Taxation in Germany

Taxes in Germany—being a Federal Republic—are levied by the federation ("Bund"), the States ("Länder") as well as the Municipalities ("Kommunen"). Many direct and indirect taxes exist, whereof income tax and VAT are the most relevant. The German word for tax is "Steuer" which origins from the Old High German word "stiura" meaning "help". Moreover, "Steuer" means "steering".

Taxation principles

The German Constitution (Grundgesetz) lays down the principles governing taxation in Germany:

:*the ability-to-pay principle (Art. 3 para. 1 Grundgesetz):*the welfare state principle (Art. 20 Grundgesetz):*the lawfulness of taxation (Art. 2 para. 1 and Art. 20 para. 3 Grundgesetz):*equity in taxation (Art. 3 para. 1 Grundgesetz).

The right to decide on taxes is subdivided:
* The "Bund" has the right on Customs (Art. 105 para. 1 Grundgesetz)
* "Bund" and "Länder" decide together on most of the tax law. Formally the "Länder" can decide that there is no federal law. In practice there are federal laws for all taxation issues. (Art. 105 para. 2 Grundgesetz)
* The "Länder" decide on local Excise taxes (Art. 105 para. 2a Grundgesetz)
* districts/Municipalities can decide on some minor local taxes like the taxation of Dogs ("Hundesteuer")

So even if Germany is a federal state 95% of all taxes are imposed on a federal level. The income of these taxes is to be allocated to Bund and Länder as following (Art. 106 Grundgesetz):

* The Bund can use exclusively the revenue of:
** Customs
** taxes on Alcopop, Distilled beverages, Coffee, Mineral oil products, Sparkling wine, Electricity, Tobacco and Insurances
** Supplement on income taxes "Solidaritätszuschlag"
* The Länder can use exclusively the revenue of:
** Inheritance tax, tax for buying Real estate
** Taxes on Cars, Beer
** Fire protection tax, Gambling tax
* The Districts/Municipalities can use exclusively the revenue of:
** Property tax
** Trade Tax ("Gewerbesteuer")
** Taxes on Beverages, Dogs, Inns and other things

Most of the revenue is earned by income tax and VAT. These taxes are used by Bund an Ländern by quota. The Districts/Municipalities get a part of the income of the Länder.

In addition there is a compensation between rich and poor states ("Länderfinanzausgleich", Art. 107 para. 2 Grundgesetz).

Tax revenue

In 2006, German tax revenue totalled EUR 488.44 thousand million (see Monthly Report 7/2007 of the Federal Ministry of Finance, page 51 [http://www.bundesfinanzministerium.de/nn_53848/DE/BMF__Startseite/Service/Broschueren__Bestellservice/Das__Ministerium/10237,property=publicationFile.pdf] ).

Tax revenue is distributed to Germany’s three levels of government: the central government (Bund), the state governments (Laender), and local authorities. The central government, state governments and local authorities are all jointly entitled to the most important types of tax (value-added tax and income tax), which for this reason are also known as “shared taxes”. Tax revenue is distributed proportionately using a formula prescribed in the Constitution.

Germany’s fiscal administration is divided into central tax authorities and state tax authorities. Local tax offices belong to the latter. They administer the “common taxes” for the central government and the federal states. The number of tax offices in Germany totals around 650.

Income tax for residents

Individuals who are resident in Germany or have their normal place of abode there have full income tax liability. All the income earned by these persons both at home and abroad is subject to German tax (principle of world income).

Types of income

For the purposes of charging income tax in Germany, earnings are divided into seven different types of income. A distinction is made between::*income from agriculture and forestry:*income from business operations:*income from self-employed work:*income from employed work:*capital yields:*income from letting property:*miscellaneous income.If a taxpayer’s income does not fall into any of these categories, then it is not subject to income tax. This includes e.g. winnings at a game show.

Withholding taxes

Tax on income from employed work and tax on capital income are both retained by being deducted at source (PAYE tax, capital yield tax), i.e. an amount of tax is retained directly by the employer or by the bank when the earnings are paid out. The amount deducted counts as an advance tax payment.

