What is the tax payable on?
Corporation tax is a special type of income tax for legal entities (in particular incorporated businesses such as the AG, GmbH or European Company), other organized groupings of persons (such as associations) provided they are not partnerships as defined in the Income Tax Act, and conglomerations of assets (such as foundations).
The basis of taxation, as with income tax, is the income earned during the calendar year. What constitutes income, and how it is to be determined, is regulated in accordance with the Income Tax Act. However, the Corporation Tax Act also sets out specific provisions that have to be observed in the process. Corporation tax, like income tax, is a direct tax. It is a tax imposed on the person of the taxpayer and is not deductible from income.
Corporation tax and income tax exist side by side. Companies are liable for corporation tax on their profits. If profits are distributed to shareholders who are natural persons, the latter are liable for income tax on the distribution.
Who is liable to be taxed?
The Corporation Tax Act distinguishes between limited and unlimited tax liability. Unlimited liability applies to corporations, associations of persons and conglomerations of assets the registered office or place of management of which is located in Germany. Unlimited liability for corporation tax extends to income from all sources worldwide.
Bodies incorporated under public law are liable for tax only to the extent that they carry on an enterprise of an industrial or commercial nature.
Among the entities subject to limited corporation tax liability are corporations, associations of persons and conglomerations of property the registered office and place of management of which are located outside Germany. They are liable for tax on their domestic income within the meaning of section 49 of the Income Tax Act.
How much is the corporation tax?
Corporation tax is levied at the rate of 15%.
Profit distributions from one company to another are generally not included when calculating the income of the company that holds a stake in the other. This tax exemption for income from holdings prevents the taxation of profit distributions more than once in an ownership chain consisting of multiple companies. The intended outcome is that tax is imposed only (i) at the level of the corporation that generated the profit which is distributed and (ii) at the level of the individual who is the shareholder at the end of the ownership chain.
The only profit distributions that are not tax-exempt are those that a corporation receives from holdings that amount to less than 10% of a company’s share capital at the beginning of a calendar year (free float).
If the profits are further distributed to an individual, a distinction is made based on whether the individual holds the shares in the corporation as business assets or as private assets.
At the level of a shareholder who holds shares as business assets, allowance is made for the corporation tax charge on distributed profits by including only 60% of the dividends in the shareholder’s personal income tax base (this is known as the partial income system). When the shareholder is assessed for income tax, a credit is granted for the 25% withholding tax on income from capital that has already been imposed.
Where a shareholder’s stake in a corporation is held as part of his or her private assets and that shareholder receives a distribution of profits, the distribution is classified as income from capital assets and is subject to income tax. This investment income has already undergone a deduction of withholding tax on income from capital, at a rate of 25%.
This means that, as a rule, any income tax liability has already been discharged (this is the effect of the final withholding tax).
What is the legal basis?
The legal basis for corporation tax can be found in the current version of the Corporation Tax Act and the Corporation Tax Implementing Ordinance. Corporation tax law makes extensive use of the principles and provisions of income tax law, especially as regards the determination of profits and the assessment and payment of tax. Corporation tax guidelines have also been issued in the form of general administrative regulations to clarify uncertainties and points calling for interpretation.
Who collects the tax?
Corporation tax is collected by the Länder (States of Germany). It is a joint tax, meaning that the Federation and Länder share the revenue (taking half each).
What is the history behind the corporation tax?
The taxation of incorporated companies has its origins in the period of rapid industrial expansion after 1871. It began in the German states with the inclusion of companies in the newly created system of income taxation, which up to the First World War resulted in broadly divergent treatment as regards types of company and tax rates. In 1913 stock corporations were subjected for the first time to an extraordinary Reich income tax, known as the defense contribution. The Reich also included legal entities in the taxation of war profits from 1916 to 1918. When the right to impose income tax was assigned to the Reich under Erzberger’s financial reform in 1920 it was found expedient to introduce a separate, standardized Corporation Tax Act for legal entities. This was the first codification of its kind. The tax rate of 10% was subsequently raised several times and ultimately reached 65% in 1946. In 1953 the double charge on incorporated companies was lessened for the first time by reducing the rate of tax on distributions (split tax rate). From 1958 onwards it was lessened even further by changes in the tax rates.
The year 1977 saw the introduction of the crediting system, which allowed shareholders to claim the corporation tax paid on distributions as a credit towards their personal income tax. This provided a means of avoiding double taxation of distributed profits. The crediting system was replaced in 2001 by what was known as the half-income system, under which the shareholder only had to pay tax on half of the distribution.
The 2008 reform of business taxation transformed the existing half-income system into the part-income system for businesses, while the final withholding tax was introduced for private investors’ income from capital.