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Taxation in Germany

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Taxes in Germany—being a Federal Republic—are levied by the Federation (Bund), the States (Länder) as well as the Municipalities (Gemeinden). Many direct and indirect taxes exist, whereof income tax and VAT are the most relevant. The German word for tax is die Steuer which originates from the Old High German word stiura meaning help. It should not be confused with the word das Steuer, which means steering or helm.

Taxation principles

The German constitution (Grundgesetz) lays down the principles governing taxation in the following articles:

  • The ability-to-pay principle (Art. 3 para. 1 Grundgesetz)
  • Equality in taxation (Art. 3 para. 1 Grundgesetz).
  • The lawfulness of taxation (Art. 2 para. 1 and Art. 20 para. 3 Grundgesetz)
  • The welfare state principle (Art. 20 Grundgesetz)

The right to decide on taxes is subdivided:

  • The federation has the right on customs. (Art. 105 para. 1 Grundgesetz)
  • The federation and the states decide together on most of the tax law. Formally, the states can decide that there is no federal law. In practice, there are federal laws for all taxation issues. (Art. 105 para. 2 Grundgesetz)
  • The states decide on local excise taxes. (Art. 105 para. 2a Grundgesetz)
  • The municipalities and the districts (Kreise) 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 allocated by the federation and the states as following (Art. 106 Grundgesetz):

  • The federation receives exclusively the revenue of:
    • Customs
    • Taxes on alcopops, distilled beverages, coffee, mineral oil products, sparkling wine, electricity, tobacco, and insurances
    • Supplement on income taxes so-called solidarity surcharge (Solidaritätszuschlag)
  • The states receive exclusively the revenue of:
  • The municipalities and/or districts receive exclusively the revenue of:
    • Real property tax
    • Trade Tax (Gewerbesteuer)
    • Taxes on other beverages, dogs, and inns.

Most of the revenue is earned by income tax and VAT. The revenues of these taxes are distributed between the federation and the states by quota. The municipalities receive a part of the income of the states. In addition, there is a compensation between rich and poor states (Länderfinanzausgleich, Art. 107 para. 2 Grundgesetz).

Structural organisation of fiscal administration

Germany’s fiscal administration is divided into federal tax authorities and state tax authorities. The local tax offices (Finanzämter) belong to the latter. They administer the “shared taxes” for the Federation and the States and process the tax returns. The number of tax offices in Germany totals around 650.

As a result of discussions in 2006 and 2009 between Federation and States (Föderalismusreform) the Federation will further on also administer some taxes. The competent authority is the Federal Central Tax Office (FCTO) which is also competent authority for certain applications of tax refund from abroad. Since 2009 FCTO also allocates an identification number for tax purposes to every taxable person.

Jurisdiction

There is normally at least one fiscal court in every State (Berlin and Brandenburg share a court, in Cottbus). Appeal instance is the Federal Fiscal Court in Munich.

Fiscal Code

The common rules and procedures applying to all taxes are contained in the fiscal code (Abgabenordnung) as so-called general tax law. The individual tax laws regulate in which case tax is incurred.

Tax identification numbers

From 2009 onward, every German resident receives a personal tax identification number. In the coming years,[when?] businesses will be receiving a business identification number. The competent authority is the "Federal Central Tax Office" (Bundeszentralamt für Steuern).[1]

Tax revenue

German Tax Revenue 2007

In 2007, German tax revenue totaled €538.2 billion.[2]

Tax revenue is distributed to Germany’s three levels of government: the federation, the states, and the municipalities. All of these are jointly entitled to the most important types of tax (i.e., value-added tax and income tax). For this reason, these takes are also known as “shared taxes”. Tax revenue is distributed proportionately using a formula prescribed in the German constitution.

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.

If a taxpayer’s income does not fall into any of these categories, then it is not subject to income tax. This includes winnings at a game show, for example.

Income tax

German income tax rate in 2010 as a function of taxable income

The rate of income tax in Germany ranges from 0% to 45%. The German income tax is a progressive tax, which means that the average tax rate (i.e., the ratio of tax and taxable income) increases monotonically with increasing taxable income. Moreover, the German taxation system warrants that an increase in taxable income never results in an decrease of the net income after taxation. The latter property is due to the fact that the marginal tax rate (i.e., the tax paid on one euro additional taxable income) is always below 100%.

Income tax rate in 2010

No income tax is charged on the basic allowance, which is €8,004 for unmarried persons and €16,008 for jointly assessed married couples. Beyond this threshold, the marginal tax rate increases linearly from 14% to 24% for a taxable income of €13,469 (€26,938 for married couples). In the subsequent interval up to a taxable income of €52,881 (€105,762 for married couples), the marginal tax rate increases linearly from 24% to 42%. The last change to the occurs at a taxable income of €250,730 (€501,460 for married couples) when the marginal tax rate jumps from 42% to 45%. The course of the marginal tax rate and the resulting average tax rate are depicted in the graph to the right.

