduction, it must be taken into account that <?page no="269"?> 270 4 Trade tax it is only permissible if the property concerned has not been exempted from land tax (Sec. 9 no. 1 sent. 1 GewStG). Example: In 2018, the business assets of the Sissi GmbH include several developed properties with a ratable uniform value of € 400,000. The properties are not exempt from land tax. In order to avoid double taxation with two real taxes, the trade income can be reduced in 2018. The deduction amount is 1.2 % of the € 400,000 ratable uniform value increased by a factor of 1.4. The increased ratable uniform value is € 560,000 (140 % of € 400,000). This results in a deduction amount of € 6,720 (1.2 % of € 560,000). ./ . Corresponding with the addition provision under Sec. 8 no. 8 GewStG, the business profit is reduced by the shares in the profit of a domestic and/ or foreign partnership in accordance with Sec. 9 no. 2 GewStG. With respect to the deduction of the profit shares in domestic partnerships, the purpose is that the partnership itself is considered to be the subject of trade tax and thus must pay the trade tax itself. For the purposes of personal income tax, the partnership is not, however, considered to be the subject of taxation, but rather the individual partners who each earn business income within the meaning of Sec. 15 (1) no. 1 EStG with their profit shares. This profit share was, however, already subject to trade tax at the level of the partnership so that in order to avoid assessing trade tax twice, the profit shares must be deducted again to calculate the trade tax for an individual partner. This relationship becomes clear in Figure 67. Figure 67: Treatment of profit shares of partners in a partnership <?page no="270"?> 4.2 Business profit 271 With respect to the deduction of profit shares in foreign partnerships, the purpose is to assure the domestic character of trade tax. ./ . The national intercorporate privilege for trade tax is regulated in the deduction provision under Sec. 9 no. 2a GewStG, which corresponds with Sec. 8 no. 5 GewStG and provides for a deduction of the profits from distributions by domestic capital companies if the holdings amount to at least 15 %. The provision under Sec. 9 no. 7 GewStG also corresponds with Sec. 8 no. 5 GewStG which assures the international intercorporate privilege for trade tax if, in addition to minimum holdings of 15 %, the foreign capital company is actively engaged in an activity. However, if a lower minimum participation rate is stipulated in a double taxation agreement, this is decisive for the application of the international intercorporate privilege for trade tax pursuant to Sec. 9 no. 8 GewStG. The deduction provisions of Sec. 9 no. 2a, 7 GewStG provide for a deduction of the intercompany dividends only to the extent that these profit shares were previously included in the starting amount for determining the trade income. Apart from the 5 % business expenses deduction prohibition, profit shares of a capital company are not already included in the starting amount for the determination of trade income due to their exemption pursuant to Sec. 8b (1) KStG, provided no free float dividends within the meaning of Corporate Income Tax Act exist. It is therefore not necessary to reduce these exempted profit shares by 95 %. Thus, only a deduction of the 5 % nondeductible business expenses is required, as these were previously included in the starting amount for determining the trade income. However, these non-deductible business expenses pursuant to Sec. 8 (5) KStG do not represent profits from shares (Sec. 9 no. 2a sent. 4 GewStG). For this reason, the flat-rate non-deductible business expenses are not subject to the deduction regulations, so that no trade tax deductions can be considered for them pursuant to Sec. 9 no. 2a, 7 GewStG. Ultimately, a trade tax deduction rule according to Sec. 9 no. 2a, 7 GewStG for intercompany dividends for capital companies is therefore without scope of application. In the case of partnerships, the profit shares in accordance with Sec. 3 no. 40 lit. d EStG were considered at the taxable 60 % share in the starting amount used to determine the trade income. If the requirements are met, the deduction provisions are applied. The remaining 60 % profit shares subject to income tax are reduced from the business profit in accordance with Sec. 9 no. 2a, 7 GewStG. However, this deduction amount still has to be reduced by the expenses in economic connection with the trade tax exempt dividend. <?page no="271"?> 272 4 Trade tax Figure 68: Distinction between intercorporate and free float dividends <?page no="272"?> 4.2 Business profit 273 Example: In 2018, the following German shareholders hold shares in the domestic Müller GmbH as follows: • Sole proprietor Heinrich at 15 % • Elisabeth OHG at 10 % • Sissi GmbH at 40 % • Fritz AG at 35 % The investments are held as business assets. Furthermore, Sissi GmbH's shareholding was only increased from 10 % to 40 % in the course of 2018 through the acquisition of shares. For the deduction provision of Sec. 9 no. 2a GewStG, the participation quota existing at the beginning of the assessment period is relevant. Accordingly, only the sole proprietor Heinrich and the Fritz AG meet the requirements for claiming the deduction pursuant to Sec. 9 no. 2a GewStG, as they hold at least 15 % of the shares. The dividends of the sole proprietor Heinrich contained in the starting amount for the determination of the trade income in accordance with Sec. 3 no. 40 lit. d EStG at 60 % are to be reduced in the determination of the trade income. Pursuant to Sec. 8b (1) KStG, the Fritz AG does not require such a deduction. ./ . Income from the trade of foreign permanent establishments reduces the business profit in accordance with Sec. 9 no. 3 GewStG. This deduction is founded in the domestic character of trade tax. Figure 69: Deductions for benefits and membership fees according to Sec. 9 no. 5 GewStG <?page no="273"?> 274 4 Trade tax ./ . Corresponding with the addition provisions under Sec. 8 no. 9 GewStG, the deductible maximum amount for donations made is regulated in Sec. 9 no. 5 GewStG. The deductible portion for expenses to support charitable, ecclesiastical or religious purposes in accordance with Secs. 52-54 AO amounts to 20 % of the business profit increased by the addition in accordance with Sec. 8 no. 9 GewStG. Alternatively, a deduction of 4 % of the sum of all turnover plus the wages and salaries paid during the fiscal year is also possible. If the benefits exceed the permissible maximum amounts, it is possible according to Sec. 9 no. 5 sent. 8 GewStG to carry these excess amounts forward to later periods. For donations that create or increase the assets of a foundation under public law or a private foundation that is exempt from corporate income tax pursuant to Sec. 5 (1) no. 9 KStG, an additional deduction possibility up to a maximum amount of € 1 million (Sec. 9 no. 5 sent. 3 GewStG) exists upon application. However, this deduction amount is only granted to sole proprietorships and partnerships and can only be claimed once during a period of 10 years. In this respect, however, the taxpayer is given the option of distributing the deduction amount arbitrarily over the 10 years in question. Note Deductions within the meaning of Sec. 9 GewStG include the following: • 1,2 % of the ratable uniform value of the real estate belonging to the business assets and not exempt from land tax, • profit shares in partnerships, • distributions by domestic capital companies if a share of at least 15 % is held, • trade income of foreign permanent establishments, • deductible maximum amount for donations. Table 18 summarises the aims of the individual addition and deduction provisions. <?page no="274"?> 4.2 Business profit 275 Table 18: Summary of addition and deduction rules <?page no="275"?> 276 4 Trade tax 4.2.3 Loss carryforward According to Sec. 10a GewStG, the relevant trade income is decreased by the shortfalls that result from determining the relevant trade income for the previous assessment periods, taking into consideration Secs. 7-10 GewStG. As a result, it is not the business profit that forms the relevant assessment basis but rather the trade income depicted in the figure (prior to loss deduction). In particular, the additions and the deductions thus have an impact on the amount of trade income prior to loss deduction. It is therefore conceivable, for example, that there may be negative business income for income tax purposes, but a positive result is calculated for trade tax purposes. The German Trade Tax Act only makes reference to the loss carryforward (Sec. 10a sent. 1 GewStG). It is not possible to offset the losses between individual branches of one taxpayer. The trade loss can therefore only be offset against the trade business in which it arose (business identity). This restriction is based on the character of the trade tax as an object tax according to which the individual business establishment is the object of taxation and not the sums of business income. A loss carryback is also not possible. This is intended to protect smaller municipalities with few large sources of trade tax who might otherwise have to pay considerable trade tax refunds. The following formula must also be observed for trade tax pursuant to Sec. 10a sent. 1 GewStG pursuant to Sec. 10 (2) EStG: max. compensable amount = € 1 Mio. + 60 % × (trade income [before deduction of losses] ./ . € 1 Mio.) <?page no="276"?> 4.2 Business profit 277 An unlimited deduction of losses not yet offset is therefore only possible up to a positive assessment basis of € 1 million. If the basis of assessment exceeds € 1 million, a deduction of any shortfalls from previous years that have not yet been subject to tax deduction is only possible up to 60 % of the excess amount. 4.2.4 Tax allowance, federal tax rate, municipal rate and advance payments Prior to deducting the tax allowance within the meaning of Sec. 11 (1) sent. 3 GewStG, the trade income is to be rounded down to full hundred amounts after loss deduction (Sec. 11 (1) sent. 3 half-sent. 1 GewStG). The tax allowance is subsequently deducted in accordance with Sec. 11 (1) sent. 3 nos. 1 and 2 GewStG. Business establishments by virtue of economic business operations and undertakings by legal entities under public law are granted a tax allowance amounting to € 5,000. Partnerships and sole proprietorships are granted a tax allowance amounting to € 24,500. In contrast, capital companies are not entitled to a tax allowance. This is intended to compensate for the trade tax advantages enjoyed by capital companies in comparison to natural persons and partnerships resulting from the fact that contractual agreements between a capital company and its shareholders can be accepted fiscally. The managing director’s salary of a partner in a partnership is subject to trade tax as special remuneration at the level of the partnership because the special remuneration is considered to form a portion of the business profit in accordance with Sec. 7 GewStG. Different rules on tax allowances are intended to counteract this inequality. <?page no="277"?