Deductions

German income tax law makes provision for a considerable number of taxpayer’s costs to be deducted from tax. This applies in particular to costs immediately related to earnings. Apart from this, other amounts are also deductible, such as e.g. certain insurance payments, costs incurred by sickness, costs for home help, maintenance payments, and more besides.

In addition to the possibility of deducting costs from tax, there are also numerous allowances and lump-sum amounts which reduce taxable income. For instance, there is an allowance for capital earnings that is currently EUR 801 for unmarried persons and EUR 1,601 for married couples; taxable profits on sales are neglected up to a sum of EUR 512; and a lump sum of EUR 920 is deducted from income from employed work.

Tax return

The obligation to file an income tax return does not apply in all cases. Anyone exclusively earning income that is subject to withholding tax deducted at source does not have to file an income tax return: their tax debt is deemed settled on payment of the withholding tax. Despite this, any person having full tax liability may file a tax return voluntarily, taking into account the PAYE tax or capital yield tax already paid in advance. In certain circumstances, this may result in a tax refund.

Married couples can apply for joint assessment and are taxed at a more favourable rate than unmarried persons.

Tax rate

The rate of income tax in Germany increases progressively, ranging from 0% to 45% (marginal tax rate). The so-called solidarity surcharge (Solidaritaetszuschlag) at a rate of 5.5% of income tax has to be paid on top of this. No income tax is charged on the basic allowance, which is EUR 7,664 for unmarried persons and EUR 15,329 for jointly assessed married couples.

Tax allowance for children

Expenditure on child support and on children’s vocational training is taken into account with a special tax allowance, with allowances for costs expended on child supervision, education and training, and with child benefit payments.

Income tax for non-residents

Individuals who are neither resident in Germany nor have their normal place of abode there are only liable to pay tax in Germany if they earn income there which has a close domestic (German) context. This includes in particular income from real estate in Germany or from a permanent establishment in Germany.

Double taxation conventions

Germany has reached Tax treaty with about 90 countries to avoid double taxation. These agreements under public international law aim to avoid one and the same taxpayer being charged similar taxes more than once on the same income for the same period. The basic structure of the Double Taxation Conventions which Germany has signed follows the Model Tax Convention drawn up by the OECD.

Business taxes

As from 01.01.2008, Germany’s rate of corporation tax is 15%. Counting both the solidarity surcharge (5.5% of corporation tax) and trade tax (averaging 14% as from 01.01.2008), tax on corporations in Germany is less than 20%.

Corporation tax

Corporation tax is charged first and foremost on corporate enterprises, in particular public and private limited companies, as well as other corporations such as e.g. cooperatives, associations and foundations. Sole proprietorships and partnerships are not subject to corporation tax: profits earned by these set-ups are attributed to their individual partners and then taxed in the context of their personal income tax bills.

Corporations domiciled or managed in Germany are deemed to have full corporation tax liability. This means that their domestic and foreign earnings are all taxable in Germany.

Exemptions

Some corporate enterprises are exempted from corporation tax, e.g. charitable foundations, Church institutions, and sports clubs.

Flat tax

The corporation tax charged at corporate level is 15% (flat tax).

Assessment base

The assessment base for the corporation tax charged is the revenue which the corporate enterprise has earned during the calendar year. Taxable profits are determined using the result posted in the annual accounts (balance sheet and Income statement) drawn up under the Commercial Code. What is deemed income under tax law sometimes diverges from the way earnings are determined under commercial law, in which case tax law provisions prevail.

Dividends

When dividends are paid to an individual person, capital yield tax at a rate of 20% is charged and may be counted towards the shareholder’s personal income tax bill. Shareholders are only taxed on half their dividends (half-income system).

When dividends are paid to an enterprise with full corporation tax liability, the recipient business is largely exempted from paying tax on these revenues. In its tax assessment, merely 5% of the dividends are added to profits as non-deductible operating expenses. The same applies if a taxable corporate enterprise sells shares in another company.

Deducting tax from dividends paid by a subsidiary with full tax liability to a foreign parent domiciled in the EU is waived on certain conditions: the parent company has to have a direct holding in the subsidiary of at least 15%.

