GERMANY’S TAX LAWS IN A NUTSHELL (update 30 November 2020)
In Germany, the calendar year = tax year.
Hence, income taxes by individuals, for instance, are filed per calendar year.
Nonetheless, it is possible under Germany’s accounting laws that a business has a deviating business year (ending on 31 March or so). The business years’s income is to be declared /will be taxed in the year in which that business year ends.
If however, a company (such as a GmbH) wants to effectively change its business year from the calendar year to a deviating business year, effectively triggering a “tax pause”, some corporate law steps as well as the approval of the tax office in order to be tax-effective are required. Tax and corporate law experts should assist with the proper implementation of such amendment.
If you live in Germany, irrespective of your nationality, you will be subject to resident income taxation on the basis of your world-wide income, unless tax-treaty protection applies.
In 2019, a taxable income up to EUR 9,168 was tax exempt (twice that amount for a married couple). Further, exceeding income up to EUR 55,961 (twice that amount for a married couple) is taxed progressively, with rates increasing from 14% to 42%. Income portions exceeding EUR 55,961 (double that for married couple) up to EUR 265,327 (double that for married couple) are taxed at the 42% top rate.
Finally, a “rich tax rate” for income portions exceeding EUR 265,327 (double that for married couple) at a rate of 45% applies.
In 2020, these thresholds are slightly higher (thresholds for single taxpayers: EUR 9,408 – 57,042 – 270,051).
*Rates for FY 2016 and FY 2017/2018: See further below.
This is not the full income-tax story. The solidarity surcharge (Solidaritätszuschlag) of 5.5% of the tax is added to the income tax charge. Hence: Multiply your tax rate by 0.05 to calculate the solidarity surcharge burden. This surcharge was introduced in 1990 to pay for the reunification. It is time to abolish it, but respective political discussions last for 25 years now.
Germany allows a number of deductions in order to calculate the tax base for wage taxes. For example, the expenses you incur when getting to your workplace are decuctible (Pendlerpauschale).
If you are employed in German, the employer will withhold and pay to the tax office not only wage tax (as a prepayment to your annual income tax) but also social security contributions. Normally the statutory deductions are for pension, unemployment, health insurance and long-term nursing care. Costs are normally borne equally by employer and employee. The employer’s share of these contributions is not considered as taxable income. The employee’s portion is generally tax deductible.
Freelancers in Germany will start to pay incometax once the first annual income tax declaration has been filed and processed by the local tax office. The Finanzamt will estimate your tax for the current year and assess quarterly prepayments (Vorauszahlungen) of a quarter of the tax on March 10, June 10, September 10 and December 10. The total tax liability is determined by filing an income tax return, which includes all types of income from all sources.
The annual income tax assessment is usually issued by the Finanzamt between two and six months from the date the income tax return is filed. If you use a tax advisor you have 12 months to prepare and file your income tax return (example: for 2016 until 31 December 2017 at the latest). If you do not use a tax advisor you need to file earlier: The deadline is end of May and – as of the filing for 2017 – end of July. (The law has been amended and deadlines have been extended. If you use a tax advisor it will now be 14 months.
Church members will be subject to church tax.
*For FY 2017 as well as for FY 2018 the thresholds had been:
- EUR 8,820 (twice the amount for married couples)
- EUR 54,057 (twice the amount for married couples)
- EUR 256,304 (twice the amount for married couples)
For 2016, a taxable income up to EUR 8,652 is tax exempt (EUR 17,304 for a married couple). Further, exceeding income up to EUR 53,665 (EUR 107,330 for a married couple) is taxed progressively, with rates increasing from 14% to 42%. Income portions exceeding EUR 53,666 (EUR 107,331 married couple) up to EUR 254,446 (EUR 508,892 married couple) are taxed at the 42% top rate. “Rich tax rate” for income portions exceeding EUR 254,447 (EUR 508,893 for married couples).