> 278 4 Trade tax A trade tax index amount is assumed in the calculation of the trade tax (Sec. 11 GewStG). In order to determine the tax index amount for fiscal purposes, the trade income is to be multiplied by the so-called federal tax rate (Sec. 11 (2) GewStG) after making the previously described modifications and deducting the losses carried forward and the tax allowances. In accordance with Sec. 11 (2) GewStG, the amount of this federal tax rate is 3.5 %, irrespective of whether the company is operated as a partnership or a capital company. The product of the federal tax rate and the trade income is the trade tax index amount (Sec. 14 sent. 1 GewStG). The municipalities are entitled to multiply this trade tax index amount by their municipal rate in order to determine the trade tax liability (Sec. 16 (1) GewStG). The municipalities may set their respective municipal rates themselves (Sec. 16 (1) half-sent. 2 GewStG). However, it should be noted that Sec. 16 (4) sent. 2 GewStG prescribes a minimum assessment rate of 200 %. Table 19: Municipal rates in selected German municipalities <?page no="278"?> 4.2 Business profit 279 Table 19 summarises the assessment rates of selected municipalities in Germany. The assessment rates of these municipalities lie between 400 % and 500 %, whereby it should be noted that they tend to be higher in large cities. However, according to official estimates, the average assessment rate of all municipalities in Germany for trade tax in 2010 was 390 %. As is the case with personal income tax and corporate income tax, advance payments of trade tax are to be made by the taxpayer quarterly in accordance with Sec. 19 (1) GewStG (on 15 February, 15 May, 15 August and 15 November). The amount of the advance payments is generally one-fourth of the taxes that resulted from the last assessment (Sec. 19 (2) GewStG). When calculating the trade income, these trade tax advance payments must be taken into account indirectly. As a rule, trade tax prepayments were correctly recognised as expenses in the accounts. However, since trade tax and the related ancillary benefits are non-deductible business expenses pursuant to Sec. 4 (5b) EStG, the trade tax prepayments made may not reduce either the income tax or corporate income tax base or the trade tax base. As a result, the advance payments treated as expenses must be added back to determine the tax base. The addition is made off-balance at the level of income or corporate income tax (Sec. 4 (5b) EStG). Since the profit according to EStG or KStG represents the starting point for the determination of the trade income, it is ensured that the trade tax advance payments also do not have a tax-reducing effect on the determination of the trade tax. A further addition of trade tax prepayments in the determination of trade income is therefore not required. Finally, the advance payments already made are to be credited toward the resulting trade tax liability (Sec. 20 (1) GewStG). The remaining tax liability is the final payment to be made within one month after the tax assessment is made known (Sec. 20 (2) GewStG). Example: The sole proprietor Johanna calculates her trade tax provision for the year 2018. Johanna has achieved a business income in the amount of € 100,000. Additions and deductions according to Secs. 8, 9 GewStG did not arise. The trade tax prepayments of € 10,000 were taken into account as expenses within the framework of the bookkeeping, but were already added back during the income tax calculation, which correspondingly also has an effect on the determination of the trade income. The assessment rate is set by the municipality at 500 %. <?page no="279"?> 280 4 Trade tax Business income € 100,000 = ./ . Trade income Tax allowance = € 100,000 ./ . € 24,500 = × Trade income after tax allowance Federal tax rate = € 75,500 × 3.5 % = × Tax index amount Municipal rate = € 2,643 × 500 % = ./ . Trade tax liability Advance payments made = € 13,215 ./ . € 10,000 = Trade tax provision (final payment) = € 3,215 Breakdown According to Sec. 1 GewStG, the trade tax is a municipal tax. A municipality is entitled to assess trade tax if a business establishment is located within its area (Sec. 4 (1) sent. 1 GewStG). Problems occur if the company has permanent establishments in more than one municipality, a permanent establishment stretches out over several municipalities, or a permanent establishment has moved to a different municipality during the year (Sec. 28 GewStG). If one of the three circumstances exists, the trade tax index amount must be allocated to the municipalities entitled to assess trade tax in the form of fractional shares (Sec. 4 (1) sent. 2 i.c.w. Sec. 28 (1) sent. 1 GewStG). This allocation of the trade tax liability is known as the “breakdown” (Zerlegung), which is regulated in Secs. 28-34 GewStG. According to Sec. 29 (1) GewStG, the breakdown measure is the ratio of the sum of employees’ wages earned by all workers employed at all permanent establishments to the sum of the employees’ wages earned by the employees in the individual permanent establishment of the respective municipality. Exceptions (Sec. 29 (1) no. 2 GewStG) exist for companies which exclusively operate plants for the generation of electricity and other energy sources as well as heat from wind energy and solar radiation energy, because in such plants the employees employed in the permanent establishments regularly are not relevant. Note Requirements for breakdown: • Permanent establishments of the company in multiple municipalities, • permanent establishment stretches out over more than one municipality, or • permanent establishment has moved to a different municipality. <?page no="280"?> 4.4 Lump-sum crediting of trade tax 281 Example: The Isabella-AG has a permanent establishment in Ingolstadt and one in Eichstätt. The municipal rate of the city Ingolstadt is 400 %, while the municipal rate of Eichstätt is 330 %. The sum of the employees’ wages earned by the employees working in Ingolstadt amounts to € 6,000,000. The sum of the wages earned by the employees working in Eichstätt amounts to € 3,000,000. The trade tax index amount of the Isabella-AG was correctly determined to be € 1 80,000. Employees’ wages Breakdown measure Breakdown share Trade tax Ingolstadt € 6,000,000 2/ 3 × € 180,000 = € 120,000 € 480,000 Eichstätt € 3,000,000 1/ 3 × € 180,000 = € 60,000 € 198,000 € 678,000 Lump-sum crediting of trade tax Sole proprietors and co-partners are subject to a personal income tax of maximum 45 %, while capital companies are subject to a corporate income tax of 15 %. In order to mitigate this additional burden of trade tax borne by sole proprietors and partnerships in comparison to capital companies and thus to achieve a profit tax burden that is for the most part neutral to the legal form, the assessed trade tax is to be credited to the income tax liability in a lumpsum. According to Sec. 35 (1) sent. 1 no. 1 EStG, the scaled income tax is reduced for commercial businesses within the meaning of Sec. 15 (1) sent. 1 no. 1 EStG by 3.8 times the respective trade tax index amount. In the case of copartnerships within the meaning of Sec. 15 (1) sent. 1 nos. 2 and 3 EStG, the proportional tax index amount which results from the profit distribution key is taken into consideration (Sec. 35 (1) sent. 1 no. 2 EStG). However, the deduction of the tax reduction amount pursuant to Sec. 25 (1) sent. 5 EStG is limited to the trade tax actually to be paid. Note The scaled income tax is reduced by 3.8 times the (proportional) trade tax index amount for sole proprietors and co-partners. Example: Assuming a municipal tax rate of 420 %: ./ . ./ . + Profit before taxes Trade tax (€ 100,000 ./ . € 24,500) × 0,035 × 4,2 Income tax (€ 100,000 × 0.42 ./ . € 8,622) Tax credit pursuant to Sec. 35 EStG Tax burden of a sole proprietor / partnership € 100,000 ./ . € 11,099 ./ . € 33,378 <?page no="281"?> 282 4 Trade tax ./ . 3.8 × (€ 100,000 ./ . € 24,500) × 0.035* Solidarity surcharge of 5.5 % of (€ 33,378 ./ . € 10,042) + € 10,042 ./ . € 1,283 = Net income after taxes = € 64,282 *Alternative calculation: 11,099 / 4.2 × 3.8 = € 10,042. Final question on trade tax The Schanzer-GmbH is specialized in the construction of fixation machinery in Ingolstadt. Using the following data, determine the trade tax liability of the Schanzer-GmbH for 2018. 1. The tax balance sheet profit amounted to € 412,000 in 2018. 2. The interest on loans amounted to € 100,000. In addition, expenditures of € 20,000 were incurred in 2018 for the rental of two company cars belonging to the fixed assets of the Schanzer-GmbH. The Schanzer-GmbH also made leasing payments of € 75,000 for various immovable fixed assets. 3. The ratable uniform value of the real estate belonging to the Schanzer- GmbH equaled € 200,000 in 2018. There was no exemption from land tax. 4. Advance payments of trade tax in 2018, which reduced the tax balance sheet profit, amounted to € 38,000. 5. The municipal rate in Ingolstadt is 400 %. Solution 1. A business profit pursuant to Sec. 7 sent. 1 GewStG of € 450,000 is available. 2. The total amount of the loan interest (Sec. 8 no. 1 lit. a GewStG) as well as 20 % of the rental expenditures for the two company cars (Sec. 8 no. 1 lit. d GewStG) and 50 % of the leasing payments for various immovable fixed assets (Sec. 8 no. 1 lit. e GewStG) must first be added up. Subsequently, the determined value in accordance with Sec. 8 no. 1 GewStG must be reduced by the allowance of € 100,000. According to Sec. 8 no. 1 GewStG, 25 % of the remaining amount is to be added to the business profit. 3. Since the land of Schanzer-GmbH is not exempt from the land tax, 1.2 % of the ratable uniform value of the business land are to be deducted from the business profit pursuant to Sec. 9 no. 1 GewStG. The basis of assessment is 1.4 times the ratable uniform value. Accordingly, € 3,360 is to be reduced. <?page no="282"?> 4.5 Final question on trade tax 283 4. The advance payments in the amount of € 38,000 have already been added in a profit-increasing manner to the income tax calculation. Since the trade tax ties up to the profit determined according to the regulations of the income tax law, no renewed addition for purposes of the trade tax calculation has to take place. Business profit ( tax balance sheet profit plus trade tax advance payment) € 450,000 + Additions (Sec. 8 no. 1) 100 % of charges for debts 20 % of the rental payments for movable assets 50 % of the rental payments for immovable assets Allowance (Sec. 8 no. 1) + € 100,000 + € 4,000 + € 37,500 ./ . € 100,000 ./ . Thereof 25 % Deductions (Sec. 9) € 41,500 = € 10,375 + € 10,375 ./ . € 3,360 = Trade income (rounded down) × Federal tax rate (Sec. 11 (2) no. 2) = € 457,000 × 3.5 % = Tax index amount (Sec. 14 sent. 1) × Municipal rate (Sec. 16) = € 15,995 × 400 % = Trade tax ./ . Advance payments = € 63,980 ./ . € 38,000 = Final payment (Sec. 20 (2)) = € 25,980 Summary ► The personal ability of the person carrying the business is not taken into account by the trade tax. ► According to Sec. 6 GewStG, the assessment basis for the trade tax is the trade income. ► There are two different types of business establishments: • stationary business establishments and • mobile business establishments ► Trade tax is only assessed inasmuch as the business establishment is located domestically. ► The company is liable for the tax in the case of partnerships and capital companies. In the case of sole proprietorships, the owner is liable for the tax. ► The starting point for the determination of the trade income is the business profit in the respective business establishment. This is to be modified by additions within the meaning of Sec. 8 GewStG and deductions within the meaning of Sec. 9 GewStG. ► Furthermore, the trade income (prior to loss deduction) is to be reduced by the loss carryforward and the tax allowance (for partnerships). <?page no="283"?