Venture capital is (still) booming in Germany. Not as in the US or in the UK, but nonetheless remarkable.
Here are a few comments from a German tax law perspective, if you intend to act as business angel for a German start-up (in Berlin, Cologne, Munich, Hamburg, Bremen or whereever across this country). Or if your business is looking for seed financing from VC funds or business angels.
- An interest rate of nil might cause German tax issues. Not SAFE (SAFE being a common US standard for CLA’s). German tax inspectors might take the view that the loan was granted for free. The use of funds free of charge could trigger a deemed taxable advantage of 5.5% p.a. of the loan amount under German gift tax laws. Each party to such agreement can be held liable to such tax charge.
- Upon conversion of the loan receivable into equity, the investor may be able to profit from a tax privilege. Hence, if strcuctured correctly the “profit” from converting into equity at a discount to the shares’ fair market value (e.g. 20%) should not trigger German (capital gains) taxes. (And no corporate income tax, if the investment is made through a personal holding vehicle.)
- If investing from abroad, please check you local tax laws. As a principle under international tax laws, the country of your (primary) residence has the right of taxation. Tax treaty to be analysed.
- Be aware of the “dry income” trap for any interest amounts, even if not actually paid. If the CLA wording gives the investor a claim to request (annual) payment of interest amounts prior to conversion, this can be deemed taxable interest income in Germany. Non-residents may be lucky, as such interest may not be taxable for non-residents in Germany (depending on the CLA structure however, especially on granted collaterals).
- Finally, from a legal perspective: To notarize or not to notarize? In practicality, most CLA’s are not signed in front of a German notary. But a German public notary will tell the investor that there are good reasons to collect a notarization in order to be able to enforce a conversion right into equity in a German GmbH. Hence, a choice to be made.
Tax payers in Germany must file the respective annual (e.g. income) tax returns for the previous tax year (calendar year 2019) not later than 31 July 2020 unless (!) a German tax law professional is instructed to file that return on behalf of the tax payer – in that case the deadline is extended from seven to 14 months (i.e. ending on 28 February 2021).
Obviously, the German legislator believes that it is time-consuming to involve an external tax expert and therefore grants twice as much time (14 instead of 7 months) when involving such certifed tax professional. Good news for our professions..
With a proper justification being provided, it is possible to apply for a deadline extension. But the underlying statutory rules have become stricter and tax offices are quick now to assess a penalty for late payment (Verpätungszuschlag) based on Sec. 152 German Fiscal Code (Abgabenordnung).
On 6 August 2019, the German Ministry of Finance, currently headed by a Social Democrat (Olaf Scholz from Hamburg), has published on its website a draft bill on the partial (!) abolition of the German solidarity surcharge (Solidaritätszuschlag, commonly also referred to as Soli). As a background information, the solidarity surcharge is levied as an additional tax charge to either (i) your income tax or (ii) (for entities and other taxable structures) corporate income tax charge, normally at a rate of 5.5% times the tax charge.
- Example: Mat “Lewa” Lewandowski, unmarried and working in Berlin, shall have a taxable income (after deduction of expenses) in 2019 of EUR 60,000. His income tax charge in Germany, pursuant to the progressive tax rate system, shall be EUR 16,419 (corresponding to an effective tax rate of 27.37%). On top, for FY 2019 he has to pay a solidarity surcharge of EUR 903.04 (5.5%x27.37%=1.51%). Hence, his overall tax burden is 28.88%.
- Under the draft new tax law bill, in FY 2021 Lewa will not pay the “Soli” anymore. His taxable income is just below the threshold of EUR 16,956 (as provided for in the current draft). Hence, he saves EUR 903.04, or 1.51% percentage points of his income.
The partial abolition is supposed to take effect in 2021. You have guessed correctly – 2021 is the scheduled election year in Germany.
According to the draft bill, people earning significantly more than EUR 60,000 – for singles – or EUR 120,000 – for married couples – taxable income (after deductions) per year will not be exempted from the “Soli.” The tax break is reserved for German income tax payers with an annual income tax charge not exceeding EUR 16,956 (or EUR 33,912 for married couples filing a joint income tax return). (You can calculate here whether your taxable income is moderare enough to benefit from the contemplated abolition of the Soli.)
In other words, in order to be exempted from the Soli, the draft bill provides for a sharp threshold (Freigrenze) instead of a free amount (Freibetrag) for each income taxpayer. “The rich” as well as corporations (corporate income tax payers) are excluded from the contemplated new privilege.
- Question 1: Is it constitutional to exclude the “upper 10%” of income taxpayers from the abolition of the Soli?
- Question 2: Is it a good idea to exclude businesses and entrepreneurs (except for very small businesses) from the contemplated tax break?
My response, to both questions, is clearly “no.” The current draft bill appears like a late move of Merkel’s Grand Coalition (specifically of the Social Democrat part thereof), due to end in 2021 anyway.
