Types of Business Entities, Their Residence and Basic Tax Treatment
Corporate Structures and Tax Treatment
Businesses generally adopt the form of a limited liability company (GmbH) or a joint-stock company (AG). These corporations are taxed as separate legal entities. The key differences between the two relate to the treatment each receives under commercial law.
Under a GmbH, the shareholders are authorised to give instructions to a managing director, there is a low degree of fungibility of shares and there is a wide range of possibilities for the design of the articles of association.
Under an AG, a supervisory board and a management board are mandatory, with both operating independently from the shareholders regarding the business decisions. There is personal liability for the management and supervisory board, and there is a high degree of fungibility of shares.
Transparent Entities
The type of partnership most commonly used for transparent entities is the Kommanditgesellschaft (KG), which is most commonly adopted for investment purposes due to its limitation of liability. Only one shareholder (Komplementär) is unlimitedly liable as the general partner (GP), while the liability of the other shareholders (Kommanditist) is limited to their compulsory contribution. It is also possible to choose a GmbH as the GP; this means that no individual is subject to unlimited liability. This kind of partnership is referred to as a GmbH & Co. KG, and is usually chosen for private equity structures.
Determining Residence of Incorporated Businesses
According to German tax law, the residence of incorporated businesses depends on where the following are situated:
- the place of management; and
- the statutory/registered seat.
Usually, double taxation treaties (DTTs) regulate that the place of effective management is decisive in the case of a double residence of a corporation (the “tie-breaker rule”).
Due to the special circumstances caused by the COVID-19 pandemic, there is a possibility that the place of actual business management may be affected. According to an OECD guideline published on 21 January 2021, when deciding where the place of effective management is located, the place where it is usually located (notwithstanding the COVID-19 pandemic) should be taken into account.
Tax Rates
Taxation of Corporations in Germany
Corporations with a registered seat or place of management in Germany are subject to unlimited tax liability in Germany, while non-resident corporations are only taxed on their German-sourced income. The income of a corporation is qualified as business income that is subject to corporate tax and municipal trade tax at an approximate total rate of 30%.
The corporate tax rate (including a solidarity surcharge) stands at 15.825%. A special tax rate applies for shares held in other corporations. Dividends received (as of 1 March 2013, only where the shareholding exceeds 10%) and capital gains recognised from the disposal of shares are tax exempt, although 5% of the proceeds are deemed non-deductible expenses, resulting in an effective corporate tax burden of approximately 0.7%.
Municipal trade tax rates mainly range from 13% to 17%, depending on the municipality in which the business operates. For trade tax purposes, capital gains from the sale of shares are generally tax exempt, whereas dividends received from a German-located corporation are only tax exempt if the shareholding amounts to at least 15%. However, 5% of the proceeds are deemed non-deductible expenses, resulting in an effective trade tax burden of approximately 0.7%.
Partnerships
Partnerships such as a KG are transparent for income/corporate tax purposes so that profits and losses are taxed at the partners’ level. The assets, liabilities and income of the partnership are generally allocated to the partners in proportion to their partnership interests. Municipal trade tax, however, is levied at the level of the partnership (if it conducts a trade or commercial activity).
The recent amendment of the German Corporate Income Tax Code introduced a new “check the box” system. For fiscal years beginning after 31 December 2021, partnerships can apply to be treated like a corporation for corporate income tax and trade tax purposes. This, however, does not apply for civil law, real estate transfer tax (RETT), inheritance tax or gift tax purposes, so it must be carefully assessed if such option is considered.
The exercise of such option is considered a deemed change of form (Formwechsel) from a partnership to a corporation for German income and trade tax purposes, so might result in a taxable event.
Individuals
The taxation of the income of individuals (who own a business or are a partner in a transparent partnership carrying out a business), generated by themselves or through the partnership, generally depends upon their personal tax rate; tax rates are up to 47.5%, including a solidarity surcharge of 5.5%, and possibly a church tax. However, dividend payments and capital gains from the sale of shares that are realised in the context of a business are subject to so-called partial-income procedures, so that only 60% of the income deriving from dividends or capital gains will be taxed.
In 2021, the exemption limit on which no solidarity surcharge applies was increased for individuals and there is now a mitigation zone in which the full solidarity surcharge will not apply. However, the solidarity surcharge continues to be levied on the corporate income tax of corporations (particularly GmbHs and AGs), as before.
This article was first published in: Chambers Global Practice Guide Corporate Tax, 2023 (last updated 14 March 2023)