2. Introduction to German Tax System and Income Tax

1
2. Introduction to German Tax System and Income
Tax

• Topics
• System of Income Tax (EStG) and Tax Liability
• Scope of Business Income
• Non-business activities
• Determination of Income
• Compensation of losses

2
Tax Law

• is a part of public financial law and
• linked to civil law (tax provisions refer to
  terms and definitions determined in civil law,
  esp. company law).

3
Allocation of Tax Revenue Art. 106 GG

• Federation - e.g. customs duties, solidarity
  charge
• German States - e.g. inheritance and gift tax,
  real estate transfer tax, property tax
• - tax equalisation among states
• Joint Taxes - allocated to the Federation and
  the States (e.g. share in EStG / KStG /
  USt)
• Municipalities - share in trade tax (GewSt) and
  real estate tax

4
Direct Taxes tax payer and tax debtor is
identical

• Income Tax
• Corporation Tax
• Trade Tax

• Einkommensteuer (ESt)
• Körperschaftsteuer (KSt)
• Gewerbesteuer (GewSt)

5
Indirect Taxes Tax Payer and Tax debtor
are not identical

• Value Added Tax

• Umsatzsteuer (USt)

6
Tax Revenue 2006 in Germany (bn )

• Joint Taxes 329.3
• Federal Taxes 88.1
• States Taxes 21.7
• Community Taxes 49.3

7
Tax Revenue 2007 billion
Value Added Tax 169.6
Income Tax on income from employment 131.8
Income Tax on other income Withholding Tax 25.0 13.8
Trade Tax 40.1
Corporation Tax 22.9
Total Tax Revenue 538.2
8
National tax ratio in Germany tax revenue/GNP

• Year national tax ratio
• 2000 23
• 2001 21.6
• 2002 21.0
• 2003 20.9
• 2004 20.0
• 2005 20.1
• 2006 21.2

9
Sources of German Tax Law

• Binding norms (come into existence by
  legeislative
• power or by decree)
• Issued by the Minister of Finance, binding
  only the
• members of the Internal Reveneue Service

Tax Acts (Steuergesetze)
Ordinances (Durchführungsverordnungen)
Administrative Guidelines (Einkommensteuerric
htlinien)
10
Principle of Residence - 1 EStG
Unlimited Tax Liability 1 para. 1 EStG
Principle of residence (flat/dwelling or
presence for more than 6 months in
Germany) Worldwide income is taxable
Limited Tax Liability 1 para. 4 EStG
Principle of residence (no residence in
Germany) Only domestic income is
taxable
11
Determination of Taxable Income according to 2
EStG

• (1) Income from agriculture and forest economy
• (2) Income from trade and business
• (3) Income from independent personal services
• (4) Income from employment
• (5) Income from capital investments
• (6) Income from rent and leasing
• (7) Other income within the definition of 22
  EStG
• Sum of income (of an individual)
• - Special reliefs (i.g. for elder people)
• Total amount of income ( Gesamtbetrag der
  Einkünfte)

12
Determination of Taxable Income (Continuation)

• - Compensation of losses according to 10d EStG
• - Personal deductions
• (Sonderausgaben and außergewöhnliche
  Belastungen)
• Income
• - Tax allowances ( preferential treatments)
• TAXABLE INCOME
• Apply Income Tax Rate according to 32a EStG
• You can use the Income Tax Table (basic and
  splitting-table)

13
Income Net Income Einkünfte
Gross Income from sources (1) to (7) Revenues from sources (1) to (3) ( Gewinneinkünfte Revenues from sources (4) to (7) (Überschusseinkünfte)
less source related expenses less Business Expenses less Income related Expenses ( Werbungskosten)
Net Income ( Einkünfte) Profit Surplus of income above income related expenses
14
Activities must be determined to achieve income
( Einkünfteerzielungsabsicht)

• Financial benefits and expenses covered by the
  7
• categories of income are only subject to
• income tax as long as there is a fair chance
  to
• produce a surplus.
• Total income must exceed total expenses during
• the period of the total project.
• Permanent losses or hobby-projects will not be
  excepted for tax purposes!

15
Income from sources (1) to (3) Profit
oriented sources Gewinneinkünfte

• Income from agriculture/forest economy - 13
• Income from trade and business -
  15
• Income from
• independent personal services
  - 18

16
Income from source (2) - 18 EStG

• Independent service income includes
• Income from professional services (i.g.
  scientific, artictic, musical, educational or
  literary activities exercised in an independent
  capacity)
• Listed professions i.g. notaries, attorneys,
  dentists, tax advisors, ...
• Similar professions
• Independent service income is not subject to
  trade tax !

17
Income from source (3) - 15 EStG

• Scope of income from business and trade - 15
  (2)
• Any independent activity,
• undertaken to make a profit,
• requiring business relationships to third
  parties,
• which is not an independent personal service
  related to sources (1) and (2).

18
Income from source (3) 15 EStG

• All business and trade income is subject to trade
  tax !

