Author:
By Dr. Filip Schade, Steuerberater, Master of Laws
Wagemann + Partner PartG mbB, Berlin,
E: [email protected]
Edited by:
Grant Gilmour, B.SC., MBA, CPA BC, CA, CPA AZ
Integra Tax World Newsletter Editor
E: [email protected]
In this article, I will give you a brief overview of the current economic situation in Germany and the reasons for this development. Following this, I will explain existing and planned tax incentives and subsidies and critically assess them. At the end of the article I will make four proposals for a more far-reaching reform of German tax law in order to make Germany attractive again as a business location for entrepreneurs and investors.
1. Current economic situation in Germany
First, I would like to say a few words about the current economic situation in Germany.
Real GDP forecast, annual growth rate
Sources: OECD Economic Outlook: Statistics and Projections, Kiel Institute for the World Economy
Some clues are provided by the forecast of the gross domestic product. The table above shows that Germany is one of the few countries and the only country on the most developed countries list with a shrinking gross domestic product in 2023. Only a slight increase in gross domestic product is predicted for 2024. Whether this will be the case remains to be seen. This is in line with the view of most experts, who see German economic situation as rather bad.
What is the reason for this gloomy economic outlook?
On the one hand, it can be because there is a huge public investment backlog of around 130 billion Euros. Stimulus measures that have not yet added stimulus. On the other hand, this may be because the income tax rates have a significant influence on the choice of business location as well as on the way companies finance their investments. And Germany has higher than average income tax rates.
Over the past two decades, Germany has consistently occupied the position of a high-tax country when compared to its peers. In the European Union, Germany is currently the highest taxing country. It is however a lower tax rate than it was around 20 years ago, as can be seen clearly in the chart below. Since 2018, Germany’s effective tax burden has even exceeded the level of the US. The US profoundly reformed its tax system with the Tax Cuts and Jobs Act, which lowered its tax burden. If tax burden is an obstacle for investments and launching business in Germany, the question arises as to what to do about it.
Development of the Effective Average Tax Rate since 1998
Source: Hardeck, I./Heckemeyer, J.H. (2023), Steuer und Wirtschaft, pg. 210.
2. Overview of already available tax incentives and subsidies in Germany
What specific tax incentives are available in Germany at the moment? Generally, Germany does not offer tax incentives. Please keep this in mind. We will come back to it later. Partly, not offering tax incentives is a question of the state budget, and partly, it reflects the federal constitutional requirement for equal treatment of all taxpayers. An incentive would mean unequal treatment.
Nevertheless, a few tax incentives exist. I present a selection of them below.
- There is the “Investment Deduction Amount” (Investitionsabzugsbetrag), which can be used by small and medium-sized companies for the purpose of acquiring or manufacturing movable fixed assets. The tax benefit can amount up to 50 percent of the probable acquisition or production costs of such assets.
- Next, Germany has the so-called tax-exempt “6b reserve”. In principle, this is intended to enable the tax-free transfer of hidden reserves (unrealized gains) resulting from the exchange of real estate with new German real estate that is acquired or manufactured by the taxpayer. Both properties must be assets used for business purposes only. Consequently, the taxation of the hidden reserves (unrealized gain) is postponed so that the entrepreneur has more current funds for necessary investment projects.
- As well, in order to push the green transition and electromobility in Germany and meet the climate targets, the German legislator has introduced a special depreciation rate for the acquisition of new electric utility vehicles as well as electrically powered cargo bicycles. Such vehicles need to be business assets. The special depreciation rate amounts to 50% of the actual acquisition costs.
- Finally, Germany has been providing subsidies for research and development since the beginning of 2020. The German Research Allowance Act (Forschungszulagengesetz) targets to establish and strengthen Germany as a location for innovation as well as technology hot spot. Eligible expenses are in particular the wages paid by the entrepreneur for employees working on eligible R&D projects and expenses for contract research. The maximum amount of subsidy is currently limited to 1 million Euros for each entrepreneur per year.
But where is the problems when it comes to the tax incentives?
The requirements for benefiting from the mentioned tax incentives are sometimes very unclear, which is why there are unfortunately often disputes with the German tax office as to whether an entrepreneur meets the requirements for claiming the Investment Deduction Amount or whether the special depreciation rate can be applied to a specific asset. This leads to considerable compliance costs and long processing times on the part of the German tax office.
The same applies to the German research allowance. To receive this subsidy, an application procedure must first be completed, in which a certifying authority decides whether the R&D activity of the entrepreneur is eligible at all. If the certification authority rubber-stamps the R&D project, a corresponding R&D certificate is issued, which must next be submitted to the German tax office responsible for granting the subsidy. The tax office in turn checks the eligibility and amount of the expenses. And that takes time…
Apart from that, the practical problem here is that the certifying authority has too few capacities which takes a lot of time to process and in some cases the certifying authority lacks the necessary know-how to assess the eligibility of a R&D project.
This can be frustrating and detrimental to the fiscal promotion of entrepreneurs or R&D. And entrepreneurs may choose alternative tax locations for their businesses as a result.
3. Overview of planned tax incentives and subsidies in Germany
The German government is acting to add incentives and promote growth. This is to be done with the government draft of a Growth Opportunities Act (Wachstumschancengesetz).
In this draft, the federal government is pursuing a carrot and stick approach.
