Germany, with Berlin as the beating heart of young entrepreneurs, is a vibrant place in the European and worldwide start-up scene. Besides other factors, this can be explained by the, in comparison to other industrial countries, competitive tax system which is applicable for companies in Germany. The following paragraphs should provide an overview of the German tax system and its rules which are most relevant for start-ups and their employees.
Besides taxes on corporate income, a start-up has to consider the tax consequences resulting from the value added tax (VAT) regime in Germany. The value added tax, measured on its total annual amount, is the most important tax levied in Germany.
Finally, personal income tax consequences for individuals working for a start-up should be considered.
Start-ups in Germany are mainly established as corporations in the legal form of a limited liability company (GmbH). Corporations with corporate seat or place of management in Germany are liable to corporate income tax as tax residents on their worldwide income, unless otherwise provided in tax treaties.
Non-resident corporations having neither seat nor place of management in Germany are liable to corporate income tax only with their German source income generated inside Germany (e.g. through a permanent establishment).
The taxable income of corporations is based on the annual financial statements prepared under German generally accepted accounting principles (GAAP), subject to numerous adjustments for tax purposes.
Furthermore, municipalities impose a trade tax on income. For purposes of this tax, the taxable income for corporate income tax purposes is subject to certain adjustments.
The corporate income tax rate in Germany, which is applicable on the taxable income of the enterprise, is 15 %. A 5.5% solidarity surcharge is imposed on corporate income tax, resulting in an effective tax rate of 15.825%.
The average effective trade tax rate amounts to approximately 14%. If a company operates in several municipalities, the trade tax base is allocated according to the payroll paid at each site.
Taking into account the various municipality multipliers, the combined average tax rate for corporations (including corporate income tax, solidarity surcharge and trade tax) is flat and ranges from approximately 23% to 33%.
Annual corporate income tax and trade tax returns must be filed by 31 May (31 July for financial years starting 2018 and after) of the year following the tax year. Typically the tax year is the calendar year though a fiscal year end deviating from the calendar year is also common for German companies. An extension of the filing deadline to 31 December of the year following the tax year (28/29 February of the second year following the tax year for financial years starting 2018 and after) is granted if a licensed tax advisor prepares the return.
Prepayments of corporate income tax as well as trade tax with respect to the estimated tax liability are made in quarterly instalments and are usually determined by the tax amount due for the previous year.
The taxable income is the tax base for corporate income tax. The taxable income is determined starting with the annual business profit or loss in the financial statements of the company prepared under German GAAP. The annual income or loss from the financial statements is subject to income adjustments following special tax accounting rules and further adjustments relating to e.g. non-deductible business expenses tax or the application of tax exemption rules for certain types of income. Consequently, the taxable income regularly differs from the annual business profit in the financial statements.
Typical income adjustments for tax purposes are the following:
After income for tax purposes has been determined, certain adjustments need to be made to calculate taxable income. Major adjustments include the following non-deductible expenses:
Further adjustments of the tax base have to be made for trade tax purposes. The major adjustments include a 25% add-back of interest expenses with respect to debt, a 6.25% add-back of license payments, a 5% add-back of lease payments for movable assets and a 12.5% add-back of lease payments for immovable assets.
Dividends and capital gains (from sales of corporate shares) received by resident corporations and branches of nonresident corporations from their German and foreign corporate subsidiaries are generally exempt from tax. 5% of such dividends and capital gains will be treated as non-deductible business expenses (i.e. taxation of dividends received at an effective tax rate of 1.5%). Certain requirements apply to participate in the tax exemption.
Capital losses from sales of shares or write-downs on shares are not deductible.
The possibility to use start-up or formation expenses before the original business activity of the enterprise begins depends on the legal form of the enterprise. As long as the start-up is run by a single person or a partnership, initial expenses would be deductible from the initiator’s personal income tax burden. If the start-up is established in the legal form of a corporation, for example a limited liability company, such a corporation is authorized to use similar expenses incurred after the notarial certification of the statute. No transfer of earlier expenses (i.e. from a pre-incorporation phase) is possible.
Tax losses incurred within the original business activity may be generally carried forward without time limitation.