> 284 4 Trade tax ► The tax index amount results by multiplying the trade income and the federal tax rate. ► The trade tax liability is the product of the tax index amount and the municipal rate. ► The quarterly advance payments are to be deducted from the trade tax liability in order to determine the amount of the final payment and/ or the tax refund entitlement. ► A breakdown of the trade tax liability is to be carried out if • permanent establishments of the company are in multiple municipalities, • a permanent establishment stretches out over multiple municipalities, or • a permanent establishment has moved during the year. ► Sole proprietors and co-partners may deduct 3.8 times the (proportional) trade tax index amount from the scaled income tax. Questions 1. Characterize the trade tax. 2. Name the assessment basis for the trade tax. 3. To what object of taxation does the trade tax relate? Are there different types of it? 4. When are several establishments of a taxpayer to be assessed as a single establishment? 5. What is the starting value for the determination of the assessment basis? 6. Why should trade tax modifications be made? 7. Which additions are to be made? 8. What is special about the addition of financing expenses with regard to those that are subject of the interest barrier regulation? 9. What deductions are to be performed? 10. What additional modifications are to be performed? 11. How are losses taken into account? 12. How are the trade tax index amount and the trade tax liability determined? 13. How is the final payment and/ or entitlement to a refund calculated? 14. When and how is the tax index amount broken down? 15. Why do sole proprietors receive a lump-sum credit of the trade tax on their income tax? Literature Dietrich Grashoff, Florian Kleinmanns, Aktuelles Steuerrecht 2017 (Current tax law 2017), Munich, 13 th ed. 2017, pp. 210-130. Dieter Schneeloch, Stephan Meyering, Guido Patek, Betriebswirtschaftliche Steuerlehre, Bd. 1: Grundlagen der Besteuerung, Ertragsteuern (Business taxation, Vol. 1: Principles of taxation, profit taxes), Munich, 7 th ed. 2016, pp. 187-200. Klaus Tipke Joachim Lang, Steuerrecht (Tax law), Cologne, 22 th ed. 2015, pp. 717-737. <?page no="284"?> Legal neutrality of taxation Principle of legal neutrality of taxation As a central aim of the 2008 corporate tax reform, the legislator cited the strengthening of the competitiveness of partnerships by ensuring a tax burden that is largely neutral in terms of legal form. This was intended to give taxpayers the option of choosing the legal form of a company unaffected by tax aspects. This objective resulted from the significant differences in the tax burden between capital companies on the one hand and sole proprietorships or partnerships on the other. The reasons for this were the principle of separability or non-transparency in the case of capital companies and the principle of unity or transparency in the case of partnerships. In accordance with the principle of separability, capital companies as independent tax subjects were subject only to relatively low corporate income tax in the case of retention of profits, because the level of taxation actually strived for was only achieved through renewed taxation of the distribution of profits to a natural person. In contrast, as a result of the transparency principle, all profits of sole proprietorships and partnerships were always taxed at the personal income tax rate of the (co-)entrepreneur, which was generally significantly higher. A distinction between accumulated and withdrawn profits - analogous to the procedure for capital companies - was not made for partnerships from a tax point of view. As a result of these differences in taxation, capital companies were favoured in the case of retaining earnings over partnerships which were denied such a retaining option. In order to illustrate the problem that arises when partnerships, in contrast to capital companies, are not granted a retaining option, the following tax burden comparison is intended to show the effect of accumulation in the case of capital companies withnon-retaining option for partnerships. A trade tax municipal rate of 420 % and an income tax threshold rate of 45 % are assumed. The trade tax allowance granted only to partnerships within the meaning of Sec. 11 (1) sent. 2 no. 1 GewStG is not taken into account. Sole proprietorship/ partnership Capital company ./ . ./ . ./ . Company profit Trade tax Corporate income tax Income Tax, 45 % € 100,000 ./ . € 14,700 - ./ . € 45,000 € 100,000 ./ . € 14,700 ./ . € 15,000 - <?page no="285"?> 286 5 Legal neutrality of taxation + ./ . Trade tax credit Solidarity surcharge € 13,300 ./ . € 1,744 - ./ . € 825 == Remaining Tax burden (for retention) = € 51,856 = € 48,144 = € 69,475 = € 30,525 On the basis of the aforementioned assumptions, the example shows the significant differences in taxation if only capital companies could accumulate tax-priviliged. The possibility of a preferential taxation of retained profits to which only capital companies were entitled until the assessment period 2007 leads to an overall tax burden of approx. 30 %. In comparison, a partnership would be subject to a significantly higher tax burden of approx. 48 % due to the lack of distinction between retained and distributed profits. Since there is a different tax burden in Germany for accumulated and distributed profits, any tax burden comparison should take into account the taxation at shareholder level in addition to the taxation at company level. If capital companies distribute the profits to natural persons, the total burden for the shareholders increases by the flat-rate withholding tax if the shares are held as private assets, otherwise by the effects of the partial-income method. If other capital companies are included in the investment chain, a corporate income tax and trade tax burden occurs at the level of that capital company. The amount of this tax burden depends on whether the intercorporate privilege for corporate income and/ or trade tax applies. Assuming that the shares in the capital company in the above example are held directly by a natural person as private assets, the additional income tax including solidarity surcharge amounts to € 18,324 in the event of a distribution. The total burden for a full distribution then amounts to € 48,849 (€ 30,525 + € 18,324). In the case of sole proprietorships and partnerships, the amount of the tax burden (without taking into account the possibility of preferential taxation of accumulated profits) is generally independent of the profit distribution and is not subject to any further tax burden in the event of withdrawal by the sole proprietor or co-entrepreneur. It can thus be stated that in the case of a complete distribution of profits, capital companies are burdened slightly more heavily (€ 48,849) than sole proprietorships or partnerships (€ 48,144). The lower the personal income tax rate of the sole proprietor or co-entrepreneur, the greater is the tax advantage (of the company including the shareholder level) in comparison to capital companies. As an interim result, it should be noted that the choice of the tax-optimal legal form is primarily influenced by the relevant income tax rate of the sole proprietor or the co-entrepreneur as well as the distribution ratio of the profit. In the extreme case of full accumulation, the capital company is more advantageous, <?page no="286"?> whereas in the extreme case of full distribution, the advantage lies on the side of the sole proprietorship or partnership. The so-called accumulation privilege described below can reduce the differences in taxation. In general, however, it should be noted that the lower the personal income tax rate of the sole proprietor or co-entrepreneur, the greater is the tax advantage of the sole proprietorship or co-entrepreneurship. Approaches for the implementation of legal form neutral taxation in Germany As an attempt to achieve a legal neutrality of taxation as part of the 2008 corporate tax reform, the introduction of the accumulation privilege already described in Chapter 2.2.8.3 “Special rates according to Secs. 34 and 34a EStG” also give private entrepreneurs the opportunity to subject profits not withdrawn on application to a special income tax rate of 28.25 % (including the solidarity surcharge of 29.8 %). In the case of co-entrepreneurs, this only applies if the profit share is at least 10 % or exceeds € 10,000. For both sole proprietors and co-entrepreneurs, the prerequisite for the accumulation privilege is that the profit is determined by the accrual method in accordance with Sec. 4 (1) sent. 1 or Sec. 5 EStG. In connection with the possibility of crediting trade tax within the meaning of Sec. 35 EStG, which is granted only to sole proprietors and partnerships, a level of taxation should be achieved which corresponds approximately to the tax burden from corporate income tax and trade tax of capital companies. Figure 70 illustrates this approach. Figure 70: Realization of a taxation neutral in legal form by Sec. 34a EStG 5.2 Implementation of legal form neutral taxation 287 <?page no="287"?