Integrated fiscal units

Under German tax law, separate companies may be treated as integrated fiscal units for tax purposes (Organschaft). In an integrated fiscal unit, a legally independent company (the controlled company) agrees under a profit and loss pooling agreement to become dependent on another business (the controlling company) in financial, economic and organisational terms. The controlled company undertakes to pay over its entire profits to the controlling company. Another requirement is that the controlling company has to hold the majority of voting rights in the controlled company.

In tax terms, recognition of a fiscal unit means that the income of the controlled company is allocated to the controlling company. This provides an opportunity to balance profits and losses within the integrated fiscal unit.

Trade tax

Entrepreneurs engaging in business operations are subject to trade tax as well as corporation tax. In contrast to corporation tax, trade tax is charged by the local authorities, who are entitled to the entire amount. The percent rate for levying trade tax is fixed by each local authority separately within the range of rates prescribed by the central government. As from 01.01.2008, the rate averages 14% of profits subject to trade tax.

Assessment procedure

The business entity has to file the trade tax return with the tax office, like its other tax returns. Taking any allowances into account, the tax office calculates the trade earnings and then gives the applicable figure for a trade tax assessment to the local authority collecting the tax. The underlying profit base, as well as the book-tax differences for the local trade tax jurisdictions, may differ from that used for the corporation tax. On the basis of the collecting rate (Hebesatz) in force in its area, the local authority calculates the trade tax payable.

Unincorporated enterprises

One-man businesses and members of a partnership may deduct a large portion of trade tax from their personal income tax bill.

Incorporated enterprises

As from 01.01.2008, corporate entities may no longer deduct trade tax from their taxable profits.

Value-added tax

As a matter of principle, all goods and services performed in Germany by a business entity are subject to value-added tax. This German VAT is part of the European Union Value Added Tax system.

Exemptions

Certain goods and services are exempted from value-added tax by law; this applies for German and foreign businesses alike.

For example, the following are exempted from German value-added tax:

:*export deliveries:*intra-Community supply of goods:*services provided by certain professional groups (e.g. doctors):*financial services (e.g. granting loans):*letting real estate in the long-term:*cultural services provided to the public (e.g. by public theatres, museums, zoos, etc.),:*value-added by certain institutions providing general education or vocational training:*services provided in an honorary or voluntary capacity.

Tax rate

The rate of value-added tax rate generally in force in Germany is 19%. A reduced tax rate of 7% applies e.g. on sales of certain foods, books and magazines.

Payment of the tax

Within 10 days of the end of each calendar quarter, the business entity has to send the tax office an advance return in which it has to give its own computation of the tax for the preceding calendar quarter. The amount payable is the value-added tax it has invoiced, minus any amounts of deductible input tax. Deductible input tax is the value-added tax which the entrepreneur has been charged by other business entities.

The amount thus calculated has to be paid to the tax office by way of an advance. Larger businesses have to file the advance return every month. For entrepreneurs who have only just taken up professional or commercial operations, the monthly reporting period likewise applies during the first calendar year and in the year after that.

At the end of the calendar year, the entrepreneur has to file an annual tax return in which it has again calculated the tax.

mall undertakings

Entrepreneurs whose turnover (plus the value-added tax on it) has not exceeded EUR 17,500 in the preceding calendar year and is not expected to exceed EUR 50,000 in the current year (small enterprises), do not need to pay value-added tax. However, these small enterprises are not allowed to deduct the input tax they have been billed.

References

* [http://www.gesetze-im-internet.de/gg/index.html German Constitution (Grundgesetz)]
* [http://www.gesetze-im-internet.de/estg/index.html German Income Tax Law (Einkommensteuergesetz)]
* [http://www.gesetze-im-internet.de/kstg_1977/index.html German Corporation Tax Law (Koerperschafsteuergesetz)]
* [http://www.gesetze-im-internet.de/gewstg/index.html German Trade Tax Law (Gewerbesteuergesetz)]
* [http://www.gesetze-im-internet.de/ustg_1980/index.html German Value-Added Tax Law (Umsatzsteuergesetz)]
* [http://www.bundesfinanzministerium.de/nn_318/DE/Wirtschaft__und__Verwaltung/Steuern/Veroeffentlichungen__zu__Steuerarten/Internationales__Steuerrecht/001.html Germany’s Double Taxation Conventions]
* [http://www.germantaxes.info Basic information about German taxes by the Federal Central Tax Office]