2. Introduction to German Tax System and Income Tax Topics : System of Income Tax (EStG) and Tax...

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

Prof.Dr. von Wuntsch - Spezielle Probleme der Einkommensteuer

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).


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


Direct Taxes = tax payer and tax debtor is identical

Income Tax

Corporation Tax

Trade Tax

Einkommensteuer (ESt)

Körperschaftsteuer (KSt)

Gewerbesteuer (GewSt)


Indirect Taxes= Tax Payer and Tax debtor are not identical

Value Added Tax Umsatzsteuer (USt)


Tax Revenue 2006 in Germany (bn €)

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


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


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 %


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 (Einkommensteuerrichtlinien)


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


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 EStGSum of income (of an individual)- Special reliefs (i.g. for elder people)Total amount of income (= Gesamtbetrag der Einkünfte)


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)


Income = Net Income = EinkünfteGross 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


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!


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


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 !


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).


Income from source (3) § 15 EStG

All business and trade income is subject to trade tax !


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


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)


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


Profit determination - §§ 4 (1) and 5 (1) EStG

Comparison of business property = Profit

+ Withdrawals from business

(Entnahmen)

- Value of contributions

(Einlagen)

= taxable Profit


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.


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 !


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)


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

Compensation of LossesTopics:

(a) Off-set losses within each or other sources of income (§ 2 para. 3 ESG)

(b) Carrying losses back and/or forward (§ 10d EStG)


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)


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


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 ?


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).


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


Ways of levying income tax

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.

Withholding Tax on income from employment (Lohnsteuer)

Withholding Tax on income from capital investments (Kapitalertragsteuer)


Individual and Joint 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).

Assessment

(a) in accdordance to individual income

(Einzelveranlagung)

(b) in accordance to joint income of married couples

(Ehegattenveranlagung)

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

?


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)

11,64424.7 %

11,64424.7 %

23,288 23,288

Income B 0 94,000

Tax sum (basic table)

0 31,29633.3 %

31,296

Joint Tax(splitting table)

23,288

24.7 %

23,288

Advantage 8,008Prof.Dr. von Wuntsch - Spezielle Probleme der Einkommensteuer

2. Introduction to German Tax System and Income Tax Topics : System of Income Tax (EStG) and Tax...

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