Carrot
The carrot is the fiscal promotion of innovation and investments in new technologies, which is intended to strengthen Germany’s competitiveness as a business location. For this purpose, tax benefits amounting to approximately 7 billion Euros are planned.
Here is a selection of the proposed tax benefits:
- The introduction of a climate protection investment premium in the amount of 15 percent of eligible expenses is planned. The tax premium is intended to provide incentives for German business to invest in energy-efficient projects in order to reduce energy consumption. The premium shall be capped at 30 million Euros for each entrepreneur for a funding period limited until 2029.
- Temporary special depreciation rates for newly constructed residential buildings shall be provided. This is intended to accelerate construction of residential buildings in Germany and alleviate the acute housing deficit in cities.
- The conditions for the tax eligibility of R&D shall be improved. In addition to the wages of employees in R&D projects and the expenses for contract research, acquisition or manufacturing costs of assets used in the R&D project shall also to be considered eligible. The maximum subsidy shall be raised to a maximum of 3 million Euros for each entrepreneur per year.
This is still draft law.
It has been in the media that the German government wants to attract certain companies from the semiconductor industry to Germany. For example, the German government is going to subsidize the construction of two semiconductor factories in Eastern Germany (more precisely in Dresden and Magdeburg) with about 15 billion Euros. The factories are generally to be operated by Taiwanese company Taiwan Semiconductor Manufacturing Company (TSMC) and Intel. In order to justify the subsidies, the German government will invoke the European Chip Act, which shall bolster Europe’s competitiveness and resilience in semiconductor technologies and shall help to achieve both the digital and green transition. But the EU Commission has still to approve the subsidies. This is because of the legal conditions of the European state aid law.
One question in the media is whether the generous subsidies to the two semiconductor companies will upset the EU’s internal market. The German go-it-alone approach is obviously contrary to the EU goal of balanced economic growth across the entire area of the EU. This question of upsetting the market is visible when the media reports that the German government’s subsidy gifts displeased the German SME sector, which is threatening a constitutional appeal, claiming that the subsidies violate the constitutional requirement for equal treatment of all taxpayers.
Stick
The tax benefits of around 7 billion Euros must somehow be financed, because the German national debt is currently at a record high of 2.3 trillion Euros. This is one of the reasons why the German federal government wants to continue the fight against tax avoidance. At the same time, this should ensure a level playing field in international context. In view of this, Germany continues to push the Pillar 2 project and implemented the global minimum taxation into national German law by the end of last year.
Understanding how Pillar 2 and a global minimum tax rate will impact business decisions is hard to predict at this point in time. For example the German law on the implementation of Pillar 2 (Mindestbesteuerungsrichtlinie-Umsetzungsgesetz), allows certain subsidies granted abroad not to be covered by the minimum tax rate of 15%, provided they meet certain conditions specified in the law. At first glance, every German entrepreneur thinks in this moment: Great, I can continue to have my investments abroad subsidized if the subsidies are in line with Pillar 2. However, the German legislator does not make it that easy for German companies. For the cases just described, there are numerous regulations in Germany’s Double Tax Agreements or in national law – such as a switch from tax exemption to tax crediting in Germany if the company makes investments in a foreign special economic zone or the German tax office denies tax exemption for foreign income if the foreign country grants tax incentives to persons with limited tax liability that a person with unlimited tax liability there does not receive.
Also, according to initial scientific findings, Pillar 2 will hardly generate any more tax revenue, but rather result in a migration of substance-based, real economic activities to countries with lower taxation. This could have devastating consequences for Germany as a business location: Less economic activity due to a decline in investment in Germany goes hand in hand with a negative impact on the German labour market and on wage tax, which is very important for German tax revenue in the middle term.
4. Proposals for a more far-reaching reform of German tax law
How can Germans make Germany attractive for businesses and investors again? What adjustments can be made to make German tax law competitive again? I have prepared a short wish list of measures that would make our lives much easier in daily tax practice and with which I would like to conclude my article.
First, it is imperative to reduce tax bureaucracy. The continuing increase in record-keeping and reporting obligations must be stopped and some obligations eliminated, such as the mandatory disclosure rules targeting international tax schemes. In addition, clearer and less complex tax regulations should be created that reduce legal uncertainty for businesses. The reversal of burden of proof to the detriment of the taxpayer should also be kept to a minimum.
Second, the fiscal procedure should finally be digitalized, for example the application procedure for the refund of German withholding tax on dividends, interest and royalties. A mainly automated application procedure with review of only critical cases would also be a considerable relief.
Third, the anti-avoidance tax system in Germany should be coordinated and scaled back. The main goal must be to create a coherent and comprehensive system of anti-avoidance rules in German tax law.
Lastly, the tax loss offset possibilities should be significantly improved. Especially innovative and riskier investments by companies that have a generally profitable business model could be promoted in this way.
Please send you comments to Dr. Filip Schade, Steuerberater, Master of Laws
[email protected]
About the Author:
Dr. Filip Schade, StB, LL.M.
Tax Advisor
Filip Schade qualified as German Tax Advisor in 2021. Before joining Wagemann + Partner PartG mbB as an international tax specialist in 2022, he did his PhD in European and International Tax Law at a German university. He has his master’s degree in German and Polish Law.
Filip offers tax consulting services primarily to foreign as well as to German companies and individuals regarding international cases.
Filip gives also lectures in German and International Tax Law at two German universities and has written numerous articles on taxation published in German and foreign tax journals.
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