> 288 5 Legal neutrality of taxation However, the accumulation privilege within the meaning of Sec. 34a EStG can only meet this objective to a limited extent, since the tax burden on accumulated profits of capital companies and partnerships with trade tax, corporate income tax or income tax as well as the solidarity surcharge are only formally at the same level. However, the actual amount of the tax burden on profits accumulated in the partnership is assuming a marginal tax rate significantly higher than that on profits retained in capital companies. There are two main reasons for this deviation: Firstly, the transparency principle leads to the fact that the (co-)entrepreneur himself is regarded as a tax subject of income tax and solidarity surcharge. Thus the entrepreneur is also forced to pay the tax due on his profit shares by withdrawing them from the company if he cannot afford them from his private assets. In the amount of these (inevitable) withdrawals, however, he cannot make use of the preferential taxation for retained profits under Sec. 34a EStG, since a possible beneficiary amount within the meaning of Sec. 34a EStG must be reduced in the amount of these withdrawals. Note The preferential treatment of Sec. 34a EStG only partially leads to a taxation that is neutral in legal form. Due to the lack of consideration of non-deductible business expenses within the scope of the beneficiary amount in sense of Sec. 34a EStG as well as the problem of often unavoidable withdrawals for the settlement of private taxes, the actual tax burden level is normally significantly higher than the special tariff of Sec. 34a EStG in the amount of 28.25 % plus solidarity surcharge. In addition, the amount available for beneficiary taxation within the meaning of Sec. 34a EStG is reduced by non-deductible business expenses - in particular in the form of trade tax. This results from the fact that, pursuant to Sec. 34a (2) EStG, the tax balance sheet profit is decisive for determining the beneficiary amount. However, trade tax was recognised as an expense when determining the tax balance sheet profit. However, the addition of trade tax as a non-deductible business expense required under Sec. 4 (5b) EStG is only made retrospectively off the balance sheet. Thus, the trade tax liability is not subject to the preferential tax rate of Sec. 34a EStG in the amount of 28.25 % due to its non-deductibility, but is taxed as part of the business income with the personal tax rate of the (co-)entrepreneur. The following sample calculation is intended to illustrate this problem once again: <?page no="288"?> ./ . Profit before deduction of trade tax Trade tax € 100,000 ./ . € 14,000 = ./ . Tax balance sheet profit Balance of withdrawals and deposits = € 86,000 ./ . € 0 = + Undrawn profit (eligible) Trade tax as non-deductible business expense = € 86,000 + € 14,000 = Business income = € 100,000 As a result of these two facts, the intended equivalence between the tax burden on profits retained in partnerships and the tax burden on profits retained in capital companies is significantly disturbed. This problem does not exist for a shareholder of a capital company, as capital companies have their own legal personality. A distribution of profits to settle the tax liability is therefore not necessary, as the company itself is liable for trade tax, corporate income tax and solidarity surcharge. This permits a complete retention of the profit remaining after deduction of corporate income tax and the solidarity surcharge. The following example is intended to illustrate once again more favourable treatment of retained profits of capital companies in comparison to retained profits of partnerships, which continues to exist despite the introduction of accumulation privilege within the meaning of Sc. 34a EStG. It is again assumed that a trade tax municipal rate of 420 % and an income tax marginal rate of 45 % will be applied. The trade tax allowance within the meaning of Sec. 11 (1) sent. 2 no. 1 GewStG, which is exclusively granted to sole proprietors and partnerships, is not taken into account. It is also to be assumed that the entire profit, with the exception of tax payments, is to be retained. Sole proprietorship / partnership Capital company ./ . ./ . ./ . ./ . +./ . Company profit Trade tax Corporate income tax Income Tax on non-benefical profits (trade tax + income tax + solidarity surcharge) in the amount of € 37,012 Income tax on retained profits in the amount of € 62,988 Trade tax credit Solidarity surcharge € 100,000 ./ . € 14,700 - ./ . € 16,655 ./ . € 17,794 + € 13,300 ./ . € 1,163 € 100,000 ./ . € 14,700 ./ . € 15,000 - - - ./ . € 825 == Remaining Tax burden (for retention) = € 62,988 = € 37,012 = € 69,475 = € 30,525 5.2 Implementation of legal form neutral taxation 289 <?page no="289"?> 290 5 Legal neutrality of taxation Calculation of the maximum accumulation privilege (T): The problem with the calculation of the maximum accumulation privilege is as follows: The special tariff of Sec. 34a EStG can only be claimed on the profit not withdrawn. However, the income tax resulting from the application of the special tariff regularly represents a withdrawal and cannot therefore be taxed at a preferential rate. This problem is illustrated in the following example. The derivation takes place in two steps: Step 1: First of all, the profit after trade tax (profit-tax) has to be determined. According to Sec. 4 (5b) EStG, trade tax is a non-deductible business expense and is therefore always subject to the normal income tax rate: Profit after trade tax = profit ./ . trade tax = € 100,000 ./ . € 14,700 = € 85,300 Step 2: Since both the income tax resulting from the application of Sec. 34a EStG and the income tax on trade tax represent withdrawals and therefore cannot be taxed at a preferential rate, the profit from trade tax must be divided into a tax-privileged part (T) and a non-privileged part. Profit after trade tax = maximum accumulation privilege (T) + income tax × (1 + solidarity surcharge) The income tax liability consists of three components: I. income tax on the accumulation amount amount (T) (application of the special tariff pursuant to Sec. 34a EStG): T × 0.2825 II. income tax on the withdrawal to settle the income tax liability (application of the normal rate): (profit after trade tax ./ . T) × 0.45 III. income tax on trade tax less trade tax credit: trade tax × 0.45 ./ . trade tax credit This results in the following equation: Profit after trade tax = T + [I. + II. + III.] × (1 + solidarity surcharge) ↔ Profit after trade tax = T + [T × 0.2825 + (profit after trade tax ./ . T) × 0.45 + trade tax × 0.45 ./ . trade tax credit] × (1 + solidarity surcharge) ↔ 85,300 = T + [T × 0.2825 + (85,300 ./ . T) × 0.45 + 14,700 × 0.45 ./ . 13,300] × (1 + solidarity surcharge) By correspondingly reforming and resolving the equation, the maximum accumulation privilege T is € 62,988. Conversely, this results in a total tax burden of € 37,012 from income tax and trade tax. <?page no="290"?> The tax burden for sole proprietors and partnerships has been reduced through the introduction of the accumulation privilege within the meaning of Sec. 34a EStG. However, the deficiencies in design described above lead to an actual burden of up to 37 % on sole proprietorships and partnerships, even in the case of full profit retention, which is significantly higher than that on capital companies. As a result, a taxation of companies that is neutral in legal form is still not guaranteed. Instead, there remains a considerable increase in the complexity of the taxation system, which once again leads ad absurdum the aim of simplifying tax law. On the whole, it must be questioned to what extent it makes economic sense to retain profits in companies and thus only make them available for business use instead of distributing them to the shareholders for free use through nonretention. In the past it has been assumed that the investment behaviour of capital companies leads to better economic results than a reinvestment of the distributed capital by the shareholders themselves. Taking into account the previous tax regulations, it would be more profitable to finance the investments through undistributed profits (so-called lock-in effect ). This profitability assumption has now also been extended to partnerships Literature Dietrich Grashoff, Florian Kleinmanns, Aktuelles Steuerrecht 2017 (Current tax law 2017), Munich, 13 th ed. 2017, pp. 130-136. Klaus Tipke Joachim Lang, Steuerrecht (Tax law), Cologne, 22 th ed. 2015, pp. 739-747. Günter Wöhe, Ulrich Döring, Gerrit Brösel, Einführung in die Allgemeine Betriebswirtschaftslehre (Introduction to General Business Administration), Munich, 26 th ed. 2016, pp. 230-232. 5.2 Implementation of legal form neutral taxation 291 <?page no="292"?> Final comprehensive case Information regarding corporate income tax In the fiscal year (= calendar year) 2018, the power supply company named Edwin-GmbH, shows a preliminary net income on the commercial balance sheet of € 1,100,000. In order to develop the interconnections between the commercial and tax balance sheet on the one hand, and on the other to reveal mistakes that are often made, certain positions have been particularly emphasized. The preliminary surplus in the commercial balance sheet is thus assumed to be € 2,200,000 for didactic reasons so that the following positions, which as a result were not accounted for, can be discussed separately: Income from investments 1) + € 200,000 Provision 2) ./ . € 150,000 Advance payments of corporate income tax in 2018 ./ . € 200,000 Advance payments of trade tax in 2018 ./ . € 100,000 Pecuniary penalty 3) ./ . € 250,000 Interest for loans ./ . € 600,000 The following supplemental information exists on the individual positions of the P&L: 1. The Edwin-GmbH holds 20 % of the shares in the Linden-AG. The dividends for the fiscal year 2017 were decided in the general meeting on 20 June 2018, of which a dividend of € 200,000 went to the Edwin-GmbH and was transferred to their bank account on 1 July 2018. 2. Under German commercial law, because of existing delivery obligations, the Edwin-GmbH must set aside a provision of € 150,000 for contingent losses from pending transactions in accordance with Sec. 249 (1) sent. 1 of the German Commercial Code (HGB). 3. The Edwin-GmbH was fined with € 250,000 by the antitrust authorities for illegal price agreements. Note: The solidarity surcharge is not taken into consideration for the sake of simplicity. <?page no="293"?> 294 6 Final comprehensive case Information regarding personal income tax Edwin (single, born 1970, childless) is the managing director of the Edwin- GmbH. The following amounts are recorded on his wage tax card for 2018: Gross employee wages € 120,000 Withheld wage tax € 18,900 Withheld church tax € 1,512 Edwin did not receive church tax refunds in 2018. For his union membership, Edwin pays an annual membership fee of € 40. In addition, he has incurred travel costs to work by private car of € 1,200 (220 working days, distance apartment/ work 18.18 km). Edwin receives a profit distribution of € 60,000 due to his 50 % share in the GmbH, which he holds as private assets. After deduction of capital yields tax of € 15,000, an amount of € 45,000 was credited to his bank account in May 2018. In 2018, Edwin transfers € 30,000 interest to his house bank for a bank loan taken out to finance this investment. In addition, the house bank charged him € 1,200 in 2018 for the management of the GmbH shares. In addition, Edwin donates € 30,000 in 2018 to a charitable organisation to save the world's climate. Tasks a) Calculate the taxable income, the provisions to be set aside for trade tax (municipal tax rate = 400 %), and the provisions to be set aside for corporate income tax for the Edwin-GmbH. b) Calculate Edwin’s personal income tax liability for 2018. Solution notes Table 20 is intended to visually depict the following again: 1. The changes of the commercial balance sheet (1 st column) as well as the adaptation of the commercial balance sheet to the tax balance sheet (2 nd column) are to be made within the scope of the regular bookkeeping by way of accounting records (transfers and subsequent bookings). The taxable income in accordance with the German Corporate Income Tax Act (3 rd column) and the trade profit in accordance with the German Trade Tax Act (4 th column) is to be determined by way of a separate ancillary calculation and thus outside of the balance sheet . 