Depreciation and amortisation
Depreciation on movable fixed assets is calculated on the straight-line method over the asset’s anticipated useful life. Depreciation takes the residual value of the asset into account only if it is material, with any gains on a sale being treated as normal business income. Certain assets worth less than EUR 800 can be depreciated in total in the year of acquisition. Alternatively, certain assets acquired in one business year worth less than EUR 1,000 each can be pooled together as a compound item and depreciated over five years.
In response to the COVID-19 pandemic, enhanced depreciation rates were introduced for movable assets acquired or made after 31 December 2019 and before 1 January 2023 of up to the factor of 2.5 compared to currently applicable depreciation rates and up to a maximum of 25% per annum. For movable assets acquired or produced after 31 December 2022, the regular straight-line method applies.
As a further stimulation measure implemented due to the COVID-19 pandemic, the German tax administration allows, for business years ending 31 December 2020 onwards, the taxpayer to assume a useful life of only one year for specific digital assets (software and hardware) for tax purposes, resulting in a full depreciation/amortisation of the acquisition costs in the year of the acquisition. The measure is also available for the remaining acquisition costs of the assets acquired in earlier business years.
Buildings are depreciated on a variety of straight-line or reducing-rate systems designed to reach a full write-down between 25 and 50 years, depending on the age of the building and on whether the taxpayer was its first owner. With changes coming into force by 1 January 2023, the regular deprecation rate for buildings for residential purposes completed after 31 December 2022 has been increased from 2% per annum to 3% per annum.
In addition to normal depreciation, special depreciation is deductible for tax purposes in certain limited circumstances (e.g. small businesses, ancient monuments, buildings in designated renovated city zones).
Acquired intangibles are amortised straight-line over their estimated useful lives; goodwill is amortised over 15 years.
Assets such as securities, stocks and bonds, shares, land, and working assets cannot be depreciated according to plan.
Start-up and formation expenses are deductible as incurred.
Annual net interest expense (the excess of interest paid over that received) of group companies is only deductible at up to 30% of EBITDA for corporation and trade tax purposes. The 30% limitation applies to all interest, whether the debt is granted by a shareholder, related party, or a third party.
This limitation does not apply where the total net interest expense for the year is less than EUR 3 million or where the net amount paid to any one shareholder of more than 25% (or a related party) is no more than 10% of the total. However, this latter concession is dependent on the demonstration that the equity-to-gross assets ratio of the company is no more than two percentage points below that of the group as a whole. Unused EBITDA potential may be carried forward for up to five years to cover future excess interest cost. Non-deductible interest expenses can be carried forward without time limit and will be deductible from future income as if it were interest of the relevant year (viz. there is an excess of EBITDA). This carryforward is otherwise subject to the same principles as the loss carryforward, including curtailment on change of shareholder(s).
In a decision on 14 October 2015, the Federal Fiscal Court held the interest limitation to be in breach of the constitution and asked the German Federal Constitutional Court to give a definitive ruling. Only the Constitutional Court is authorised to decide if the regulation is unconstitutional and may thus no longer be applied.
It must be emphasised that the interest limitation is additional to, and not a substitute for, the transfer pricing requirement that related-party finance be at arm’s length.
Following (and beyond) the OECD recommendations on Action 5 of the Base Erosion and Profit Shifting (BEPS) Project, Germany has introduced a restriction on the deductibility of certain royalty payments to related parties. According to the royalty limitation rules, expenses arising for the assignment of use or the right to use rights, in particular of copyrights and industrial property rights, in trade, technical, scientific and similar know-how, knowledge, and skills (e.g. plans, designs, processes), may not be a deductible business expense or may only be partially deductible.
The limitation will apply where:
- the recipient of the income from the assignment of rights is a related party, vis-à-vis the debtor
- the income in the hands of the (direct or indirect) recipient is subject to a special preferential regime, which does not correspond to the OECD Modified Nexus Approach, and
- the income received for the assignment of the rights is taxed at a rate less than 25% (low taxation) at the level of the (direct or indirect) recipient.
If the conditions of the provisions are met, the expenses in question will become proportionately non-deductible. The non-deductible portion of expenses is calculated as follows:
(25% - Income tax burden in %) / 25%
Hybrid mismatch arrangements
Under Article 9 and 9b of the EU Anti-Tax Avoidance Directive (ATAD), EU member states are, inter alia, required to disallow the tax deduction of expenses that arise from hybrid mismatch arrangements. Hybrid mismatches can arise (i) if the income corresponding to the expenses is not taxed (or is taxed at a lower rate) in the creditor's jurisdiction (deduction / non-inclusion; D/NI outcome) or (ii) if the expenses are tax deductible in another jurisdiction (double deduction; DD outcome). An exception may apply to the extent the taxpayer has so-called 'dual inclusion income' (i.e. income that is included in the ordinary income of two jurisdictions).
In addition, the tax deduction of expenses shall be disallowed in cases of an imported hybrid mismatch. An imported hybrid mismatch can arise if a hybrid mismatch between two foreign jurisdictions is shifted ('imported') into another jurisdiction via the use of a non-hybrid instrument (e.g. normal loan).
The aforementioned obligation was implemented into German law by the introduction of a new Section 4k Income Tax Act (ITA) in June 2021 being applicable for expenses incurred after 31 December 2019. Section 4k ITA is accompanied by amendments in other sections of the German ITA and CITA to ensure the inclusion as ordinary income in cases of hybrid mismatch arrangements (e.g. through disallowing the application of the German domestic participation exemption).