Today (31 July 2019) the revised “general deadline” for tax filings in Germany (tax year = calendar year 2018) expires.
The good news:
- The “general deadline” was extended by two months, now ending on 31 July. Previously the deadline was 31 May (for tax filings for 2017 or earlier years).
- Moreover, the “extended deadline”, applicable for taxpayers that file respective tax returns through a tax advisor or tax lawyer, was extended by two months as well. It now ends 14 months after the end of the respective tax year / calendar year. (Previously, i.e. for tax filings for 2017 or earlier years, the deadline was after 12 months, i.e. 31 December of the following year).
Example (new “extended deadline”): Taxpayer Andy Thom, originally from Scotland, has worked as a tennis coach in Berlin and Hamburg in 2018 and earned EUR 60,000 from students (business expenses not yet reflected). Andy must file an income tax (Einkommensteuer) return and, due to relevant turnover exceeding the thresholds for “small entrepreneurs”), his VAT (Umsatzsteuer) return for 2018. He might also have to file a trade tax (Gewerbesteuer) return. Andy has engaged the local German tax advisor Tommy Doll to take care of the tax filings. When are Andy’s tax filings due?
As Andy has engaged a tax law professional and assuming that Andy’s tax office is duly informed on the engagement of Tommy Doll, the relevant deadline is not 31 July 2019, but the last day of February 2020. That 29 February 2019 is a February which will further extend the deadline to the Monday thereafter. Hence, Andy’s tax advisor must file not later than on 2 March 2020 electronically Andy’s annual tax returns for 2018.
The bad news:
- If the extended deadline is missed, the tax authorities must assess penalty payments, unless another deadline extension is successfully applied for. It should be demonstrated that it was reasonably not possible to meet the deadline. The respective provisions (Section 152 German Fiscal Code) have become much stricter.
The ugly news:
- The tax office has the right to shorten the statutory deadline and request from certain taxpayers an earlier filing (e.g.: as of 31 May or 30 August for the previous year). Here we have a new weapon for the tax administration to put pressure on slow or “difficult” taxpayers. Not good.
The end of the Angela era
Angela Merkel, in office for more than 13 years now, will not run again for chancellor again in the Federal German elections scheduled for late September 2021 (date to be confirmed). The German economy is still doing good. The public’s focus is on issues such as the Brexit debate.
These are the reasons why not much “tax law reform” is happening at the moment in Germany. Tax law is not on top of anybody’s agenda at the moment.
A few thoughts on where we stand at the moment:
- Real estate transactions might get even tighter tax rules. For your information, acquisition of real estate in Germany is not subject to VAT (unless you opt for it, being an entreprenur) but to Real Estate Transfer Tax (RETT) at rates from 3.5 up to 6.5% (read here under 4.). Large investors operate through special entities (special purpose companies) that acquire real estate. In an exit, the investor will not sell the property, but the shares in the company. If the investor sells just 94% of the company’s shares, no RETT is triggered. The remaining 6% are the “RETT blocker” as only an acquisition of 95% or more in a company owning German real estate triggers RETT. Well, initiated through a few Länder, these rules might get further tightened: The threshold may go down to 90% (rather than 95%) and “holding periods” will be further extended.
- Apple/Google/Facebook/Starbuck’s/IKEA royalty structure: Since 2011 an international discussion on minimizing local tax burdens through license structures is going on. Many multinationals make good many in Germany but pay almost no taxes. Profits are offset inter alia against charges for (trademark /franchising) license payments. This is the general perception in Germany. This may be partially true but from a technical perspective it is far more complicated. The reason why this “works” is primarily not an issue of German but of foreign tax regimes. I discuss this in technical seminars, e.g. in mid-February 2019 in Frankfurt. What Germany is doing now is to limit deductions from royalty payments (i) for trade-tax purposes as well (ii) for income tax purpose through the Lizenzschranke rules (license-barrier rules pursuant to § 4j EStG effective as of 1 January 2018. The objective is to come to an international approach on further tackling the problem (on OECD and/OR EU level) by 2021.
- German property tax (annually charged on German real estate you own) needs reform due to constitutional reasons. There are proposals on the table, but nothing has been decided on. Technically and politically it is not easy to change (replace) the existing rules.
- Other technicalities have been changed. The deadline for filing tax returns was extended to 14 months (if you use a tax law advisor). Morover, taxpayers increasingly being asked to file any tax return electronically. And so on.
Let’s wait for the German economy to turn sour and/or a new chanecellor take office (due in late 2021 at the latest) before the next wave of “tax law reforms” hits Germany. For investors and residents, a pause on the tax reform front should be good news. (Of course, tax rates are always too high).
Today, Angela Merkel’s party (Christian Democrats together with Bavaria’s CSU) and her “red” coalition partner (Social Democrats) have published a “letter of intent” of what could be the basis for German politics in the next four years, provided that yet another red&black coalition (and hence another Angela Merkel term) is signed-off by the Social Democrats’ party conference to be held on 21 January 2018.