2. The changes that are made to the assessment basis (3 rd column) in accordance with the provisions of the German Income Tax Act and the German <?page no="294"?> 6.3 Solution notes 295 Corporate Income Tax Act (KStG) also apply to the trade tax . For this reason, the taxable income in accordance with KStG is assumed in the calculation of the trade tax (4 th column). 3. The changes made in accordance with special provisions of German trade tax law (4 th column) only apply to trade tax and are thus not included in the assessment basis for corporate income tax. 4. The trade tax reduces both the commercial balance sheet profit and the tax balance sheet profit by booking the trade tax provision as an expense. However, it does not reduce the corporate income tax base. 5. Also in the case of the provision for corporate income tax , it is recognized as an expense, which reduces both the commercial balance sheet profit and the tax balance sheet profit. Table 20: Relation between commercial balance sheet profit/ tax balance sheet profit/ taxable income according to KStG/ trade income according to GewStG <?page no="295"?> 296 6 Final comprehensive case Solution 6.4.1 Determination of the taxable income/ provision for trade tax/ provision for corporate income tax Commercial balance Tax balance Taxable income according to KStG Trade tax Preliminary net income for the year € 2,200,000 € 1,100,000 € 1,250,000 € 1,610,000 a) Income from investments 1) + € 200,000 ./ . € 200,000 Thereof 5 % non-deductible expenses + € 10,000 b) Provision 2) c) Advance payment of corporate income tax in 2018 3) ./ . € 150,000 ./ . € 200,000 + € 150,000 + € 200,000 d) Advance payments of trade tax in 2018 4) ./ . € 100,000 + € 100,000 e) Pecuniary penalty 5) ./ . € 250,000 + € 250,000 f) Interest 6) ./ . € 600,000 + € 125,000 = Net income before tax ./ . Provision for trade tax ./ . Provision for corporate income tax € 1,100,000 ./ . € 142,900 ./ . € 41,500 € 1,250,000 ./ . € 142,900 ./ . € 41,500 € 1,610,000 € 1,735,000 = Net income after taxes € 915,600 € 1,065,600 1) According to Sec. 8b (1) KStG, a deduction is carried out in the determination of the taxable income under KStG. This deduction also applies to trade tax in accordance with Sec. 9 no. 2a GewStG. As a result of the Sec. 8b (5) KStG, only 95 % of the income is exempted. 2) Under German tax law, a provision may not be made for contingent losses from pending transactions in accordance with Sec. 5 (4a) EStG. A correction is made within the scope of preparing the tax balance sheet. 3) Advance payments of corporate income tax must be added back into the taxable income in accordance with Sec. 10 no. 2 KStG. 4) Since the trade tax advance payments pursuant to Sec. 4 (5b) EStG are non-deductible business expenses, they must be added back to the tax balance sheet profit outside the balance sheet. 5) The German Corporate Income Tax Act stipulates that the pecuniary penalty is to be added back to the taxable income in accordance with Sec. 10 no. 3 KStG. 6) The interest must first be reduced by a tax allowance of € 100,000. Then, according to Sec. 8 no. 1 lit. a GewStG, 25 % of the remaining amount ((€ 600,000 ./ . € 100,000) x 25 % = € 125,000) increase the trade tax assessment base. <?page no="296"?> 6.4 Solution 297 Calculation of the provision for trade tax Trade tax rate = 0,035 × 400 % = 0.14 ./ . Trade tax liability Advance payments of trade tax in 2018 1,735,000 × 0.14 = € 242,900 ./ . € 100,000 = Provision to be set aside for trade tax € 142,900 Calculation of the provision for corporate income tax Corporate income tax liability 1,610,000 × 0.15 = € 241,500 ./ . Advance payment of corporate income tax in 2018 ./ . € 200,000 = Provision to be set aside for corporate income tax € 41,500 6.4.2 Calculation of the tax liability for 2018 The calculation scheme of Sec. 2 EStG is used in determining Edwin’s tax liability. Figure 71: Income tax calculation scheme <?page no="297"?> 298 6 Final comprehensive case Application of the flat-rate withholding tax within the meaning of Sec. 32d EStG a) Income from dependent-employment Edwin’s managing director’s salary belongs to the income from dependentemployment in accordance with Sec. 19 (1) sent. 1 no. 1 EStG. This income is to be determined in accordance with Sec. 2 (1) no. 2 EStG as surplus earnings over income-related expenses. Gross employee wages (earnings i.a.w. Sec. 8 i.c.w. Sec. 19 EStG) € 120,000 ./ . ./ . ./ . ./ . Income-related expenses (Sec. 9 EStG) Traveling costs Account maintenance charges (lump-sum) Trade union memberships fee € 1,200 € 16 € 40 Total income-related expenses € 1,256 Income from dependent-employment in 2018 € 118,744 Note: The sum of the income-related expenses is higher than the lump-sum allowance of € 1,000 so that the actual costs are to be claimed (Sec. 9a sent. 1 EStG). b) Income from capital assets Edwin earns dividends from its shares which belong to income from capital assets pursuant to Sec. 20 (1) no. 1 EStG. These are generally subject to the flat-rate withholding tax within the meaning of Sec. 32d EStG. However, as Edwin holds more than 25 % of the shares in the Edwin-GmbH, it is permissible to apply the exception in Sec. 32d (2) no. 3 lit. a EStG. This allows Edwin, upon request, an option for subjecting the dividend income to the partial-income method within the meaning of Sec. 3 no. 40 lit. d EStG. In order to ensure the lowest possible tax burden, the two taxation options must therefore be weighed against each other. Earnings (gross dividends) Savers’ lump-sum (Sec. 20 (9) sent. 1 EStG) € 60,000 ./ . € 801 Tax base of the flat-rate withholding tax within the meaning of Sec. 32d EStG Tax rate in the amount of 25 % according to Sec. 32d (1) sent. 1 EStG = € 59,199 25 % Income tax burden Withheld capital yields tax = € 14,800 ./ . € 15,000 Refund claim = ./ . € 200 <?page no="298"?> 6.4 Solution 299 Note: The tax burden on dividend income in the amount of € 15,000 has a compensatory effect pursuant to Sec. 43 (5) sent. 1 EStG. A deduction of the actual income-related expenses is excluded pursuant to Sec. 20 (9) sent. 1 EStG. In order for Edwin to be able to claim the savers’ lump-sum, the assessment option should be applied for within the scope of the so-called compensation via assessment pursuant to Sec. 32d (4) EStG. c) Total income and total amount of income Since the capital yields tax has a compensatory effect on dividend income, it is no longer included in the total income or total amount of income. This means that both the total income and the total amount of income amount to € 118,744. d) Special expenses  Completely deductible special expenses The withheld church tax of € 1.512 is fully deductible as special expenses pursuant to Sec. 10 (1) no. 4 EStG.  Partially deductible special expenses Contributions for purposes within the meaning of Sec. 52 AO Deductible maximum amount (20 % of 118,744) € 30,000 / . € 23,749 € 23,749 Balance to be carried forward (Sec. 10b (1) sent. 9 EStG) € 6,251 Deductible donation (Sec. 10b (1) sent. 1 EStG) € 23,749 → Total special expenses : € 23,749 + € 1,512 € 25,261  Special expense deduction for contributions to social insurance Employee contributions to pension insurance are deductible as pension expenditures. 1. Employee’s contribution to statutory pension insurance Sec. 10 (1) no. 2 lit. a EStG 2. Employer’s contribution to statutory pension insurance Sec. 10 (1) no. 2 lit. a EStG € 7,254 € 7,254 3. Total contributions 4. Maximum amount Sec. 10 (3) sent. 1 EStG 5. To be considered € 14,508 € 23,712 (24.7 % of € 96,000) € 14,508 <?page no="299"?> 300 6 Final comprehensive case 6. Thereof 86 % Sec. 10 (3) sent. 4 and 6 EStG 7. Less tax-exempt employer’s contribution Sec. 10 (3) sent. 5 EStG € 12,477 ./ . € 7,254 8. Deductible pension expenses € 5,223 9. Health and nursing care insurance Sec. 10 (1) no. 3 EStG 10. Unemployment insurance Sec. 10 (1) no. 3 EStG 11. Total contributions 12. Maximum amount Sec. 10 (4) EStG 13. Minimum amount Sec. 10 (1) no. 3a EStG 14. Other deductible provident expenditures € 5,217 € 1,170 € 6,387 € 1,900 € 5,217 € 5,217 15. Total deductible provident expenditures subject to most favourable tax treatment € 10,440 → Total special expenses : € 1,512 + € 23,749 + € 10,440 € 35,701 The most favourable tax treatment according to Sec. 10 (4a) EStG is carried out ex officio. Note : The donation amount of € 6,251, which is not allowed for the deduction of special expenses, has to be determined separately. In later assessment periods, it is possible to claim this as special expenses within the limits of the permitted maximum amounts. e) Rate The scaled income tax for Edwin results from the application of the basic table to the taxable income in accordance with Sec. 32a (1) EStG. Total amount of income (Sec. 2 (3) EStG) € 118,744 ./ . Special expenses ./ . € 35,701 Taxable income (Sec. 2 (5) EStG) € 83,043 Income tax to be assessed for 2018 (Sec. 32a EStG) € 26,256 ./ . Withheld wage tax (Sec. 36 (2) no. 2 EStG) ./ . € 18,900 ./ . Withheld capital yields tax (Sec. 36 (2) no. 2 EStG) ./ . € 200 Income tax remaining to be paid for 2018 € 7,156 <?page no="300"?> 6.4 Solution 301 Note : The church tax and the solidarity surcharge are not taken into consideration for the sake of simplicity. This also applies to the following considerations. f) Total income tax burden Income tax to be assessed for 2018 € 26,256 + Flat-rate withholding tax on dividend income + € 14,800 Total income tax burden 2018 € 41,056 Application of the partial-income method within the meaning of Sec. 3 no. 40 lit. d EStG a) Income from dependent-employment Gross employee wages (earnings i.a.w. Sec. 8 i.c.w. Sec. 19 EStG) € 120,000 ./ . ./ . ./ . ./ . Income-related expenses (Sec. 9 EStG) Traveling costs Account maintenance charges (lump-sum) Trade union membership fee € 1,200 € 16 € 40 Total income-related expenses € 1,256 Income from dependent-employment in 2018 € 118,744 b) Income from capital assets Earnings (gross dividends) 60 % thereof according to Sec. 3 no. 40 lit. d EStG Income-related expenses (60 % of bank charges and interest on loans according to Sec. 3c (2) EStG) € 60,000 € 36,000 ./ . € 18,720 Income from capital assets in 2018 € 17,280 Note: If a decision is made to apply the partial income procedure instead of the flatrate withholding tax within the meaning of Sec. 32d EStG, no savers’ lumpsum pursuant to Sec. 20 (9) EStG is granted to reduce income from capital assets (Sec. 32d (2) no. 3 sent. 2 EStG). <?page no="301"?> 302 6 Final comprehensive case c) Total income and total amount of income Thus, both the total income and the total amount of income (€ 118,744 + € 17,280 =) are € 136,024. d) Special expenses  Completely deductible special expenses The retained church tax of € 1.512 is fully deductible pursuant to Sec. 10 (1) no. 4 EStG.  