Germany does not have a consistent nationwide tax rate for companies. For corporations, the average overall tax burden is just below 30 percent, with certain local municipalities offering significantly lower rates still. Hence, Germany offers one of the most competitive tax systems of the big industrialized countries.
Components of Company Taxation
Companies are usually taxed on two levels:
1. Corporations - such as the limited liability company (GmbH) or the stock corporation (AG) - are subject to corporate income tax (Körperschaftssteuer), whereas partnerships are subject to personal income tax (Einkommenssteuer). Both taxes are levied by the federal government.
- Corporate Income Tax for Corporations
- Personal Income Tax for Partnerships
2. All business operations - corporations and partnerships alike - are subject to the trade tax (Gewerbesteuer), which is imposed by local municipalities (i.e. the town or city where the company is based).
- Trade Tax for all business operations
As a result of the fixed and variable components, the overall tax burden can differ by up to 10 percent between locations.
Corporate Income Tax for Corporations
Companies Liable to Corporate Income Tax
Corporate companies, such as the limited liability company (GmbH) or the stock corporation (AG), based in Germany or with an executive board in Germany are liable to corporate income tax on globally generated income. Dividends that have been generated and taxed abroad may be exempt from taxation in Germany or taxes paid in a foreign country can be offset against taxation in Germany.
Corporate companies who are not based in Germany nor have an executive board in Germany are only liable to corporate income tax on income generated inside Germany (e.g. via a permanent establishment, dividends or licenses).
Corporate Income Tax Base
Taxable income (i.e. annual business profit) forms the tax base for corporate income tax. Under German commercial law, corporate company annual profit is calculated according to the accrual basis accounting method. This is recorded in the annual financial statement and forms the basis for determining taxable income.
However, German tax law provides different accounting options and income correction rules, meaning that the taxable income usually differs from the annual profit determined in the financial statement under commercial law.
Corporate Income Tax Rate
Corporate income tax is levied as a flat nationwide tax at a rate of 15 percent of taxable corporate income.
In addition a solidarity surcharge (Solidaritätszuschlag) is added on top of the corporate income tax. The solidarity surcharge was introduced in 1995 to finance German reunification. The surcharge is 5.5 percent of the 15 percent corporate income tax; creating a total of 0.825 percent of taxable income.
Thus, corporate income tax and solidarity surcharge add up to a total of 15.825 percent.
Taxation of Dividends
If a German subsidiary company distributes profits to its foreign parent company (a dividend payment) then a 25 percent rate of withholding tax (Kapitalertragssteuer) is payable in Germany.
In the event of the existence of a double taxation agreement (DTA) between the Federal Republic of Germany and another country, the rate of withholding tax that is paid can be reimbursed according to the agreements made in the corresponding DTA.
As a rule, dividend payments on the basis of a DTA are taxed at a reduced rate of taxation at levels of just 5, 10 or 15 percent. At a partial level there is also the possibility of an initial exemption from withholding tax.
The withholding tax paid in Germany can also be credited against the tax liability of the parent company which exists abroad or the parent company is made exempt from the taxation in regard to the received dividends. In effect, this means that no double taxation takes place.
As a rule, two fifth of the withholding tax paid can be reimbursed if the creditor of the dividend-paying German corporation is a foreign corporation and if there is no DTA between Germany and the foreign nation.
Within the EU, dividend payments between a corporate domestic subsidiary company and a corporate foreign parent company are tax-free over and above a 10 percent stake.
Profits which are distributed to private stock-holders are liable to a final withholding tax (Abgeltungssteuer) of 25 percent plus the solidarity surcharge. The final withholding tax is retained by the debtor of the dividend or the institution managing the deposit (for instance a bank) and then paid to the tax office. However, the application of a DTA may lead to a lower withholding tax if the private stockholder resides in another country.
Personal Income Tax for Partnerships
Companies Liable to Personal Income Tax
Partnerships such as the civil law partnership (GbR), the general commercial partnership (oHG) or the limited partnership (KG) are not separate legal entities but associations of partners, with the partners themselves generally being subject to all rights and obligations. Accordingly, partnerships are not subject to corporate income tax (Körperschaftssteuer) but to personal income tax (Einkommenssteuer), with the individual tax rate applicable to each shareholder.
Personal Income Tax Rates
The personal income tax rate starts at:
• 14 percent for an annual income exceeding the tax-free allowance of EUR 8,652.
• It rises progressively to a maximum personal income tax rate of 42 percent which is applicable to annual income of EUR 53,666 or more.
• An increased tax rate of 45 percent applies to every euro in excess of earnings of EUR 254,446 per year.
These tax rates also apply for personal income tax for employees.
As with corporate income tax, the solidarity surcharge is also added to personal income tax. Accordingly, the solidarity surcharge is 5.5 percent of the individual personal income tax rate of every partner. If a partner has an individual income tax rate of 30 percent, the combined personal income tax + solidarity surcharge burden on the partner’s share in the profits would add up to 31.65 percent.
Harmonizing Corporation and Partnership Tax Rates
Generally, distributed and retained earnings of partnerships are subject to personal income tax with progressively rising tax rates. In order to reduce the tax burden for partnerships (making it similar to the tax burden of corporations), two options exist for partnerships:
- To avoid a progressively rising personal income tax rate, partnerships can apply for a flat taxation rate of 28.25 percent plus solidarity surcharge on retained earnings - leading to a flat taxation rate of 29.8 percent equaling the tax burden for corporations. (If retained earnings (taxed according to flat taxation) are distributed to partners at a later date, the distributed earnings are, under certain conditions, subject to a subsequent taxation rate of 25 percent.)
- Trade tax payments for both distributed and retained earnings can be offset against personal income tax. Please refer to our chapter on trade tax for more information.
- Trade Tax
Companies Liable to Trade Tax
All commercial business operations in Germany are liable to pay trade tax (Gewerbesteuer) irrespective of their legal form.
The trade tax is set by local authorities which means it can vary from one municipality to the next. However, trade tax is generally the same rate for all businesses within one municipality. Trade tax in Germany is currently set at between 7 and 17 percent.
Determining the Trade Tax Rate
The corresponding rate of trade tax depends on two components:
- The tax base rate (3.5 percent throughout Germany)
- The multiplier (Hebesatz) stipulated individually by every municipality
The taxable income of the company is multiplied with the tax base rate (3.5 percent) which results in the so-called tax base amount. The tax base amount is then multiplied with the corresponding municipal multiplier; which results in the sum total of trade tax which is due.
The multiplier is set by each municipality. On average, it is between 350 and 400 percent but may not total less than 200 percent. There is no upper limit for the municipal multiplier. It is generally higher in urban areas than it is in rural areas, although it does currently not total more than 490 percent in any of the large cities.
Partnerships have an annual tax free allowance for trade tax of EUR 24,500.
The solidarity surcharge is NOT levied on trade tax.
Offsetting Trade Tax against Personal Income Tax
Offsetting Trade Tax against Personal Income Tax
Partnerships can offset some of the trade tax they pay against personal income tax - to the total of 3.8 times the trade tax base amount.
This means that there is in effect no trade tax burden for partnerships in municipalities with a multiplier of under 380 percent. Trade tax still has to be paid to the municipality. However, it can be offset against the personal income tax.