Under the restrictions of the so-called minimum taxation, only 60% of annual taxable profits in excess of EUR 1 million can be offset by loss carryforwards. As a result, 40% of the portion of profit exceeding EUR 1 million is subject to tax. Both rules apply for both corporate income tax purposes and trade tax purposes. For corporate income tax (not trade tax) purposes, an optional loss carryback is permitted for one year up to the maximum amount of EUR 1 million.
Under the German loss-trafficking rule, tax loss carryforwards (corporate income tax and trade tax loss carryforwards) are forfeited proportionally if, within a five-year period, more than 25% of the shares of a loss-making entity are directly or indirectly transferred to a single new shareholder or a group of shareholders. If, within a five-year period, more than 50% of the shares are transferred, the entire loss carryforward is forfeited. Exceptions apply to the loss-trafficking rule under specific conditions for group restructurings and to the extent sufficient taxable built-in gains are available or under a recently introduced “same business operation” rule.
Loss carryforwards are also generally forfeited in the course of a merger, change of legal form and liquidation of the loss-making company.
German tax law contains a set of rules that allow the adjustment of inter-company transfer prices. All of the measures are based on the arm’s-length principle. Germany has implemented the Authorized Organisation for Economic Co-operation and Development (OECD) Approach (AOA).
Specific documentation rules apply for transfer-pricing purposes. On request of a tax auditor, the taxpayer is required to submit the transfer-pricing documentation within 60 days (in the case of extraordinary business transactions, within 30 days). Non-compliance with these rules may result in a penalty.
The German value added tax system, as a part of the European Union value added tax system, is comparable with the tax systems in the other countries in the EU. A taxable person, for value added tax purposes, is any business entity or individual that independently carries out any economic activity in any place in Germany
VAT is payable on the following transactions:
The amount of tax payable will correspond to the rate applicable to the goods or services supplied. A standard rate in the amount of 19 % generally applies to all supplies of goods or services, unless a specific provision allows a reduced rate or an exemption. A reduced rate in the amount of 7 % applies for example to newspapers and books, cultural services or food.
Besides this exist special tax exemptions for certain transactions. Examples of exempt supplies of goods and services are financial transactions, insurance services, medical services or export deliveries.
A taxable person (entrepreneur) may recover input tax, which is VAT charged on goods and services supplied to it for taxable business purposes (used for taxable (output) services or supplies). Exceptions to this rule exist. A taxable person generally recovers input tax by deducting it from output tax, which is VAT charged on supplies made.
Input tax includes VAT charged on goods and services supplied in Germany, VAT paid on imports of goods and VAT self-assessed on the intra-Community acquisition of goods (see the chapter on the EU) and VAT on purchases of goods and services taxed under the reverse-charge procedure.
A valid tax invoice or customs document must generally accompany a claim for input tax.
Input tax may not be recovered on purchases of goods and services that are not used for business purposes (for example, goods acquired for private use).
Input tax directly related to making exempt supplies is generally not recoverable. If a German taxable person makes both exempt and taxable supplies, it may not recover input tax in full.
If the amount of input tax recoverable in a monthly period exceeds the amount of output tax payable in that period, the taxable person has an input tax credit. The credit is generally refunded.
In general, preliminary VAT returns are filed quarterly (electronically), but monthly returns must be filed if the VAT payable for the preceding year exceeded EUR7.500. Also newly established taxable persons must file monthly VAT returns for the first and second year of registration.
The preliminary VAT return must be submitted by the 10th day after the end of the filing period. The VAT authorities must receive payment in full by the same day. Because the regular filing deadline is relatively short, the VAT authorities allow a permanent one month filing and payment extension on written application. However, taxable persons that must submit monthly preliminary VAT returns must pay a special prepayment equal to 1/11 of the preceding year’s VAT liability by the due date.
In all cases (monthly, quarterly or no preliminary returns), an annual VAT return must be submitted by 31 May of the year following the end of the VAT year. If a German tax advisor is engaged to prepare the VAT returns, the filing deadline is 31 December of the following year.
Non-established businesses, which have no fixed establishment in Germany, generally are not required to register for German VAT if all of its supplies are covered by the reverse-charge procedure (under which the recipient of the supply must self-assess VAT). The reverse-charge procedure does not apply to supplies of goods located in Germany (except supplies of installed goods) or to supplies of goods or services made to private persons.
A German taxable person must generally provide VAT invoices for supplies made to other taxable persons and to legal entities, including exports and intra-Community supplies. This obligation generally does not exist for supplies that are VAT-exempt. Invoices are not automatically required for supplies made to private persons.