Partially deductible special expenses Contributions for purposes within the meaning of Sec. 52 AO Deductible maximum amount (20 % of € 136,024) € 30,000 ./ . € 27,205 € 27,205 Balance to be carried forward (Sec. 10b (1) sent. 3 EStG) € 2,795 Deductible donation (Sec. 10b (1) sent. 1 EStG) € 27,205 Deductible social security contribution € 10,440 € 27,205 + € 1,512 + € 10,440 € 39,157 Note : The donation amount of € 2,795, which is not permitted for the deduction of special expenses, must be determined separately. In later assessment periods, it is possible to claim this as special expenses within the limits of the permitted maximum amounts. e) Rate The scaled income tax for Edwin results from the application of the basic table to the taxable income in accordance with Sec. 32a (1) EStG. ./ . Total amount of income (Sec. 2 (3) EStG) Special expenses € 136,024 ./ . € 39,157 ./ . ./ . Taxable income (Sec. 2 (5) EStG) Income tax to be assessed for 2018 (Sec. 32a EStG) Withheld wage tax (Sec. 36 (2) no. 2 EStG) Withheld capital yields tax (Sec. 36 (2) no. 2 EStG) € 96,867 € 32,062 ./ . € 18,900 ./ . € 15,000 Income tax refund in 2018 € 1,838 The income tax burden shows significant differences depending on the chosen taxation methodology for capital income. Due to the choice of the flat- <?page no="302"?> 6.4 Solution 303 rate withholding tax within the meaning of Sec. 32d EStG, Edwin is ultimately subject to a total burden of € 41,056. In contrast, the income tax to be determined for the application of the partial-income method within the meaning of Sec. 3 no. 40 lit. d EStG is considerably lower at € 32,062. This difference is due to the fact that Sec. 20 (9) EStG expressly prohibits the deduction of the actually incurred income-related expenses. In addition, the application of the partial-income method has a positive effect on the maximum possible deduction of donations in assessment period 2018 (the amount deductible in the future will be reduced accordingly). In view of the results obtained, Edwin is therefore advised to take an option for the exemption under Sec. 32d (2) no. 3 lit. a EStG, which allows him to apply the partial-income method to the dividend income and the deduction of directly income-related expenses. <?page no="304"?> List of figures Fig. 1 Ratio of government expenditures to the GNP for Germany 2016 .13 Fig. 2 Development of the expenditure-GNP ratio from 1980 to 2016.......14 Fig. 3 Tax and contribution ratio for Germany 2016......................................14 Fig. 4 Possibilities of financing for the state.....................................................17 Fig. 5 Approaches of systematization ................................................................19 Fig. 6 Tax scale in 2018 ..........................................................................................24 Fig. 7 Classification of the taxes according to the tax sovereignty.............25 Fig. 8 Revenue from selected types of German taxes in 2016 ......................29 Fig. 9 Forms of assessing income tax .................................................................31 Fig. 10 Personal and impersonal liability for personal income tax ...............33 Fig. 11 Personal income tax liability.....................................................................34 Fig. 12 Unlimited vs. limited (personal) tax liability ........................................42 Fig. 13 Organization of income according to the way the income is determined .....................................................................................................43 Fig. 14 Organization of income according to its priority ................................45 Fig. 15 Determination of the taxable income .....................................................46 Fig. 16 Determination of income tax liability ....................................................48 Fig. 17 Classification of earnings ..........................................................................49 Fig. 18 Classification of expenses ..........................................................................50 Fig. 19 Methods of determining income ..............................................................59 Fig. 20 Characteristics of business income .........................................................75 Fig. 21 Scope of business income ..........................................................................76 Fig. 22 Sale of shares in capital companies .........................................................81 Fig. 23 Characteristics of income from self-employment................................84 Fig. 24 Scope of income from self-employment ................................................85 Fig. 25 Scope of the income from dependent-employment ............................90 Fig. 26 Basic system of the taxation of capital income ....................................95 Fig. 27 The systematics of Sec. 32d EStG ............................................................98 Fig. 28 Exceptions to the special tariff of Sec. 32d EStG................................101 <?page no="305"?> 306 List of figures Fig. 29 Income-related expenses regarding capital income ..........................106 Fig. 30 Scope of income from rent and lease ....................................................110 Fig. 31 Scope of the other income .......................................................................112 Fig. 32 Scope of benefits within the meaning of Sec. 24 EStG .....................121 Fig. 33 Loss compensation ....................................................................................127 Fig. 34 The tax treatment of losses .....................................................................131 Fig. 35 The different types of special expenses ...............................................135 Fig. 36 Forms of pensions and their taxation ...................................................140 Fig. 37 Prerequisites for taking private supplementary retirement provision into account..............................................................................141 Fig. 38 Determination of retirement provision expenses deductible as special expenses .........................................................................................142 Fig. 39 Vocational training and further education costs ...............................153 Fig. 40 Maximum amounts for the deduction of benefits within the meaning of Sec. 10 (1) and (2) EStG ......................................................154 Fig. 41 Calculation scheme for political donations .........................................155 Fig. 42 The different types of extraordinary expenses ..................................158 Fig. 43 The dual system of family benefit compensation..............................164 Fig. 44 Most favourable tax treatment for the child allowance 2018 ......167 Fig. 45 Scope of extraordinary income ..............................................................171 Fig. 46 Determination of the beneficiary profit within the meaning of Sec. 34a EStG ................................................................................................178 Fig. 47 Taxable income vs. tax balance sheet profit........................................179 Fig. 48 Determination of the amount subject to subsequent taxation .......181 Fig. 49 Crediting of trade tax in accordance with Sec. 35 EStG...................185 Fig. 50 Cumulative requirements for co-partner status.................................196 Fig. 51 Determination of the business income of the partner......................199 Fig. 52 Determination of the total taxable profit.............................................200 Fig. 53 Overview of the corporate income tax liability .................................214 Fig. 54 Determination of corporate income tax...............................................216 Fig. 55 Distinction between declared and hidden profit distribution ........220 Fig. 56 The concept of hidden profit distribution ...........................................225 <?page no="306"?> List of figures 307 Fig. 57 Distinction between hidden profit distribution and hidden equity contribution....................................................................................228 Fig. 58 Valuation of contributions.......................................................................229 Fig. 59 Effects of the hidden equity contribution............................................231 Fig. 60 Treatment of the distribution by the recipient ...................................233 Fig. 61 Basic principle of the interest barrier ...................................................237 Fig. 62 Exceptions to the interest barrier regulation pursuant to Sec. 8a KStG in conjunction with Sec. 4h (2) EStG .........................................241 Fig. 63 Basic principle of the EBITDA carryforward .....................................242 Fig. 64 The types of business establishment.....................................................257 Fig. 65 Objectives of the trade tax modifications ............................................261 Fig. 66 Additions pursuant to Sec. 8 no. 1 GewStG ........................................264 Fig. 67 Treatment of profit shares of partners in a partnership ..................270 Fig. 68 Distinction between intercorporate and free float dividends.........272 Fig. 69 Deductions for benefits and membership fees according to Sec. 9 no. 5 GewStG ..............................................................................................273 Fig. 70 Realization of a taxation neutral in legal form by Sec. 34a EStG...287 Fig. 71 Income tax calculation scheme...............................................................297 <?page no="307"?> List of tables Table 1 Differentiation of the profit tax types ................................................. 28 Table 2 Cross-border workers and citizens of the EU/ EEA .......................... 38 Table 3 Scope of application of the notional unlimited tax liability........... 39 Table 4 Scope of application of limited tax liability ....................................... 39 Table 5 Profit vs. surplus types of income ........................................................ 44 Table 6 Selected non-deductible business expenses ....................................... 52 Table 7 Realization principle vs. inflow-outflow principle .......................... 55 Table 8 Methods of determining profit.............................................................. 67 Table 9 Differentiation of self-employment from dependent-employment ............................................................................................................. 70 Table 10 Differentiation between asset administration and business activities...................................................................................................... 75 Table 11 Scope of the income from capital assets ............................................. 