The 28-pager as published today does touch a few tax issues.
- A “fair taxation” of multinationals, specifically those acting within the digital economy, is to be promoted (four respective multinationals are explictly mentioned).
- A common consolidated tax base within the EU, stipulating minimum corporate tax rates, is to be further promoted.
- A substantial financial transaction tax is to be finalized.
For German tax law-practitioners, these aspects points offer no surprises and remain vague.
More specifically, however:
- R&D specifically for SME’s is to be promoted by taking the respective R&D headcount and research expenses as a starting point. This could mean that a factor is being put on such tax-deductable expenses. Othe countries already do this. This may be good news. But let’s wait for the details.
- The solidarity surcharge is to be abolished in a Step 1 for “90% of the taxpayers” over the next four years. Let’s see whether companies and corporations that pay the solidarity surcharge on top of the German Corporate Income Tax (1.825% on top of 15% CIT) will be relieved. I am afraid they won’t, but let’s wait what happens.
- The flat tax (25% plus solidarity surcharge) on interest income is to be abolished. (Dividend income and other income from capital investments is not mentioned.)
- “Property acquisitions for families” are to be promoted. This is translated by commentators as a potential Real Estate Transfer Tax relief for the acquisition of a first family home. Let’s seen when and how this happens.
- Venture capitalists might also get better tax laws, but nothing precisely has been included.
That is all, basically.
The best news for German taxpayers is what is not written in the paper: No tax hikes, except for the interest income taxation, are explicitly mentioned. As a tax-practitioner I feel relieved, because any tax increase “for the wealthy” would have hit many thousands of family-owned German companies, organized as tax transparent (such as GmbH& Co. KG). Won’t happen now.
Finally, the French touch: The paper mentions repeatedly “France” as the ally for (i) pushing tax initiatives for “fair taxation” and (ii) fighting tax evasion. Pourquoi pas – but note that Germany’s anti-avoidance rules (and enforcement of tax laws) are quite stringent in international comparison already.
Where is my decanter.
German gift tax and inheritance tax laws have become even more complex recently. The reasons are constitutional law requirements (former inheritance tax laws to be held as unconstitutinal) as well as permanent amendments to the law due to political wish-lists.
Cross-border donations or inheritance scenarios are even more complicated. As a rule of thumb, a non-resident German inheritance taxation is triggered if relevant assets or just one of the involved individuals is based in Germany (or holds a German citizenship).
A tax compliance challenge (for domestic as well as cross-border cases) is to assess whether assets can be qualified as tax-privileged business assets for German tax purposes. The underlying idea is that (i) even though in general inheritance tax and gift tax rates “for the wealthy” have been increased, the transfer of business operations is exempted, provided that existing jobs (measured by the payroll amounts) are being preserved.
Due to international tax-law abuse discussions at OECD level and elsewhere (tackling Base Erosion and Profit Shifting, BEPS) Germany has made a move and introduced legislation according to which (in a nutshell) it is tax detrimental for Germany-based taxpayers to pay license fees to non-resident licensors if such licensor benefits from specific foreign IP tax regime (such as a patent box, license box or innovation box regime) unless such foreign IP tax law provision requires adequate substance to be documented at licensor level in order to qualify for the IP tax incentive.
Precisely: Even if a specific licensor has adequate substance (e.g. employs own R&D staff) the German licensee may not fully deduct its royalty expenses anymore, if the foreign licensor benefits from a reduced tax rate due to a local IP tax privilege which is inconsistent with the OECD nexus approach.
Example: The income tax charge of the received royalty at licensor level (abroad) is effectively 2% due to a black-listed patent box regime (i.e. not sufficiently requiring substance, hence inconsistent with the OECD nexus approach). At German licensee level 92% of the license expenses will not be tax-deductible due to the new tax rules. (The not-deductible portion of the royalty expense is calculated as follows: 25% less the effective tax burden of 2%, divided by 25%).
It is noted that the new provision aims at motivating foreign legislators to supplement (or abolish) its IP tax law incentives even before this will be mandatory due to OECD agreements by 2021.
The German legislator has introduced a Section 4j to its Income Tax Act (§ 4j EStG). The purpose of the new provision is to limit the deductability of royalty payments to non-resident creditors for German individual taxpayers as well as corporations and (tax-transparent) partnerships.
The new provision is a result of anti-abuse discussions on the international level (OECD, EU) triggered through structures used by some multi-nationals. IKEA, Starbucks, Apple, Microsoft and others have become notorious for their deemed “profit-shifting” by means of royalty structures.
Well, the new German “royalty threshold” provision is a toothless tiger. It will hardly have any effect. I will explain in some detail in one of the next posts.
Some people that move to Germany (“expats” or returnees) expect outstanding compensation or severance payment from an earlier employment or activities abroad, outside Germany. Does Germany have a right to tax such payments? The answer is: That depends. (continue reading)