Tax System

Overview

German tax are rates are competitive in comparison with other countries. The peak tax rate for personal income is principally 42 %. The corporation tax applicable to corporations has been reduced to 15 % lately. .

The Most Important Taxes for Investors

The German tax system is very balanced. The most important taxes are the income tax levied on every citizen’s income, and the company taxes based on corporations revenues. There are also other taxes such as excise taxes on mineral oil or tobacco, for example, as well as sales tax, real estate transaction tax, and the trade tax charged directly by the municipalities.

Income Tax

Every citizen who has a main place of residence in Germany or lives primarily in Germany is liable to pay income tax. If an individual spends more than six months of the year in Germany, Germany is regarded as the main place of residence. In this case the individual principal is obliged to pay tax on all income earned around the world, regardless of whether this comes from wages of salary, interest, or dividend payments. Citizens who live abroad all or most of the time have limited tax obligations. In these cases, only domestic income and investment income must be taxed.

The tax rate progresses linearly form the lowest rate of tax up to the highest rate. EUR 8,004.00 per year currently is fully exempt from income tax. The first EUR above this line is taxed at 14 %. The tax rate then increases in small steps up to the maximum rate of 42 %, which is applied to earnings of EUR 52,842.00 or more. The tax rate for taxable income exceeding EUR 250,731.00 is 45 %.

As a result of the unification of the Federal Republic of Germany and the German Democratic republic in 1990, Germany took on enormous financial responsibilities. A solidarity surcharge was therefore introduced in 1995 to finance German unification. The surcharge is 5,5 % on the income tax amount assessed.

Corporation Tax

Companies in Germany are usually taxed on two levels. Corporations such as the stock corporation (AG) and limited liability company (GmbH) are subject to corporation tax, which is levied by the federal government. In addition, cities and communities impose a municipality charge, the trade tax.

There is a standard corporation tax rate of currently 15 % for both a company’s retained (undistributed) profits and its distributed profits.

However, if profits are distributed to shareholders, the shareholders must in turn pay income tax on these profits. Before amendment the “partial-income system” is used to reduce this double taxation burden. In this procedure the shareholder only has to pay further taxation on 60 % of the dividends and profit payouts. As a result, after pay out to the shareholder only this 60 % is subject to income tax, whereas the other 40 % remains tax-free.

If the corporate share is part of the private property of a person a final withholding tax (Abgeltungssteuer) with a rate of 25 % applies, which is considerably lower than normal income tax of up to 45 %. However, profit payouts are fully subject to that rate of 25 %, the partial income system does not apply.

The solidarity surcharge is also levied on corporation tax.

Trade Tax

All business operations acting in Germany are subject to trade tax. Business operations include independent activities that aim to achieve profits over the long term, and thus also include corporations, in particular. Independent freelancers such as doctors, architects, lawyers, or artists are exempt from the charge. For natural persons running a business and for partnerships there is a tax-free allowance of EUR 24,500.00.

The tax is calculated on the basis of the operating profit, which is determined based on the company’s profit using a legally specified calculation method.

However, the actual level of trade tax depends significantly on the municipality in which the business operations are located. Each municipality must define a municipal multiplier (Hebesatz), by which the trade tax determined according to the statutory tax rate is multiplied. This multiplier is at least 200 % by law, and in conurbations in particular, can rise to more than 400 %.

Real Estate Tax

Anyone who owns land in Germany must pay real estate tax. The amount of tax depends on the value of the land and the buildings erected on it. However, the amount is often calculated not on the basis of the market value of the real estate but on a value that is usually much lower. Real estate tax is defined by the municipalities and is usually between one and two percent of the defined real property value. This charge can also be set off against tax.

Real Estate Transfer Tax

When real estate is sold or changes owner, a real estate tax of 3.5 % of the purchase price is levied as of a consideration of over EUR 2,500.00. This tax is usually paid by the buyer. The rate of 3,5 % applies in Bavaria and most other states.

Value Added Tax

Value added tax (VAT) is not a tax on companies, because it is only paid by the end user of a product or service. The normal VAT rate of 19 % is just under the European average. A lower rate of seven percent is charged for goods and services needed on a day-to-day basis, such as food, newspaper or public transport. Some services such as banking services, healthcare professions or non-profit making work are VAT-exempt. The official German name for VAT is Umsatzsteuer, but it was originally called Mehrwertsteuer and is still often referred to by this name.

