An overview of the new regulations
The intention behind the legislation is to considerably enhance the fiscal environment for medium-sized professional partnerships and family enterprises and to further internationalise corporation tax law. The following new rules, in particular, serve this purpose.
- The introduction of an option for professional partnerships and partnership organisations to be treated as corporations for tax purposes (Section 1a Corporation Tax Act [Körperschaftsteuergesetz, KStG]).
- The globalisation of the sections of the Reorganisation Tax Act [Umwandlungssteuergesetz, UmwStG] that are relevant for the reorganisation of corporations (Section 1 UmwStG, Section 12(2),(3) KStG).
- The scrapping of adjustment items for intergroup overpayments and underpayments of profit transfers – due to pre-consolidation differences – (Sections 14 and 27 KStG) and, instead, treating these differences as (non-taxable) contributions or repayments of capital.
- Abolition of the non-deductibility rule for declines in profit due to currency fluctuations incurred in connection with shareholder loans (Section 8b(3) KStG).
In the next editions of the PKF newsletter we will provide greater details on all the areas where there are new rules. In the sections below, however, we have addressed solely the main features of the proposed statutory provisions on the option model.
The motivation for the option model
We have already discussed, in this article, the potential introduction of an option for partnerships to be treated as corporations for tax purposes and analysed the benefits of the effects of such an option. There was an announcement about the option model already in the package of measures to boost economic recovery, overcome the crisis and provide a future-focused stimulus that was passed by the German federal government on 3.6.2020; however, this was then not included in the 2nd Coronavirus Tax-Related Assistance Act.
The option model dates back to the so-called Brühl recommendations on reforming business taxation, in 1999. In the meanwhile, there has indeed been a convergence between the overall tax burdens of corporations and partnership members, nevertheless, there are considerable differences in terms of the system and the procedure of taxation. These relate, in particular, to the special business assets as well as the supplementary partner tax accounts of the members of a partnership. In an international context these particularities of German tax law are largely unknown.
Core elements of the provisions on the option model
(1) Treated as a corporation – The option model allows professional partnerships (KG [German limited partnership], oHG [German ordinary partnership] and comparable foreign companies) and partnership organisations as well as their partner members the possibility of being treated as a corporation and its non-personally liable shareholders for income tax purposes and, consequently, also from a procedural perspective.
(2) Exercised by filing an application – The option to be treated as a corporation for tax purposes can be exercised by filing an irrevocable application from the partners involved. The application has to be filed prior to the start of the financial year when taxation in accordance with KStG is supposed to happen. There are no plans for allowing the option to be exercised retroactively. The application would have a direct effect on the taxation of all the partners. Opting for corporation tax would require a resolution adopted by a majority of the partners of, at least, three-quarters of the votes cast.
(3) Consequences for taxation – As a result of exercising the option, the organisation will be treated as a corporation for tax purposes both substantively and procedurally; its partners will be classified as non-personally liable shareholders in a corporation. Consequently, all the provisions of, in particular, the KStG, EStG, the Reorganisation Tax Act, the Investment Tax Act and the Foreign Transaction Tax Act that relate to corporations will apply.
Please note: Exercising the option would however not alter the fact that an organisation that has to be “treated as a corporation” for income tax purposes would nevertheless still be a partnership under civil law.
(4) Change of legal form and tax neutrality – Transitioning to corporation tax would be deemed to be a change of legal form within the meaning of the Reorganisation Tax Act. To achieve tax neutrality no business assets that are essential for operations may be retained. This means that special business assets that are necessary for business operations likewise would have to be contributed.
(5) Civil law – Since, under civil law, the organisation will continue to exist as a professional partnership or partnership organisation then, unlike a corporation, it will not have nominal capital. The equity that has to be shown in the tax accounts will be recognised in total in the contribution account for tax purposes. Liabilities owed to a partner that are shown in a variable partner account will not be included in equity. The persons authorised to represent the organisation in accordance with commercial law or a partnership agreement will be regarded as the legal representatives of the partnership that has exercised the option.
(6) Taxation of the partners – A holding in a partnership that exercised the option will be deemed to be a share-holding in a corporation. Instead of commercial income the partners will now generate investment income from dividends/withdrawals that will be treated as income from capital assets. Furthermore,
- interest for partners’ loans will lead to income from capital assets,
- remuneration for work to income from employment and
- rental and lease income to income from letting and leasing.
Please note: There are no plans for allowing an equivalent option to be exercised by sole traders.