Change In Taxation Of Partnerships. Authorities Draft Handed For German Act On The Modernization Of Corporate Tax Regulation: Proper Of Selection For Buying and selling Partnerships On Corporate Taxation. – Tax

BUSE Rechtsanwälte Steuerberater

Germany:

Change In Taxation Of Partnerships. Government Draft Passed For German Act On The Modernization Of Corporate Tax Law: Right Of Choice For Trading Partnerships On Corporate Taxation.

15 June 2021

BUSE Rechtsanwälte Steuerberater

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On March 24, 2021, the German government passed a
draft bill for the modernization of corporate tax law. The
legislative process is intended to be completed already in the
current legislative period. Somewhat surprisingly, the draft of the
German Act on the Modernization of Corporate Tax Law contains,
among other regulations, a right for trading partnerships to opt
for corporate income taxation. This is planned to come into effect
from the 2022 assessment period, but the application must be
submitted to the tax authority before the start of the fiscal year.
Since applications will be possible after the law has come into
force at the earliest, it is likely that action will have to be
taken within a short timeframe if the option is intended to be
exercised already for a fiscal year beginning on January 1, 2022.
Therefore, partnerships and their partners should, irrespective of
the still ongoing legislative process, consider timely whether they
wish the option to be exercised. In this regard, a number of points
need to be taken into account.

Background

So far, partnerships have been subject to trade tax on their
profits, but not to corporate income tax. Instead, the partners
have been subject, depending on the legal form, to personal income
tax or corporate income tax on their share of profits (so-called
“transparent taxation”). This applies irrespective of
whether their share of profits has been paid out or retained to
strengthen equity in the partnership. Corporations (e. g. German
limited liability companies and joint-stock companies), on the
other hand, are subject to trade tax and corporate tax income tax
on their profits, but their shareholders are only taxed once
dividends are paid out. Although the corporate income tax rate is
significantly lower at 15% than the personal income tax rate (up to
45%), the aggregate tax rate for paid out profits is similar for
partnerships and corporations. This is achieved by crediting trade
tax against personal income tax for partners of partnerships on the
one hand and the reduced tax rate for dividends (final withholding
tax) on the other hand. But things are different for retained
profits: As long as a corporation retains profits, the aggregate
tax rate is lower than that of a partnership, because the
shareholders are only taxed once dividends are
distributed. Thus, corporations enjoy a cash flow
advantage as long as profits are retained.

To eliminate this disadvantage of partnerships, the so-called
Brühl Recommendations already included an option model 20
years ago. Instead of this, the legislator had only included an
optional beneficial tax rate for profits that are retained in the
partnership (Article 34a German Income Tax Act) in the law, which
is comparatively complex and partially has disadvantages. Even if
the timing is surprising, the German government now obviously
intends to implement into the law, additionally, the possibility to
achieve comprehensively equal taxation for partnerships and
corporations.

For Which Partnerships is an Option Interesting?

The option model is interesting for all partnerships
whose investment and cash flow planning is based on internal
funding through retained profits. For joint
partnerships that pay out their profits to partners on a regular
basis, it usually makes more sense to maintain transparent
taxation. If it is intended to partially retain and partially
distribute profits, it is worthwhile to make a model calculation
that is as accurate as possible.

Additionally, partnerships that plan to retain profits should
also examine the advantages and disadvantages of exercising the
option in detail and make any necessary preparations. The following
points may be decisive:

Does the structure of the partners accounts fit? Profits that
are credited to shareholder loan accounts and can be withdrawn at
any time are to be considered distributed under the draft bill. If
necessary, the partnership agreement will need to be amended.
Does exercising the option result in the taxation of unrealized
capital gains? Exercising the option is to be regarded as a change
of legal form within the meaning of the German Conversion Tax Act.
Such a change of legal form generally can be made on a no gain and
no loss basis. However, this is not always the case. It is possible
that business assets owned by the partners, but connected to the
partnership (so-called Sonderbetriebsvermögen), needs to be
restructured first.
Are there participations in foreign corporations? It is
possible that withholding taxes on dividends from foreign
corporations can no longer be credited against German tax after the
option has been exercised.
Are there any trade tax losses carried forward? Their fate when
the option is exercised is unclear so far.

Important: Exercising the option is not
intended to have any impact on the inheritance and gift tax
classification of the partnership. This is important because the
inheritance and gift tax benefits for business assets are connected
to stricter requirements for corporations than they are for
partnerships. Furthermore, after an option has been exercised, it
is possible to opt back to transparent taxation with effect for the
future, whereby this is deemed to be another change of legal form
for purposes of taxation.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.