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.