Companies must add VAT to their prices. They have to transfer the VAT received to the tax authority. The VAT the company pays itself when purchasing goods or services can be offset against the claim of the tax authority return (Vorsteuerabzug). In practice, companies also occasionally pay out more VAT that they receive. This is often the case in the start-up phase, for example, when expenditure is high, but income is still low. In these cases, the tax authority refunds the excess tax paid.

Trade within the European Union is free from customs and other restrictions. However, a few rulings must be borne in mind with regard to VAT: When goods or services are sold to private consumers in other member states, the VAT for a delivery from Germany is included on the invoice in the same way as for deliveries within Germany, and is collected and transferred to the tax authority. The foreign consumer therefore pays the German supplier the price including VAT, and the vender then transfers the VAT to the German tax authority. In the case of imports from countries that also charge VAT, however, no German VAT needs to be paid. The German consumer only pays the purchase price including (foreign) VAT to the foreign importer, which then pays the VAT in its home country.

Goods imported from non-EU states, on the other hand, are liable to VAT. The rate of import turnover tax is also 19 % and is paid to the customs authority. However, the import turnover tax on goods imported from non-EU states can be deducted as input tax (Vorsteuer) by the tax authority if the company sells the goods on. A prerequisite for this is that the company has the necessary import documents with customs proof of payment (e.g. the import declaration). Exports are exempt from VAT.

Legal System

Having Rights

A reliable framework of underlying conditions is one of the most important factors for business success. This is often understood to be merely fair dealings with partners and customers. However, a legal system that protects the rights of individuals and helps them to enforce these rights is just as important.

Germany is a modern constitutional state. The systematically structures and balanced legislation creates security, because it uses transparent decision criteria that can be understood by all. The German legal system is a model for legal systems in many other countries.

Enforcing Rights

It is not enough to have rights, if you are not able to enforce them effectively. This is guaranteed in the Federal Republic of Germany. The judiciary is effective and efficient. Every second action is settled by the courts within three months. Costs can be calculated, because they depend on the value of the claim involved, and fee regulations make the costs of legal advice clear. In no other country in the world court orders to safeguard industrial property protection are effected as quickly. Entry in the land register kept by the relevant court, needed for the purchase of real estate, can also be ensured very quickly in advance by means of a provisional entry.

One example of the advantages of German law is the liability rulings for companies. In contrast to other countries, actions for damage that could threaten a company’s existence are sarcely conceivable, as in Germany, compensations orders are not awarded as punishment (no punitive damages).

Reliable laws enable companies to plan their investment initiatives effectively. Positive administrative decisions in licensing procedures provide a secure base for starting building work or operating plants. Objections can usually be raised against negative decisions, and in these cases, the next more senior authority decides; ultimately there is the option of a lawsuit.

The Courts

Ordinary Courts

The ordinary courts hear civil and criminal disputes. The cases usually go to the local court. A right of appeal is usually permitted against initial decisions, and in this case, higher courts up to the level of the Federal Court of Justice (Bundesgerichtshof) settle the case.

Labor Courts

The labor courts are responsible for disputes arising from industrial relations, in particular those relating to collective bargaining agreements or the termination of contracts of employment. A right of appeal against judgments by the labor courts is possible up to the level of the regional labor courts and the federal labor court.

Administrative Courts

The legal system protects citizens and companies from arbitrary or incorrect decisions by the authorities. Those affected by administrative decisions may seek legal protection from the administrative courts. A right of appeal is permitted against decisions of the courts of first instance.

Fiscal Courts

The fiscal courts decide on disputes relating to taxes and charges that are subject to federal legislation, and in the case of an appeal, the dispute is taken to the federal finance court.

European Court of Justice

The task of the European Court of Justice, located in Luxembourg, is to ensure the standardized application of European law. In legal disputes in member state courts that relate to the validity or correct application of European law, arising controversies with respect to these questions are resolved by the European Court of Justice.

EU citizens or companies can also bring an action directly to the Court of First Instance of the European Court of Justice against a decision by a European Community body, if the decision is directed against them directly or if they are directly and individually affected by it.

However, the European Court of Justice is not a court of appeal against decisions made by member state courts, and is not able to reverse these decisions.