96 Table 12 Tax consequences from the allocation of capital income to private or business assets ....................................................................... 97 Table 13 Exceptions of Sec. 32d (2) EStG...........................................................104 Table 14 Requirements for the deduction of the elderly allowance ...........122 Table 15 Disability lump-sums depending on the degree of disability ......162 Table 16 Classification of tax categories............................................................191 Table 17 Tax subjectivity of the company ........................................................196 Table 18 Summary of addition and deduction rules .......................................275 Table 19 Municipal rates in selected German municipalities.......................278 Table 20 Relation between commercial balance sheet profit/ tax balance sheet profit/ taxable income according to KStG/ trade income according to GewStG.............................................................................295 <?page no="308"?> Translations English - German Accrual method Betriebsvermögensvergleich Accumulation privilege Thesaurierungsbegünstigung Acquisition costs Anschaffungskosten Additive profit determination Additive Gewinnermittlung Advance payment of trade tax Gewerbesteuer-Vorauszahlung Advance payments Vorauszahlungen Allowance Freibetrag Alternative school Ersatzschule Amount subject to subsequent taxation Nachversteuerungspflichtiger Betrag Ancillary income types Nebeneinkunftsarten Annuities Renten Annuities certain Zeitrenten Assessment Veranlagung Assessment basis Bemessungsgrundlage Assessment option Veranlagungsoption Average tax rate Durchschnittssteuersatz Basic pension Basis-Rente Basic tax rate Eingangssteuersatz Beneficiary amount Begünstigungsbetrag Benefits Zuwendungen Business earnings Betriebseinnahmen Business expenses Betriebsausgaben Business income Einkünfte aus Gewerbebetrieb Calculation scale Durchrechnungstarif Capital company Kapitalgesellschaft Capital gain Veräußerungsgewinn Capital yields tax Kapitalertragsteuer Cash method accounting Einnahmen-Überschuss-Rechnung <?page no="309"?> 310 Translations Child allowance Kinderfreibetrag Child benefit Kindergeld Church tax Kirchensteuer Compensation Entschädigung Compulsory assessment Pflichtveranlagung Concern clause Konzernklausel Contributions Einlagen Contributions, constructive equity Einlagen, verdeckte Co-partnership Mitunternehmerschaft Corporate income tax Körperschaftsteuer Costs of tax consultation Steuerberatungskosten Cross-border workers Grenzpendler Deductible amount Abzugsbetrag Depreciation Abschreibung Depreciation for wear Absetzung für Abnutzung Determination of income Einkunftsermittlung Differential tax rate Differenzsteuersatz Disability lump-sum Behinderten-Pauschbetrag Discrete period taxation Abschnittsbesteuerung Disposal of (shareholdings) shares Veräußerung von Beteiligungen Domestic income Inländische Einkünfte Donations Spenden Double taxation Doppelbesteuerung Earnings Einnahmen Elderly allowance Altersentlastungsbetrag Escape clause Escape-Klausel Expenditures Aufwendungen Extraordinary expenses Außergewöhnliche Belastungen Extraordinary income Außerordentliche Einkünfte Family benefit compensation Familienleistungsausgleich Favourable calculation Günstigerrechnung Federal tax rate Steuermesszahl Final payment Abschlusszahlung <?page no="310"?> Fiscal year Wirtschaftsjahr Flat-rate withholding tax Abgeltungsteuer Foreign income Ausländische Einkünfte Future security benefits Zukunftssicherungsleistungen Gifts Geschenke Graduated scale Staffeltarif Half-income method Halbeinküfteverfahren Hobby activity Liebhaberei Income from capital assets Einkünfte aus Kapitalvermögen Income from dependent-employment Einkünfte aus nichtselbstständiger Arbeit Income from farming and foresting Einkünste aus Land- und Forstwirtschaft Income from investments Beteiligungserträge Income from self-employment Einkünfte aus selbsständiger Arbeit Income from rent and lease Einkünfte aus Vermietung und Verpachtung Income-related expenses Werbungskosten Income types Einkunftsarten Individual assessment Einzelveranlagung Intention of realizing profits Gewinnerzielungsabsicht Intercorporate privilege Schachtelprivileg Interest barrier Zinsschranke Joint assessment Zusammenveranlagung Legal entity Juristische Person Legal neutrality Rechtsformneutralität Life annuity funds Leibrenten Loss carryback Verlustrücktrag Loss carryforward Verlustvortrag Loss compensation Verlustausgleich Loss deduction Verlustabzug Lottery winnings Lotteriegewinne Lump-sum allowance for employees Arbeitnehmer-Pauschbetrag English - German 311 <?page no="311"?> 312 Translations Lump-sum allowance for income-related expenses Werbungskosten-Pauschbetrag Lump-sum allowance for special expenses Sonderausgaben-Pauschbetrag Lump-sum allowances Pauschbeträge Lump-sum care allowance Pflege-Pauschbetrag Lump-sum wage tax Lohnsteuerpauschalierung Maintenance payments Unterhaltsleistungen Marginal tax rate Grenzsteuersatz Membership fees Mitgliedsbeiträge Method of determining profit Gewinnermittlungsmethode Mobile business establishment Reisegewerbe Most favourable tax treatment Günstigerprüfung Municipal rate Hebesatz Net income principle Nettoprinzip Off-balance sheet additions Außerbilanzielle Hinzurechnungen One-fifth rule Fünftelregelung Other income Sonstige Einkünfte Other pension expenditures Sonstige Vorsorgeaufwendungen Partial-income method Teileinkünfteverfahren Partnerships Personengesellschaften Partner, silent Gesellschafter, stiller Partner, typical silent Gesellschafter, typisch stiller Party donations Parteispenden Payments in kind Sachbezüge Pecuniary penalties Geldstrafen Pension allowance Renten-Freibetrag Pensional lump-sum Vorsorgepauschale Pensions Pensionen Pension tax allowance Versorgungs-Freibetrag Permanent burdens Dauernde Lasten Personal income tax Einkommensteuer Personal taxes Personensteuern Subsequent taxation amount Nachversteuerungsbetrag <?page no="312"?> English - German 313 Primary income types Haupteinkunftsarten Principle of global income taxation Welteinkommenprinzip Principle of separability Trennungsprinzip Principle of transparency Transparenzprinzip Profit Gewinn Profit distribution Gewinnausschüttung Profit distribution, declared Gewinnausschüttung, offene Profit distribution, hidden Gewinnausschüttung, verdeckte Profit income types Gewinneinkunftsarten Provident expenditures Vorsorgeaufwendungen Rate Tarif Real splitting Realsplitting Reasonable burden Zumutbare Belastung Recurring remunerations Wiederkehrende Bezüge Reduced average tax rate Reduzierter Durchschnittssteuersatz Remuneration for the members of the supervisory board Aufsichtsratsvergütungen Rental and lease payments Miet- und Pachtzinsen Retirement benefits Versorgungsbezüge Retirement Income Act Alterseinkünftegesetz Retirement provisions Altersvorsorgeaufwednungen Riester pension Riester-Rente Rürup pension Rürup-Rente Savers’ lump-sum Sparer-Pauschbetrag Schedule system Schedulensystem Self-employment Selbstständigkeit Separate and uniform determination of profits Gesonderte und einheitliche Gewinnfeststellung Separate balance sheets Sonderbilanzen Separate business assets Sonderbetriebsvermögen Shareholder debt financing Gesellschafter-Fremdfinanzierung Short fiscal year Rumpfwirtschaftsjahr Source principle/ theory Quellenprinzip/ -theorie Special business earnings Sonderbetriebseinnahmen <?page no="313"?> 314 Translations Special expenses Sonderausgaben Special remuneration Sondervergütungen Splitting method Splitting-Verfahren Subsequent taxation Nachgelagerte Besteuerung Supplementary balances Ergänzungsbilanzen Supply services Versorgungsleistungen Surplus income types Überschusseinkunftsarten Surviving dependents allowance Hinterbliebenen-Pauschbetrag Sustainability Nachhaltigkeit Taxable income Zu versteuerndes Einkommen Tax index amount Steuermessbetrag Tax liability Steuerpflicht Tax threshold Freigrenze Territoriality principle Territorialitätsprinzip Threshold scale Anstoßtarif Top tax rate Spitzensteuersatz Trade income Gewerbeertrag Trade tax Gewerbesteuer Vocational training costs Berufsausbildungskosten Wage tax Lohnsteuer Wage tax card Lohnsteuerkarte Withdrawal Entnahme <?page no="314"?> Final payment Discrete period taxation Depreciation Depreciation for wear Deductible amount Additive profit determination Retirement Income Act Elderly allowance Retirement provisions Acquisition costs Threshold scale Lump-sum allowance for employees German - English Abschlusszahlung Abschnittsbesteuerung Abschreibung Absetzung für Abnutzung Abzugsbetrag Additive Gewinnermittlung Alterseinkünftegesetz Altersentlastungsbetrag Altersvorsorgeaufwendungen Anschaffungskosten Anstoßtarif Arbeitnehmer-Pauschbetrag Aufsichtsratsvergütungen Remuneration for the members of the supervisory board Aufwendungen Expenditures Ausländische Einkünfte Foreign income Außerbilanzielle Hinzurechrechnungen Off-balance sheet additions Außergewöhnliche Belastungen Extraordinary expenses Außerordentliche Einkünfte Extraordinary income Basis-Rente Basic pension Begünstigungsbetrag Beneficiary amount Behinderten-Pauschbetrag Disability lump-sum Bemessungsgrundlage Assessment basis Berufsausbildungskosten Vocational training costs Beteiligungserträge Income from investments Betriebsausgaben Business expenses Betriebseinnahmen Business earnings Betriebsvermögensvergleich Accrual method Dauernde Lasten Permanent burdens Differenzsteuersatz Differential tax rate Doppelbesteuerung Double taxation Durchrechnungstarif Calculation scale German - English 315 <?page no="315"?> 316 Translations Durchschnittssteuersatz Average tax rate Eingangssteuersatz Basic tax rate Einkommensteuer Personal income tax Einkünfte aus Gewerbebetrieb Business income Einkünfte aus Kapitalvermögen Income from capital assets Einkünfte aus Land- und Forstwirtschaft Income from farming and foresting Einkünfte aus nichtselbstständiger Arbeit Income from dependent-employment Einkünfte aus selbständiger Arbeit Income from self-employment Einkünfte aus Vermietung und Verpachtung Income from rent and lease Einkunftsarten Income types Einkunftsermittlung Determination of income Einlagen Contributions Einlagen, verdeckte Contributions, constructive equity Einnahmen Earnings Einnahmen-Überschuss-Rechnung Cash method accounting Einzelveranlagung Individual assessment Entnahme Withdrawal Entschädigung Compensation Ergänzungsbilanzen Supplementary balances Ersatzschule Alternative school Escape-Klausel Escape clause Familienleistungsausgleich Family benefit compensation Freibetrag Allowance Freigrenze Tax threshold Fünftelregelung One-fifth rule Geldstrafen Pecuniary penalties Geschenke Gifts Gesellschafter, stiller Partner, silent Gesellschafter, typisch stiller Partner, typical silent Gesellschafter-Fremdfinanzierung Shareholder debt financing Gesonderte und einheitliche Separate and uniform determination of <?page no="316"?