The taxable income is generally determined on the basis of a tax balance sheet, which in turn is based on the statutory accounts according to German generally accepted accounting principles (GAAP). There are certain specific tax law and accounting adjustments to be made to the statutory accounts, and additional accounting options are available. If accounting options are exercised in the tax balance sheet that diverge from the financial statements according to German GAAP, a register must be kept of the resulting variances between the financial statements and the tax computation showing the basis on which each arose and its reversal. International Financial Reporting Standards (IFRS) financial statements are not accepted as a basis for computing taxable income.
Inventories normally are valued at the lower of actual cost, replacement cost, and net realisable value. However, any write-downs below actual cost must be made for specific reasons. If specific identification of the inventories is not possible, valuation at either standard or average cost is acceptable. The last in first out (LIFO) method is accepted as an option. First in first out (FIFO) is not accepted unless its assumption accords with the facts.
Long-term liabilities and accruals
Non-interest bearing liabilities with a remaining term of 12 months or more as at the balance sheet date, other than advance payments received, must be discounted at 5.5% per year. A similar provision applies to refurbishment (to restore an asset to its original condition) and other accruals that accumulate over time.
Generally, capital gains realised by a corporate entity from a disposal of business assets are treated as ordinary income. It is possible to postpone the taxation of part or all of the gain on real estate by offsetting the gain against the cost of a replacement property.
Capital gains from the sale of investments in other corporations are exempt from corporation and trade taxes. Corresponding losses are not deductible. However, 5% of the capital gains are added back to taxable income as non-deductible, directly-related expenses where the seller is resident or has a PE/representative in Germany.
Dividends received on significant holdings are exempt from corporation and trade taxes. Portfolio dividends are taxable. For corporation tax and trade tax purposes, different qualified portfolio holdings are applicable. With respect to corporation tax, a minimum shareholding of at least 10% is required and must be met at the beginning of the calendar year. For trade tax purposes, additional requirements need to be fulfilled (e.g. an active income criterion for certain foreign-source dividends) and different rules apply for German-source and foreign-source dividend income from shareholdings of at least 15% (or 10% insofar as the Parent/Subsidiary Directive is applicable). Following a decision of the ECJ on 20 September 2018 (C-685/16), according to which the rules for trade tax purposes infringe the free movement of capital (Article 63 TFEU) to the extent that these rules subject a deduction of profits from shareholdings in a company with its management and head office in a non-member state to stricter conditions than a deduction of profits from shareholdings in a non-exempt company governed by national law, it might be expected that the respective rules for trade tax purposes are amended.
For corporation tax purposes, 5% of the tax-free gross dividend is added back to taxable income as non-deductible business expenses. For dividends exempted for corporation as well as for trade tax purposes, the taxable amount of 5% of the dividends for corporation tax purposes is also taxable for trade tax purposes.
Note that, for example, banks do not enjoy this exemption on dividends from securities held for trading.
In principle, a declaration of stock dividends (by converting reserves to capital stock) by a company will not lead to taxable income for the shareholder or to other tax effects. Subsequent capital reductions, however, will be treated as cash dividends in most circumstances. In general, there is no German tax reason for distributing a stock dividend as opposed to merely leaving accumulated profits on the books to be carried forward. The decision, therefore, depends upon the situation in the investor’s home country.
Interest received is taxed as part of a company’s ordinary trading income. There is no exemption corresponding to the trade tax disallowance of 25% of the interest expense or to the general tax disallowance of net interest expense in excess of 30% of ‘earnings before interest, tax, depreciation, and amortisation’ (EBITDA) under the interest limitation rule (see the Deductions section). However, since the interest limitation is based on the net interest margin, a company can benefit from earning income as interest as opposed to an interest substitute.
Royalties received are taxed as part of a company’s ordinary trading income. There is no special regime such as an IP Box or the like.
Foreign income, except dividends, received by a resident corporation from foreign sources is included in taxable income for corporation tax unless a tax treaty provides for an exemption. Foreign PE income, in most cases, is exempt from corporation and trade taxes, while double taxation on most items of passive income (e.g. interest and royalties) is avoided by foreign tax credit or, at the taxpayer’s option, by a deduction of the foreign taxes as an expense.
Irrespective of any tax treaty, income from a foreign branch or partnership is, in general, not charged to trade tax. However, with effect from the 2017 period of assessment, certain passive income arising to a foreign PE will be deemed to have been earned by a domestic PE for trade tax purposes.
The Foreign Tax Act provides for anti-avoidance (including controlled foreign company [CFC]) rules with respect to subsidiaries in certain lines of business subject to a low-tax regime. A low-tax regime is one in which the rate applicable to the income in question is less than 25%. Most forms of passive income fall under the CFC rules, which essentially attribute the income to the German shareholder as though it had been earned directly. Active business income is not generally caught where the business operates from properly established facilities.
Investment income held in an EU/EEA subsidiary is also exempt from attribution, provided the subsidiary is commercially active in its country of operation and maintains at least a minimum establishment.
Other provisions give the tax office the right to insist on full disclosure of all the facts and circumstances surrounding a transaction as a condition for the deduction of a business expense incurred within an essentially tax-free environment for the supplier. This rule operates independently of ownership or shareholding considerations.