BUSE lawyers tax consultants
Change in the taxation of partnerships. Government draft law for the modernization of corporate tax law passed: Commercial companies have the right to vote in corporate taxation.
June 15, 2021
BUSE lawyers tax consultants
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On March 24, 2021, the federal government passed a draft law to modernize corporate tax law. The legislative process should already be completed in the current legislative period. Surprisingly, the draft of the Corporate Tax Law Modernization Act contains, among other things, an option for partnerships to corporation tax. This should come into force from the assessment period 2022, but the application must be submitted to the tax office before the start of the financial year. Since applications are only possible after the law has come into force, action is likely to be required in the short term if the option is to be exercised for a financial year beginning January 1, 2022. Therefore, partnerships and their partners should check in good time whether they want to make use of the option, regardless of the ongoing legislative process. There are a few points to consider.
Partnerships are so far subject to trade tax on their profits, but not to corporation tax. Instead, the shareholders are subject to income tax or corporation tax on their share of the profits, depending on their legal form (so-called “transparent taxation”). This applies regardless of whether their profit share was distributed or reinvested to strengthen the equity of the partnership. Corporations (e.g. German limited liability companies and stock corporations), on the other hand, are subject to trade tax and corporation tax on their profits, but their shareholders are only taxed after dividends have been paid out. Although the corporate income tax rate of 15% is significantly lower than the personal income tax rate (up to 45%), the overall tax rate on distributed profits is similar for partnerships and corporations. This is achieved by offsetting trade tax against the income tax of partners in partnerships on the one hand and the reduced tax rate for dividends (final withholding tax) on the other. The situation is different with retained earnings: as long as a corporation retains profits, the overall tax rate is lower than that of a partnership, since the shareholders are only taxed after the dividend has been paid out. Thus, companies enjoy a cash flow advantage as long as profits are retained.
In order to eliminate this disadvantage of partnerships, the so-called Brühl recommendations already contained an option model 20 years ago. Instead, the legislature had only included an optional favorable tax rate for profits retained in the partnership (Section 34a EStG) in the comparatively complex and sometimes disadvantageous law. Even if the timing is surprising, the federal government now apparently intends to legally implement the possibility of largely equal taxation of partnerships and corporations.
For which partnerships is an option interesting?
The option model is of interest to all partnerships whose investment and cash flow planning is based on self-financing through retained earnings. In the case of partnerships that regularly distribute their profits to partners, it usually makes more sense to maintain transparent taxation. If profits are to be partially retained and partially distributed, a model calculation that is as accurate as possible is worthwhile.
In addition, partnerships that plan to retain profits should also carefully examine the advantages and disadvantages of exercising an option and make the necessary preparations. The following points can be decisive:
- Does the structure of the partner accounts fit? Profits that are credited to shareholder loan accounts and can be called up at any time are deemed to have been distributed according to the draft law. If necessary, the articles of association must be adapted.
- Does exercising the option result in taxation of unrealized capital gains? Exercising the right to choose is to be regarded as a change of form within the meaning of the Transformation Tax Act. Such a change of legal form can in principle take place without profit or loss. However, this is not always the case. It is possible that the business assets of the shareholders that are connected to the company (so-called special business assets) must first be restructured.
- Are there any investments in foreign corporations? It is possible that withholding taxes on dividends from foreign corporations can no longer be offset against German tax after exercising the option.
- Are there any trade tax loss carryforwards? Your fate when exercising the option is so far unclear.
Important: Exercising the right to choose should not have any impact on the inheritance and gift tax classification of the partnership. This is important because the inheritance and gift tax advantages for business assets are tied to stricter requirements for corporations than for partnerships. In addition, after exercising an option, there is the possibility of reverting to transparent taxation with effect for the future, whereby this applies as a renewed change of legal form for tax purposes.
The content of this article is intended to provide general guidance on the subject. Expert advice should be sought regarding your specific circumstances.
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