Corporate - Income determinationLast reviewed - 31 December 2022
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 are normally 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 where it meets German GAAP in the individual case.
Long-term liabilities and accruals
For business years ending on or before 31 December 2022, non-interest-bearing liabilities with a remaining term of 12 months or more as at the balance sheet date, other than advance payments received, had to be discounted at rate of 5.5% per annum. The discounting rule for non-interest-bearing liabilities has been abolished for business years ending after 31 December 2022 with an option to apply to revoke the discounting for business years ending before 31 December 2022. The abolition of the discounting rule will give rise to expenses from the dissolution of the discounted amount in affected cases. The respective discounting rule for accruals with a remaining term of 12 months or more remains unchanged and continues to apply for business years ending after 31 December 2022.
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 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 in which the dividend was received. For trade tax purposes, a minimum shareholding of at least 15% at the beginning of the relevant tax year is required.
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 tax purposes 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 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.
Based on the wording of long-standing German tax law, income generated upon the licensing of IP rights or the sale of IP rights may be considered to be within the scope of German non-resident taxation if the underlying IP is registered in a German book or register. This may hold true even if the transactions are 'foreign-to-foreign', i.e. do not include a German resident counter-party. The respective rules have been amended through the Finance Act 2022. According to the new regulation, royalties and capital gains from German-registered rights between third parties are, in general, excluded from the catalogue of German-source income that is subject to limited taxation both for the future and (retroactively) for all open cases in the past. However, payments made after 31 December 2021 to taxpayers residing in a so-called 'tax haven' within the meaning of the German Tax Haven Defence Act remain taxable. Royalties and capital gains from sales between related parties within the meaning of Section 1 para. 2 German Foreign Tax Act received and realised respectively until 31 December 2022 continue to qualify as German-source income. Royalties and capital gains received from 1 January 2023 onwards are only subject to limited taxation where a tax treaty precluding Germany’s taxation right of the income does not exist or cannot be claimed in the specific case (e.g. based on the German domestic anti-treaty shopping rules) or if the payment is made to a taxpayer residing in a tax haven within the meaning of the German Tax Haven Defence Act.
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. Due to the transposition of the EU Anti-Tax Avoidance Directive (ATAD) into German law, changes to German CFC rules were enacted in June 2021 applicable for business years beginning after 31 December 2021.