209. Tax Reform 2000: Final Legislation - Part I

By Robert E Tromp

Tax Reform 2000 - officially the Act for the Reduction of Tax Rates and Reform of Business Taxation, or Tax Reduction Act (Steuersenkungsgesetz) - was enacted into law on 14 July 2000 after the government out manoeuvred the staunch CDU/CSU opposition in an interesting display of legislative finesse.

Lacking the votes to carry its bill in the Federal Council of States, the second chamber of the German legislature, the government was forced into negotiations with the opposition after the Federal Council voted in early June to reject the measure which the Federal Parliament had passed in mid-May. Negotiations in a Conference Committee composed of representatives from the Federal Parliament and the Federal Council led to adoption of a committee resolution on 6 July 2000 recommending changes to the government's bill. However, this resolution was adopted against the votes of the opposition delegates on the committee and hence did not represent a full consensus. The Federal Parliament immediately ratified the bill as amended by the Conference Committee resolution, sending it back to the Federal Council. To the government's relief and delight, this body passed the amended measure on 14 July 2000 thanks to the swing votes of four states governed by coalitions which included opposition parties (FDP or CDU). Without the consent of the opposition members, the respective states would have had to abstain from voting.

The revisions made in committee were not in themselves enough to secure passage of the bill, nor was there time prior to the summer break for the Federal Parliament to vote on yet another version. To obtain the votes of the four swing states, the government instead gave assurances (documented in a resolution adopted by the Federal Council) that it would make two further changes:

• reduction of the maximum income tax rate to 42 % in 2005 (instead of to 43 % as envisaged by the bill as enacted) and
• reenactment (on a once-in-a-lifetime basis) of the recently repealed 50 % tax break for individuals selling businesses (sole proprietorships, partnership interests, or "material" shares in corporations)

The government has since released draft legislation (Supplemental Tax Relief Act), scheduled to take effect on 1 January 2001, making good on these promises.

This article provides an overview of the changes instituted by Tax Reform 2000 based on information available at 15 September 2000. The article's focus is on aspects relevant for international investors. Hence, corporate tax changes (Part II) are treated more amply than are changes affecting primarily individuals (Part III). Part IV surveys briefly changes made in non-income tax areas.

While the government was obliged to accept certain modifications to obtain legislative approval of its plans, the general contours of Tax Reform 2000, including the complete redesign of the corporation tax system, have remained remarkably close to the bill introduced in February 2000. The key features of the measure enacted include:

• abandonment
of the current split-rate imputational system of corporate taxation, under which corporation tax paid by a distributing corporation is fully creditable to domestic dividend recipients, who include the credit amount in their income; adoption of a "classical" system under which corporate profits are subject to a definitive, non-creditable 25 % corporation tax
• 100 % dividends-received exemption
for corporations on domestic and foreign dividends, regardless of holding period, percent stake, activity requirements, or tax treaty
• 100 % capital gains exemption
for corporations on sales of shares in domestic and foreign corporations, regardless of percent stake, activity requirements, or tax treaty, subject, however, to a one-year holding period requirement (Conference Committee change)
• application of the 25 % corporation tax, the dividends-received exemption, and the capital gains exemption to domestic permanent establishments of foreign corporations and to dual resident corporations
• elimination of step-ups
on reorganization of a corporation as a partnership
• for corporations, elimination of writedowns of corporate stock; non-recognition of capital losses on sales of corporate stock; for individuals, analogous denials of loss recognition
• relaxation of tax consolidation requirements
for corporation tax purposes (but not for purposes of trade tax and VAT)
• 50 % dividends-received exemption
for individuals on domestic and foreign dividends, regardless of holding period, percent stake, activity requirements, or tax treaty
• 50 % capital gains exemption
for individuals on sales of shares in domestic and foreign corporations, regardless of percent stake, activity requirements, or tax treaty, subject, however, to a one-year holding period requirement for shares held as business property (Conference Committee change)
• tax relief for individuals operating businesses in non-corporate form through a flat-rate trade tax credit against personal income tax (so-called "basic" trade tax relief regime; "check-the-box" option for taxation as a corporation deleted in committee)
• phased income tax rate reductions for individuals (lower minimum and maximum tax rates, increases in zero bracket amounts, more gradual tax rate progression for low and middle income taxpayers; maximum personal tax rate to fall to 42 % in 2005, instead of 45 % as originally planned)
• an array of revenue-generating measures (see sec. 1.4 below) to reduce the fiscal impact of the above reforms

The trade tax and solidarity surcharge remain in effect at the previous rates. The solidarity surcharge currently amounts to 5.5 % of corporate or personal income tax.

The 50 % exemption for individuals on corporate dividends received and capital gains realized on the sale of corporate stock is referred to as the "half-income" or "50 % exemption" system (Halbeinkünfte-verfahren).

The following table lists the revenue-generating (counterfinancing) measures contained in the new legislation and indicates the respective projected additional tax revenue based on the government figures released in July 2000. These and all other tax revenue data given in this article refer, unless otherwise stated, to the change in tax owing in the first tax year to which the change is applicable, not to the cash flow effect of the change in a particular period.

Plans were dropped to apply a tax rate progression clause to personal income exempt under the 50 % exemption system.

The general effective date of the new legislation is 1 January 2001. This applies both to the Tax Relief Act passed in July 2000 and to the Supplemental Tax Relief Act mentioned in sec. 1.1 above. However, special rules govern the effective date of numerous provisions. The transition to the new corporate tax system is especially complex. See in particular sec. 2.2 and 2.3 below.

This is Part I of a five-part article which treats the subjects covered in condensed form. It is intended to provide a general guide to the subject matter and should not be relied on as a basis for business decisions. Specialist advice must be sought with respect to your individual circumstances. We in particular insist that the tax law and other sources on which the article is based be consulted in the original, whether or not such sources are named in the article. Please note as well that later versions of this article or other articles on related topics may have since appeared on this database or elsewhere and should also be searched for and consulted. While our articles are carefully reviewed, we can accept no responsibility in the event of any inaccuracy or omission. Please note the date of each article and that subsequent related developments are not necessarily reported on in later articles. Any claims nevertheless raised on the basis of this article are subject to German substantive law and, to the extent permissible thereunder, to the exclusive jurisdiction of the courts in Frankfurt am Main, Germany. This article is the intellectual property of KPMG Deutsche Treuhand-Gesellschaft AG. Distribution to third persons is prohibited without our express written consent in advance.