19
Profit determination methods
A. Comparison of business property ( Betriebsvermögensvergleich) 4 (1 EStG
B. Comparison of business property ( Betriebsvermögensvergleich) 5 (1) EStG
C. Cash based accounting ( Überschuss der Einnahmen über die Ausgaben) 4 (3) EStG
20
Determination of profit from business and trade
- 5 (1) EStG

• Relevant for taxpayers who have to (or
  voluntarily) keep books and records and to
  prepare financial statements for tax purposes
  according to 140 or 141 AO ( profit more
  than 50.000 per year)
• Financial statements have to be prepared in
  accordance with the Generally Accepted German or
  International Accounting Principles
• Correlation Principle (see 5 (1) EStG)

21
Other profit determination methods- 4 (1) EStG

• Relevant for farmers
• and
• persons operating independent services who
  voluntarily keep books and records.
• No correlation with Generally Accepted German
  Accounting Principles

22
Profit determination - 4 (1) and 5 (1) EStG
Comparison of business property Profit
Withdrawals from business (Entnahmen)
- Value of contributions (Einlagen)
taxable Profit
23
Other profit determination methods- 4 (3) EStG

• Relevant for taxpayers who do not have to keep
  books and records and who do not voluntarily keep
  books and records ( profit till 50.000 per
  year)
• No correlation with Generally Accepted German
  Accounting Principles
• Cash based accounting ! (see 8 EStG)
• Relevant for persons operating an independent
  service or a small business.

24
Business expenses

• Basic provision 4 (4) EStG
• According to 4 (5) EStG some expenses are not
  deductible or limited for the purpose of tax
  accounting.
• Give examples !

25
Income from sources (4) to (7) Non-profit
sources Überschusseinkünfte

• Determine surplus of income above income-related
  expenses
• ( Income less Werbungskosten)
• Surplus is determined on a cash basis only !
• (see 8 EStG)

26
Income from sources (4) to (7) Non-profit
sources Überschusseinkünfte

• Definition of income-related expenses
• Werbungskosten (see 9 EStG)
• Cash-flow principle (see 11 EStG)
• Expenses are deductible in the year being paid

27
Compensation of Losses

• Topics
• (a) Off-set losses within each or other sources
  of income ( 2 para. 3 ESG)
• (b) Carrying losses back and/or forward ( 10d
  EStG)

28
Determination of Income - 2 EStG

• 7 Sources of Income ( Summe der
  Einkünfte)
• Sum of Income
• - special Reliefs
• Total amount of Income ( Gesamtbetrag der
  Einkünfte)
• - Losses carried back or forward ( 10d EStG)
• - other deductible expenses or reliefs
• Taxable Income ( zu
  versteuerndes Einkommen)

29
Off-setting losses (Verlustausgleich) see 2 (3) EStG horizontal within one source of income vertical among different sources of income
Carrying losses to other periods (Verlustabzug) see 10d EStG carry back Verlustrücktrag carry forward Verlustvortrag
30
Compensation of Losses
Off-setting losses is prohibited in special
cases (i.g. 15b EStG) Check Is the
investment project designed as a model for
the main purpose of saving taxes ? Does the tax
benefit exceed the original investment ?
31
Carrying losses back 10d Abs. 1 EStG

• Losses exceeding the total amount of income (
  Gesamtbetrag der Einkünfte) in one period shall
  be carried back to last year.
• The tax payer can opt for the carry forward
  method instead.
• The limit for carrying losses back amounts to
  511.500 (1,023,000 for married persons).

32
Carrying losses forward 10d Abs. 2 EStG

• Remaining losses shall be carried forward in 2
  steps
• (1) unlimited deduction up to 1 mill. ( 2 mill.
  for
• married persons), and in case of remaining
  losses
• (2) limited deduction up to 60 of the remaining
  total
• amount of income

33
Ways of levying income tax
Withholding Tax on income from employment
(Lohnsteuer)
Withholding Tax on income from capital
investments (Kapitalertragsteuer)

• Assessment Each tax payer is assessed according
  to the amount of his/her taxable income (after
  handing in a tax return)
• Certain other income is taxed by means of
  Withholding at Source. Individuals only receiving
  income from employment can hand in a tax return
  (option). In the case Withholding Tax exceeds the
  amount of standard income tax according to the
  tariff rate, the difference shall be refunded to
  the tax payer.

34
Individual and Joint Assessment
Assessment

• Although, each tax payer is assessed according to
  his/her taxable income, there is an exception for
  married couples.
• If husband and wife are both German reseidents
  they may elect the joint assessment
  (Zusammenveranlagung). In this case the income
  splitting system applies according to 26 and
  32a para. 5 EStG ( tax on ½ joint income 2).

• in accdordance to individual income
• (Einzelveranlagung)

(b) in accordance to joint income of
married couples
(Ehegattenveranlagung)
35
Assessment per person and per married couple
Alternative I Alternative II Tax per person (A) Tax per couple (B)
Mr. Merkel 0 47,000
Mrs. Merkel 94,000 47,000
Joint income 94,000 94,000
Sum of taxes per person ?
Joint taxes for couple ?
36
Assessment per person and per married couple
Mr. Merkel Mrs. Merkel Tax per person (A) (sum) Tax per couple (B) (splitting)
Income A 47,000 47,000
Tax per person (basic) 11,644 24.7 11,644 24.7 23,288 23,288
Income B 0 94,000
Tax sum (basic table) 0 31,296 33.3 31,296
Joint Tax (splitting table) 23,288 24.7 23,288
Advantage 8,008