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German Taxation


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German Taxation

  1. 1. The German Taxation System-How is it different from India. By CA.Pratik Niyogi Introduction 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: o Customs o taxes on Alcopop, Distilled beverages, Coffee, Mineral oil products, Sparkling wine, Electricity, Tobacco and Insurances o Supplement on income taxes so-called solidarity surcharge (Solidaritaetszuschlag) • The Länder can use exclusively the revenue of: o Inheritance tax, real property transfer tax o Taxes on Cars, Beer o Fire protection tax, Gambling tax • The Districts/Municipalities can use exclusively the revenue of: o Real property tax o Trade Tax (Gewerbesteuer)
  2. 2. o 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 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 income • Income from letting property • Miscellaneous income. (Excluding non-recurring and casual incomes) 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, withholding 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; 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.
  3. 3. Tax rate German Income Tax Rate 2008 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 (e.g. 25.00 % tax rate * 5.5 % solidarity surcharge = 26.375 % taxes in total). No income tax is charged on the basic allowance, which is EUR 7,834 (2009) for unmarried persons and EUR 15,668 (2009) 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 German Tax Rate on Corporate Income 1995-2009 As from 2008-01-01, 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 2008-01-01), tax on corporations in Germany is less than 30%. 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
  4. 4. Some corporate enterprises are exempted from corporation tax, e.g. charitable foundations, Church institutions, and sports clubs. Flat rate tax The corporation tax charged at corporate level is 15% (flat rate tax). Solidarity surcharge as above income tax / tax rate. 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 25 % is charged. Since 2009-01-01 this tax is final for individuals who are resident in Germany. Solidarity surcharge as above income tax / tax rate. 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 (group taxation) 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 organizational 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 2008-01-01, the rate averages 14% of profits subject to trade tax. 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.
  5. 5. Trade Tax for Unincorporated enterprises One-man businesses and members of a partnership may deduct a large portion of trade tax from their personal income tax bill. Trade Tax Incorporated enterprises As from 2008-01-01, 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, flowers and transports. 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. VAT for Small 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. Net worth tax or Wealth Tax
  6. 6. Actually there is no net worth tax. Inheritance and gift tax Inheritance tax and gift tax are regulated in one law. Taxable is either a transfer by reason of death or a gift amongst livings. There are depreciations e.g. for family houses, families as well and for entrepreneurs (up to 100 %). The tax rate is from 7 % up to 50 %. The Indian Taxation System-An overview Indian taxation system is highly organized and well developed. The entire tax structure of the country is managed by a three-tier federal arrangement, comprising of the Union Government, the respective State Governments and the various Local Bodies. Keeping in accord with the provisions of the Indian Constitution, the authority and power to levy various taxes and duties is distributed amongst these three governmental tiers, in a planned manner. The Union Government holds power to charge taxes like Income Tax (except on agricultural income), Custom Duties, Central Excise and Service Tax. On the other hand, the State Governments are empowered to levy taxes like VAT (Value Added Tax), Sales Tax, (taxes on intra-state sale of goods in states where VAT is not in force), Stamp Duty (duty on transfer of property), Land Revenue (tax on land), State Excise (duty on manufacture of alcohol), and Tax on Professions. State Governments can also impose taxes on various agriculture incomes. Since April 1, 2005, most of the State Governments in the country have substituted Sales Tax with Value Added Tax. The various Local Bodies of the country also have their own command as far as the taxation structure is concerned. They are authorized to levy Tax on Properties (buildings, etc.), Octroi (tax on entry of goods for use within areas of the Local Bodies), Tax on Markets and also Taxes on Utilities like drainage, water supply and the like. From the last decade, the taxation structure in India has witnessed major reforms and amendments. Tax Laws have been rationalized and the tax rates have also been streamlined to a great extent, leading to better enforcement, simplified payment modes and fair play. India has a well-developed tax structure with clearly demarcated authority between Central and State Governments and local bodies. Central Government levies taxes on income (except tax on agricultural income, which the State Governments can levy), customs duties, central excise and service tax. Value Added Tax (VAT), (Sales tax in States where VAT is not yet in force), stamp duty, State Excise, land revenue and tax on professions are levied by the State Governments. Local bodies are empowered to levy tax on properties, octroi and for utilities like water supply, drainage etc. In last 10-15 years, Indian taxation system has undergone tremendous reforms. The tax rates have been rationalized and tax laws have been simplified resulting in better compliance, ease of tax payment and better enforcement. The process of rationalization of tax administration is ongoing in India. Since April 01, 2005, most of the State Governments in India have replaced sales tax with VAT.
  7. 7. Government of India provides tax incentives for:- • Corporate profit • Accelerated depreciation allowance • Deductibility of certain expenses subject to certain conditions. These tax incentives are, subject to specified conditions, available for new investment in • Infrastructure, • Power distribution, • Certain telecom services, • Undertakings developing or operating industrial parks or special economic zones, • Production or refining of mineral oil, • Companies carrying on R&D, • Developing housing projects, • Undertakings in certain hill states, • Handling of food grains, • Food processing, • Rural hospitals etc. Double Tax Avoidance Treaty India has entered into DTAA with 65 countries including the US. In case of countries with which India has Double tax Avoidance Agreement, the tax rates are determined by such agreements. Domestic corporations are granted credit on foreign tax paid by them, while calculating tax liability in India. The comparison Basis of Differentiation Indian Taxation German Taxation 1. Name of the taxpayer Assignee Assignee 2. Assessment year 1st April to 31st March 1st Jan to 31 Dec 3. Type of Income Taxable Income in India is divided into Five heads- Salary, Business Income, Capital Gains, Income from Housing Property and Other Sources Same as India, except Income from agriculture and forestry. 4. Treatment of Agriculture income Tax exempted in India Taxable 5. Basis for differentiating between TaxpayersGender/Seniority of the Taxpayer Marital status of Taxpayer 6. Basis of Taxation Residency Concept of World Income 9. Distribution of taxation In India, Tax is progressive but still unable to capture the big fishes in a desirable manner Same but incidence of evasion is much less. 10. Attitude of People Income Taxation is Considered a burden and people tried to escape and evade taxation in every possible manner People understand the importance of taxation and comply with the extent possible. They try to save tax rather than evading it
  8. 8. 11 Wealth Tax Applicable Does not Exist 12 Filing of Income Tax Has to be filed even if entire Need not file if entire income tax is paid by TDS. income tax is paid by TDS. 13 Corporate Tax Rate 30% 15% 14 Concept of Capital Yield Tax Not Applicable When dividends are paid to an individual person, capital yield tax at a rate of 25 % is charged. Since 2009-01-01 this tax is final for individuals who are resident in Germany. 15 Integrated fiscal units (group taxation) Not Applicable 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 organizational 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. Conclusion Taxation in Germany is a complicated process. German tax system involves 118 laws, 418 exceptions, 185 forms and 96,000 policies. The tax system in Germany has been modified ample number of times due to political and corporate moves and as a result the system has become complex. However, The above facts help us to conclude that Germany has made rapid inroads in the area of taxation reforms.The concepts of Capital Yield Tax on dividends ,Group Taxation,Global Income ,low corporate taxation are the ones which a modern day economy demands.These concepts may well be considered in the context of taxation reforms happening in India. End