Germany’s value-added tax (VAT) system is similar to other EU countries. No wonder – this is due to the European Union’s VAT Directive.
Germany regular rate – except for the second half of 2020 – is 19%, the reduced rate (e.g. food, newspapers) is 7%.
As part of a corona tax relief package, VAT was lowered to 16% and (reduced rate) 5% for the second half of 2020. The regular rates of 19% / 7% are supposed to take effect again as of 1 January 2021. The moment of providing the service is decisive, not the point in time the invoice is being written.
A number of services are VAT-exempt, such as renting a flat or buying a house (this would trigger Real Estate Transfer Tax though).
If you are a business or an entrepreneur you can reclaim VAT paid, certain requirements being met.
Small entrepreneurs can make use of the small entrepeneurs rule: If your annual turnover does not exceed EUR 22,000 (FY 2020) you may be exempted from invoicing VAT – but have no right of claiming input VAT from your suppliers’ invoice.
Corporations are taxed while partnerships and similar structures are transparent (i.e. taxation a the level of the shareholder/partner, irrespective of a disribution of the profit).
A German corporation (such as a GmbH or AG) is subject to corporate income tax (Körperschaftsteuer, CIT) with its annual taxable profit. The tax rate is 15%, but solidarity surcharge at a rate of 5.5% of that tax needs to be added. Hence, the overall tax charge (including solidarity surcharge) is 15,825%. There is no progression in the CIT rates.
However, many businesses, e.g. family-owned businesses are structured as GmbH Co & KG. This is a transparent entity with the general partner being a corporation (GmbH). The taxable profits are annually taxed in the hand of its respective shareholders (income tax, unless that shareholder is s corporation). The limited partner normally has a profit share of nil or close to nil.
The situation is different with German trade tax (TT). The TT burden can be higher than corporate income tax liability.
Each corporation, commercial partnership or branch of a non-resident company is subject to local German trade tax if it (i) pursues business activities (unless exempted) or (ii) qualifies as a deemed business due to its legal form.
The city or municipalities assess individual trade tax rates. For example, a large city such Frankfurt am Main has a trade tax rate of 16.10% (total tax burden, including CIT/solidarity surcharge: 31.925%). The small city next door, Eschborn, levies trade tax at a rate of 9.80% (total tax rate burden, including CIT: 25.625%). This is a typical pattern in German metropolitan areas. Trade taxes are typically lower if you move out of the city. Berlin is an exception. Berlin’s trade tax rate is 14.35% and significantly lower than in other large German cities.
An option is to set up the company in a neighbouring municipality . Many of these communities charge the statutory minimum trade tax rate of 7%. This adds up to a tax charge of 22.825% – the lowest tax burden you can get as a company in Germany, unless you can claim specific tax privileges.
4. REAL ESTATE TRANSFER TAX (RETT)
The acquisition of German real estate is VAT-exempt, but subject to real estate transfer tax (“RETT”, Grunderwerbsteuer). RETT is imposed on the agreed consideration (usually purchase price) at a rate of 3.5% up to 6.5%, depending on where in Germany (in which Bundesland) the real property is situated.
It is usually agreed in the notarized purchase agreement that RETT is borne by the purchaser. Hence, the tax authorities usually submit the RETT assessment to the buyer. Upon such notice, RETT needs to be paid within one month in order to avoid fines and penalties.
These are the RETT rates as of 30 November 2020:
5. FINAL COMMENTS
The German inheritance and gift tax (Erbschaftsteuer) is the most relevant (and frequently amended) tax omitted in this overview, but covered in the blog.
Depending on what you own (property tax for real estate owners), what you do (e.g. lottery tax) or what you buy (energy, alcoholic or tobacco products, coffee) other taxes may apply.
“Two thirds of the world’s tax literature is in German,” is repeatedly heard in Germany.
This has never been verified. However, I may be part of this phenomenon with more than 60 contributions to German tax and law books and technical periodicals (as of November 2020).