A grandfathering rule exempts certain expenses that were already legally incurred before 1 January 2020.
Bad debts incurred on trading with unrelated parties are deductible once it is apparent that they are irrecoverable and all attempts to pursue the debt have failed or been abandoned. Provision for future bad debts may be made; general provisions must reflect the past experience of the business; specific provisions require specific justification based on the actual circumstances. Expenses from the write-down of loans or similar liabilities due to shareholders of more than 25% or to their related parties may not be deducted from taxable income unless a third-party creditor would have granted the loan or allowed it to remain outstanding in otherwise similar circumstances. Exchange rate losses incurred after 31 December 2021 are no longer affected by the prohibition of deduction.
Donations to recognised charities in cash or in kind are deductible up to the higher of 20% of otherwise net taxable income or 0.4% of the total of sales revenue and wages and salaries paid during the year. Donations to charities registered in other EU/EEA member states also qualify for deduction if the recipient charity meets the German requirements for recognition.
Fines and penalties
Fines and other penalty payments levied by a court, or other authority, with an intent to punish, as well as related costs, are not deductible. By contrast, payments levied to confiscate ill-gotten gains, or to relieve damage to the victims or to the public good, are deductible. Penalty payments levied for attempted tax evasion are not deductible, but late payment surcharges are deductible if the tax itself is (e.g. VAT).
All taxes borne are deductible except for corporation tax, trade tax, and the VAT on most non-deductible expenses.
Net operating losses
Net operating losses are carried forward without time limit. For corporation tax (but not trade tax), there is an optional carryback to the previous year of up to EUR 1 million. For losses incurred from tax year 2022 onwards, the loss carryback period has been extended to two tax years preceding the tax year in which the losses were incurred.
In response to the COVID-19 pandemic, the maximum loss carryback for a corporation was increased from EUR 1 million to EUR 10 million for losses incurred in 2020, 2021, 2022, and 2023.
The loss relief brought forward claimable in any one year is limited to EUR 1 million plus 60% of current income exceeding that amount. The remaining 40% of income over EUR 1 million is charged to trade and corporation taxes at current rates. This is referred to as ‘minimum taxation’.
The loss carryforward, as well as current losses of the ongoing fiscal year accrued up to the date of the harmful share transfer, is forfeited if a single shareholder directly or indirectly acquires more than 50% of the issued capital (voting rights) within a five-year period.
The forfeiture rule does not apply to share acquisitions as part of certain group internal reorganisations without effect on the single ultimate shareholder, or inasmuch as the loss carryforward is covered by hidden reserves in the company’s assets that, on realisation, will lead to German taxation. This excludes the appreciation in value of shareholdings in other companies as well as business assets held in tax exempt foreign PEs.
Further, there is an exemption from the forfeiture of tax loss carryforwards for share transfers for the purpose of restructuring the respective corporate entity.
A loss forfeiture upon a harmful share transfer can, in certain cases, be avoided upon application. Relief may be available where the company has maintained exclusively the same business during a specified observation period and during this period no ‘harmful event’ has occurred. In this context, harmful events include, for example, the discontinuance of the business, the commencement of an additional business, and a change in activity/business sector. Where the conditions are fulfilled and the company has made the application, the total tax loss carryforward available at the end of the period of assessment, in which the harmful share transfer occurred, will be classified as so-called ‘continuance-bound’ loss carryforward (Fortführungsgebundener Verlust).
The occurrence of one of the harmful events as set out in the provision will result in the forfeiture of the continuance-bound loss carryforward last assessed as far as the continuance-bound tax loss carryforward is not matched by hidden reserves under the hidden reserve exception.
In a decision on 29 August 2017, the Lower Tax Court of Hamburg has referred the question to the German Federal Constitutional Court whether the full forfeiture of losses in the case of a harmful share transfer of more than 50% is unconstitutional, which it is in the opinion of the Lower Tax Court of Hamburg. Only the Constitutional Court is authorised to decide if the regulation is unconstitutional.
Payments to foreign affiliates
A German corporation can claim a deduction for remuneration, such as interest charges (subject to the interest limitation) service fees, and royalties (subject to the royalty limitation), paid to foreign affiliates, provided the amounts are at arm’s length. Detailed provisions covering both form and substance define this. In particular, all services must be covered by prior written agreement, and it is also necessary to conclude agreements for the purchase and sale of goods in writing where this would be usual between third parties (e.g. for quantity rebates on sales). The substance tests must be satisfied, both as to value for money and as to business relevance. Thus, the manager of a German subsidiary must be able to show an adequate business benefit from a related-party transaction. These and all other aspects of inter-company (related-party) trading fall under strict and extensive documentation requirements, breach of which can lead to serious penalties.
Nevertheless, payments to foreign affiliates may not be deductible where anti-tax avoidance rules are applicable, e.g. in case of a so-called hybrid mismatch arrangement (see above) or where payments are non-deductible under the Tax Haven Defence Act ('Steueroasenabwehrgesetz', see Tax Haven Defence Act in the Other issues section).
Special features for trade tax
There are a number of differences between the income subject to trade tax and to corporation tax. The most significant is the trade tax disallowance of one-quarter of the interest costs, including interest implicit in leasing, rental, and royalty charges. Banks have an exemption from this interest disallowance.