Solidarity surcharge

On top of income tax, the so-called solidarity surcharge (Solidaritaetszuschlag) is levied at a rate of 5.5% of the income tax for higher incomes. Up to €972 (€1,944 for married couples) annual income tax, no solidarity surcharge is levied. Above this threshold, the solidarity surcharge rate increases continuously until it reaches 5.5% when the annual income tax is €1,340.69 (€2,681.38 for married couples).

For example, if €10000 income tax result from a certain annual taxable income, a solidarity surcharge of €550 will be levied on top. As a result, the tax payer owes the taxation office €10550.

Withholding taxes

Tax on income from employed work and tax on capital income are both retained by being deducted at source (pay-as-you-earn tax, wages tax, or withholding tax). Here, an amount of tax is retained directly by the employer or by the bank before the earnings are paid out.

Deductions

German income tax law allows a considerable number of taxpayer’s costs to be deducted from income when computing taxable income. This applies in particular to costs immediately related to earnings. Apart from this, other costs are also deductible, e.g., certain insurance payments, costs incurred by sickness, costs for home help, and maintenance payments. In addition to the possibility of deducting costs, there are also numerous allowances and lump-sum amounts which reduce taxable income, e.g., an allowance for capital earnings currently at €801 (€1,601 for married couples) and a lump sum of €920 is deducted from income from employed work.

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.

Tax return

The obligation to file an income tax return does not apply to everybody. For example, single assessed tax payers who exclusively earn income subject to withholding tax are exempt from this obligation, because their tax debt is deemed to be at least settled by the withholding tax. Nevertheless, any person having full tax liability is allowed to file a tax return, taking into account the tax already withheld at the source and possible deductions. In many cases, this may result in a tax refund.

Married couples can apply for joint assessment to be taxed at a more favourable rate. In this case, they must file the annual tax return as it is possible that the tax paid through withholding tax was not sufficient.

Income tax for non-residents

Individuals who are neither resident of 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 agreements

See also: International taxation

Germany has reached tax treaties with about 90 countries to avoid double taxation. These agreements fall under public international law and aim to avoid that one taxpayer is charged similar taxes more than once on the same income for the same period. The basic structure of the double taxation agreements 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 of 1 January 2008, Germany’s corporation tax rate is 15%. Counting both, the solidarity surcharge (5.5% of corporation tax) and trade tax (averaging 14% as of 2008), tax on corporations in Germany is just below 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

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 1 January 2009, this tax is final for individuals who are residents of Germany. Solidarity surcharge as above income tax / tax rate.[clarification needed]

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, e.g., 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 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 income tax/corporation tax. In contrast to the latter, trade tax is charged by the local authorities, who are entitled to the entire amount. The rate levied is fixed by each local authority separately within the range of rates prescribed by the central government. As from 1 January 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 1 January 2008, corporate entities may no longer deduct trade tax from their taxable profits.

Value-added tax

As a matter of principle, all services and products generated in Germany by a business entity are subject to value-added tax (VAT). The 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.

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.

Real property tax

The Municipalities levy a real property tax. Taxable is the real property. The tax rates vary because they depend on the decision of the local parliament. The tax is payable every quarter.

Real property transfer tax ("Grunderwerbsteuer")

Taxable is the transfer of real property. The vendee and the vendor are common debtors of the tax. In general the vendee has to pay the tax. The tax rate is defined by the single States. In general the tax rate is 3.5 %. Berlin and Hamburg use a tax rate of 4.5 %.

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 %.

Capital gains tax

In Germany there is no special capital gains tax. Only under certain conditions gains from private disposal may be taxed. Since 2009-01-01 Germany levies a final tax (Abgeltungsteuer) that may take effect like a capital gains tax for resident persons e.g. disposal of shares.

Net worth tax

There is no net worth tax.

Payroll tax

There is no payroll tax.

Financial crisis

Existing depreciations e.g. for certain private housekeeping expenses and for small and medium sized enterprises have been enhanced. A declining depreciation for movable assets has been reintroduced for two years. Businesses are allowed to carry back losses and to claim refund of paid corporation / income tax. As a result they get liquidity improvement. From 2010-01-01 on the VAT tax rate concerning hotel accommodation is reduced to 7 %.

See also

References

  1. ^ [1] Website of the German Federal Central Tax Office.
  2. ^ Bundesministerium der Finanzen; Monatsbericht des BMF Juli 2008; page 69.

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