Invoices must be issued within six months. Invoices for intra-Community supplies as well as services subject to reverse charge and rendered by taxable persons resident in the EU must be issued within 15 days following the month in which said supplies or services have been rendered.
Taxable persons must retain invoices for 10 years.
A VAT invoice is required to support a claim for input tax deduction or a refund under the EU refund schemes (see above and the chapter on the EU). A VAT credit note may be used to reduce the VAT charged and reclaimed on a supply. It is also possible to cancel an incorrect invoice and issue a revised one.
For intra-Community supplies of goods and exports, the invoice must include the statement that the supply is VAT-free. In addition, the customer’s valid VAT Identification Number (issued by another EU Member State) must be mentioned in the invoice for all intra-Community supplies of goods.
Electronic invoicing in line with EU Directive 2010/45/EU is permit.
There are no specific rules relating to the taxation of the digital economy in Germany apart from, for example, specific rules for the place of the digital service and the Mini One-Stop Shop scheme (MOSS).
Under the EU-wide MOSS regime special rules apply to the place of supply for supplies of telecommunications, broadcasting and electronic services to non-VAT taxable customers. These services are taxed in the country where the consumer is established. EU taxable persons that supply electronic services have to charge VAT to non-taxable persons established anywhere in the EU, using the destination principle. EU suppliers are permitted to discharge their VAT obligations using a Mini One-Stop Shop scheme, which enables them to fulfill their VAT obligations (VAT registration, reporting and payment) in their home country, including for services provided in other Member States where they are not established. Accordingly, EU suppliers are able to apply a simplification measure similar to the one that is in place for non-EU providers of electronic services.
Individual persons, with a domicile or a customary place of abode in Germany, are generally subject to tax on their worldwide income in Germany. In this context means the term “customary place of abode”, that an individual does not stay only temporarily (less than six months in the calendar year) at this place or in this area.
An individual person, who is not resident in Germany, is generally subject to tax only on income derived from German sources.
The German income tax law distinguishes between several categories of income, including income from employment, self-employment, investment, business and real estate. Income from each of the categories may be combined, and overall taxable income is then determined by subtracting special deductions.
In general, annual tax returns must be filed by 31 May of the year following the tax year. However, extensions for filing are granted automatically until 31 December of the year following the tax year if the return is prepared with the assistance of a tax adviser. Nonresidents may file an income tax return only if they have income that is not subject to withholding tax. For example, employers must withhold income tax (known as wage tax) for their employees.
Individual tax rates for 2016 gradually increase from an effective rate of 14% to a marginal rate of 42%. The top rate of 45% applies only if taxable income is EUR 254.447 (EUR 508.894 for married taxpayers filing jointly) or more. A basic tax-free allowance of EUR 8.652 is available for single individuals (EUR 17.304 for married couples filing a joint return). However, income from investment is generally taxed at source with a flat tax rate of 25 %.
To help finance the costs related to German unification, a 5.5% solidarity surcharge continues to be imposed on the income tax liability of all taxpayers. If a German tax resident is a member of a registered church in Germany entitled to impose church tax, church tax is assessed at a rate of 8% or 9% on income tax liability, depending on the location.
Expenditure incurred by an employee to create, protect or preserve income from employment generally is deductible. Income-related deductible expenses include for example the cost of travel between home and workplace or expenses connected with maintaining two households for business reasons (e.g. rent, home trips, per diems and moving costs, to a certain extent). A standard deduction of EUR 1.000 per year for employment-related expenses is granted without any further proof. However, an employee can claim a larger deduction if he or she proves that the expenses actually paid exceed the standard deduction.
There is no need for an approval from the tax authorities for opening a business in Germany. Tax registration is required at the corporate income tax authority of the district in which the start-up is situated. The tax registration number is valid for corporate income tax and the preliminary and annual VAT filings. On receipt of the tax number, application is possible to the Federal Office of Finance in Saarlouis for a VAT Identification Number. This number is used for EU intra-community transactions.
In addition, generally local municipalities require a registration of commercial activities, which have to be registered at the trade office of the respective municipal administration. The trade registration is typically connected to receiving a trade tax number.
If employees receive salaries, an application for a so-called Betriebsnummer is required with the social security authorities, thus the start-up can comply with the wage tax and social security filing obligations.