> German - English 317 Gewinnfeststellung profits Gewerbebetrieb Business establishement Gewerbeertrag Trade income Gewerbesteuer Trade tax Gewerbesteuer-Vorauszahlung Advance payment of trade tax Gewinn Profit Gewinnausschüttung Profit distribution Gewinnausschüttung, offene Profit distribution, declared Gewinnausschüttung, verdeckte Profit distribution, hidden Gewinneinkunftsarten Profit income types Gewinnermittlungsmethode Method of determining profit Gewinnerzielungsabsicht Intention of realizing profits Grenzpendler Cross-border workers Grenzsteuersatz Marginal tax rate Grundfreibetrag Basic tax allowance Günstigerprüfung Most favourable tax treatment Günstigerrechnung Favourable calculation Halbeinkünfteverfahren Half-income method Haupteinkunftsarten Primary income types Hebesatz Municipal rate Hinterbliebenen-Pauschbetrag Surviving dependents allowance Inländische Einkünfte Domestic income Juristische Person Legal entity Kapitalertragsteuer Capital yields tax Kapitalgesellschaft Capital company Kinderfreibetrag Child allowance Kindergeld Child benefit Kirchensteuer Church tax Konzernklausel Concern clause Körperschaftsteuer Corporate income tax Leibrenten Life annuity funds Liebhaberei Hobby activity Lohnsteuer Wage tax <?page no="317"?> 318 Translations Lohnsteuerkarte Wage tax card Lohnsteuerpauschalierung Lump-sum wage tax Lotteriegewinne Lottery winnings Miet- und Pachtzinsen Rental and lease payments Mitgliedsbeiträge Membership fees Mitunternehmerschaft Co-partnership Nachgelagerte Besteuerung Subsequent taxation Nachhaltigkeit Sustainability Nachversteuerungsbetrag Subsequent taxation amount Nachversteuerungspflichtiger Betrag Amount subject to subsequent taxation Nebeneinkunftsarten Ancillary income types Nettoprinzip Net income principle Parteispenden Party donations Pauschbeträge Lump-sum allowances Pensionen Pensions Personengesellschaften Partnerships Personensteuern Personal taxes Pflege-Pauschbetrag Lump-sum care allowance Pflichtveranlagung Compulsory assessment Quellenprinzip/ -theorie Source principle/ theory Realsplitting Real splitting Rechtsformneutralität Legal neutrality Reduzierter Durchschnittssteuersatz Reduced average tax rate Reinvermögenszugangstheorie Accretion theory Reisegewerbe Mobile business establishment Renten Annuities Renten-Freibetrag Pension allowance Riester-Rente Riester pension Rumpfwirtschaftsjahr Short fiscal year Rürup-Rente Rürup pension Sachbezüge Payments in kind Schachtelprivile Intercorporate privilege Schedulensystem Schedule system <?page no="318"?> German - English 319 Selbständigkeit Self-employment Sonderausgaben Special expenses Sonderausgaben-Pauschbetrag Lump-sum allowance for special expenss Sonderbetriebseinnahmen Special business earnings Sonderbetriebsvermögen Separate business assets Sonderbilanzen Separate balance sheets Sondervergütungen Special remuneration Sonstige Einkünfte Other income Sonstige Vorsorgeaufwendungen Other pension expenditures Sparer-Pauschbetrag Savers’ lump-sum Spenden Donations Spitzensteuersatz Top tax rate Splitting-Verfahren Splitting method Staffeltarif Graduated scale Steuerberatungskosten Costs of tax consultation Steuermessbetrag Tax index amount Steuermesszahl Federal tax rate Steuerpflicht Tax liability Tarif Rate Teileinkünfteverfahren Partial-income method Territorialitätsprinzip Territoriality principle Thesaurierungsbegünstigung Accumulation privilege Transparenzprinzip Principle of transparency Trennungsprinzip Principle of separability Überschusseinkunftsarten Surplus income types Unterhaltsleistungen Maintenance payments Veranlagung Assessment Veranlagungsoption Assessment option Veräußerung von Beteiligungen Disposal of (shareholdings) shares Veräußerungsgewinn Capital gain Verlustabzug Loss deduction Verlustausgleich Loss compensation Verlustrücktrag Loss carryback <?page no="319"?> 320 Translations Verlustvortrag Loss carryforward Versorgungsbezüge Retirement benefits Versorgungs-Freibetrag Pension tax allowance Versorgungsleistungen Supply services Vorauszahlungen Advance payments Vorsorgeaufwendungen Provident expenditures Vorsorgepauschale Pensional lump-sum Welteinkommenprinzip Principle of global income taxation Werbungskosten Income-related expenses Werbungskosten-Pauschbetrag Lump-sum allowance for income-related expenses Wiederkehrende Bezüge Recurring remunerations Wirtschaftsjahr Fiscal year Zeitrenten Annuities certain Zinsschranke Interest barrier Zu versteuerndes Einkommen Taxable income Zukunftssicherungsleistungen Future security benefits Zumutbare Belastung Reasonable burden Zusammenveranlagung Joint assessment Zuwendungen Benefits <?page no="320"?> Index accretion theory 43, 44, 45 accumulation privilege 175, 287 advance payment 188 advance payments 217, 250, 277, 279 ancillary income types 45, 109 annuities 92, 93, 112, 113 annuities certain 112 assessment 30, 97, 170, 192 assessment basis 47, 169, 215 assessment option 97, 101 basic pension 119 basic tax allowance 169 basic tax rate 23, 169 beneficiary amount 178, 288 benefits 153, 247, 274 donations 153 membership fees 153 business establishment 255, 257 calculation scale 23 capital companies 175, 259 capital company 97, 103 capital gain 80 capital gains 172, 234, 244 capital yields tax 32, 96, 99, 188, 193, 211, 250 child allowance 157, 160, 164, 166, 169, 184, 187 child benefit 157, 164, 165, 184, 187 childcare expenses 137 church tax 96, 136, 149 compulsory assessment 99, 192 concern clause 243 co-partner 77, 196 co-partnership 262 co-partnerships 33, 89, 259, 281 corporate income tax 176, 209, 285 corporations 209 costs of tax consultation 138 cross-border workers 35 declared profit distribution 220 depreciation for wear 61 differential tax rate 23 disability lump-sum 161 disposal of shares 80 domestic income 39, 215 donations 22, 153, 186, 238, 246, 268, 274 donations to political parties 186, 247 double taxation 41, 209, 271 educational allowance 161 endowments 155 extraordinary burdens 36 extraordinary expenses 139, 157 <?page no="321"?> 322 Index extraordinary income 79, 169, 171 federal tax rate 277, 278 fiscal year 55, 56 short ~ 56 foreign income 40 future security benefits 93, 94 gifts 236 graduated scale 23 half-income method 211 hidden profit distribution 105, 225, 226 hidden profit distributions 224, 234, 252 hobbies 71 income from a hobby 47 income from investments 210 income-related expenses 50, 51, 68, 69, 93, 102, 105, 110, 151 independence 77, 125, 200 independent 262 intention of realizing profits 71, 257 intercorporate privilege 266, 271 interest barrier 236, 237, 263 joint assessment 31, 143, 170, 186 legal entities 33, 195, 209, 252 legal entity 21 legal neutrality 285 legal neutrality of taxation 176 life annuity funds 112, 113, 139 life annuity insurance 119, 146 loss carryback 127, 129, 249 loss carryforward 127, 130, 249, 276 loss compensation 104, 106, 127, 249 loss deduction 127, 128, 212, 248, 276 losses 106 lottery winning 41, 48 lump-sum allowance 161 for employees 69, 94, 192 for special expenses 138 lump-sum allowances 69, 160, 192 for income related expenses 69 lump-sum care allowance 161 maintenance payments 115, 125, 147 membership fees 153 method half-income ~ 211 partial income ~ 222, 266 splitting ~ 170 methods of determining profit 59, 66 minimum tax 130, 131 mobile business establishment 257 most favourable tax treatment 118, 148, 167 municipal rate 256, 277, 278 net income principle 29, 50, 53, 106, 127, 133, 212, 256 <?page no="322"?> off-balance sheet additions 180 one-fifth rule 78, 120, 171, 172 other income 48, 92, 115, 118, 135, 147 other pension expenditures 147 partial-income method 80, 104, 210, 222, 266 partnership 87, 88, 196, 197, 260, 267, 271 partnerships 33, 89, 134, 175, 195, 240, 258, 274, 277, 285 party donations 155 payments in kind 90, 91 pecuniary penalty 51, 235 pension allowance 113 pension lump-sum 149 pension tax allowance 92 pension tax allowances 93 pensions 92, 93 permanent burdens 112, 264 personal tax 158 personal taxes 20, 53, 235 primary income types 45 principle net income ~ 50, 53, 106, 127, 133, 212, 256 of global income taxation 35, 213 of separability 195, 209, 212, 285 of transparency 175, 195, 285 source ~ 40 territoriality ~ 215 profit 28, 57, 197, 216, 260 Index 323 profit distributions 101, 219, 220, 234 profit income types 44, 70 provident expenditures 139, 145 real splitting 37, 115, 138, 146, 160 reasonable burden 159 recurring remuneration 112 reduced average tax rate 78, 171 remuneration for the members of the supervisory board 235 rent and lease payments 265, 268 retirement benefits 92, 121 Riester pension 118 Rürup pension 119, 141 savers’ lump-sum 69, 100, 222, 298 schedule system 46, 108 self-employed 86 self-employment 70 separate and uniform profit determination 202 separate balance sheets 198, 201 separate business assets 197, 201 shareholder debt financing 240 short fiscal year 56 silent partner, typical ~ ~ 264, 268 silent partners 264 source principle 40 source theory 41, 44, 116 special business earnings 198, 201 <?page no="323"?> 324 Index special expense 136 special expenses 28, 30, 36, 133, 135, 151, 186 special remuneration 198, 201, 261, 277 splitting method 124, 170 subsequent taxation 92, 144, 163 surplus income types 44, 69, 89 surviving dependents allowance 161 sustainability 71, 125 tariff assessment 97 tax allowance 21 tax index amount 256, 280 tax index amount for fiscal purposes 278 tax threshold 21, 118, 236, 239 taxable income 172, 173, 250, 251 territoriality principle 215 theory, source ~ 116 threshold scale 23 top tax rate 23, 169 top tax rates 41 trade income 256 trade tax 25, 184, 255 trade tax index amount 185 typical silent partner 264, 268 vocational training costs 163 wage tax 32, 149, 190 wage tax card 190 work artistic ~ 85 instructional ~ 86 journalistic ~ 85 scholastic ~ 85 scientific ~ 85 <?page no="325"?> ISBN 978-3-7398-3034-6 www.uvk.de www.uvk.de ISBN 978-3-7398-3024-7 In this book you will find compact, up-to-date basic knowledge about German income tax, German corporate income tax and German trade tax (legal status 1.1.2018). The textbook, which has already been published in its sixth German edition, has now been translated into English language. It clearly presents the basics of German profit taxes and introduces even the previously inexperienced reader to the world of income tax, corporate income tax and trade tax. As in the previous German editions, the focus is not on individual tax-related recommendations for action or detailed regulations, but on the fundamental systematics of the subject matter. The book is therefore the ideal companion for targeted preparation for examinations in the Bachelor‘s and Master‘s programmes at universities that are oriented towards business taxation or tax law. It is also ideally suited for self-study. Target groups are therefore students, lecturers in the field of business taxation and tax law. The book is also suitable for English-speaking practitioners (including those from abroad) who wish to develop basic knowledge of German profit taxes useful for everyday professional life. Assistants in tax consulting, tax clerks as well as landlords specialising in tax and not least also tax advisers are addressed here. The translation has been coordinated by MOORE TK