German “Check-the-Box-Option” for Partnerships

The Ger­man In­come Tax Mo­der­niza­tion Act (Ge­setz zur Mo­der­ni­sie­rung des Körper­schaft­steu­er­rechts) in­tro­du­ced the cor­po­rate in­come tax op­tion un­der Sec­tion 1a Cor­po­rate In­come Tax Act. This op­tion enab­les com­mer­cial part­nerships and part­nership com­pa­nies to opt to be ta­xed as if they were cor­po­ra­ti­ons for busi­ness years be­gin­ning af­ter 31 De­cem­ber 2021 wi­thout chan­ging their struc­ture un­der ci­vil law.

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The Fe­deral Mi­nis­try of Fi­nance com­ments in de­tail on the ap­pli­ca­tion of Sec­tion 1a Cor­po­rate In­come Tax Act in a let­ter da­ted 10th No­vem­ber 2021 (BMF-let­ter Ref. IV C 2 - S 2707/21/10001 :004; only avail­able in Ger­man lan­guage) and ad­dres­ses the fol­lo­wing as­pects, among others:

Personal Scope of Application of the Corporate Income Tax Option

Tra­ding part­nerships and part­nership com­pa­nies (such as Ger­man OHG and KG) are eli­gi­ble to ex­er­cise the op­tion. Ac­cor­ding to the Fe­deral Mi­nis­try of Fi­nance, this also ap­plies if a pu­rely as­set-ma­na­ging ac­tivity is car­ried out.

The op­tion is also open to com­pa­nies of for­eign le­gal form that cor­re­spond to a Ger­man part­nership ac­cor­ding to the com­pa­ri­son of le­gal ty­pes. The pre­re­qui­site for the op­tion is that the for­eign com­pany is sub­ject to a tax com­pa­ra­ble to Ger­man cor­po­rate in­come tax (sec­tion 1a pa­ra­graph 1 sen­tence 6 Cor­po­rate In­come Tax Act). Com­pa­nies with their re­gis­te­red of­fice and cen­tral ad­mi­nis­tra­tion ab­road can also opt for cor­po­ra­tion tax and are then sub­ject to cor­po­ra­tion tax on their do­mestic in­come.

The exis­tence of the per­so­nal re­qui­re­ments for the op­tion du­ring the ent­ire ta­xa­tion pe­riod must be pro­ven upon re­quest of the tax aut­ho­ri­ties for each year wi­thin the scope of the cor­po­rate in­come tax re­turn. If the proof is not pro­vi­ded, the tax aut­ho­ri­ties as­sume that the per­so­nal pre­re­qui­si­tes for the op­tion did not exist in the re­le­vant fi­nan­cial year.

Application

The ex­er­cise of the op­tion is only pos­si­ble upon ap­pli­ca­tion to the tax of­fice lo­cally re­spon­si­ble for the se­pa­rate and uni­form de­ter­mi­na­tion of the part­nership's in­come. The ap­pli­ca­tion must be sub­mit­ted in ac­cor­dance with the of­fi­ci­ally pre­scri­bed data re­cord. Proof must be pro­vi­ded that the re­qui­red num­ber of part­ners have agreed to the ex­er­cise of the op­tion.

Please note: An ap­pli­ca­tion form and fur­ther de­tails can be found on the Web­site of Ger­man Bun­des­zen­tral­amt für Steu­ern (in Eng­lish).

The ap­pli­ca­tion must be re­cei­ved by the tax aut­ho­rity at least one month be­fore the be­gin­ning of the busi­ness year from which the op­tion is to ap­ply. In the case of a busi­ness year with the same ca­len­dar year, the ap­pli­ca­tion must the­re­fore be sub­mit­ted no la­ter than 30th No­vem­ber of the pre­ce­ding year. This also ap­plies to newly es­ta­blis­hed com­pa­nies. It is not pos­si­ble to file an ap­pli­ca­tion be­fore the com­pany is es­ta­blis­hed, so that an op­tion for the first busi­ness year of a com­pany is ex­clu­ded.

Af­ter the ap­pli­ca­tion has been fi­led, the tax aut­ho­rity sum­ma­rily ex­ami­nes whe­ther the le­gal re­qui­re­ments for the ap­pli­ca­tion are met. If the ap­pli­ca­tion is gran­ted, the com­pany is no­ti­fied of a cor­po­rate tax num­ber. In con­trast to the no­ti­fi­ca­tion of the cor­po­rate tax num­ber, a ne­ga­tive de­ci­sion is a con­testable ad­mi­nis­tra­tive act.

The ap­pli­ca­tion is ir­re­vo­ca­ble. No fur­ther ap­pli­ca­tion is re­qui­red for sub­se­quent busi­ness years. An ap­pli­ca­tion fi­led late is in­va­lid and does not au­to­ma­ti­cally count as an ap­pli­ca­tion for the next busi­ness year.

Transition to Corporate Taxation

The tran­si­tion to cor­po­rate ta­xa­tion is con­side­red a change of le­gal form. Thus, for in­come tax pur­po­ses, an ac­qui­si­tion and dis­po­sal tran­sac­tion is deemed to have ta­ken place, which may be tax-neu­tral un­der the pro­vi­si­ons of sec­tion 20 Re­or­ga­niza­tion Tax Act. The per­so­nal re­qui­re­ments for the ap­pli­ca­tion of the Con­ver­sion Tax Act must be ful­fil­led by the com­pany and the in­di­vi­dual share­hol­ders on the tax trans­fer date at the la­test. If this is not the case for in­di­vi­dual part­ners, the built-in gains in the busi­ness as­sets of the part­nership must be dis­clo­sed.

A tax-neu­tral (fic­ti­tious) change of le­gal form also re­qui­res the trans­fer of the (eco­no­mic) ow­nership of all func­tio­nally es­sen­tial busi­ness as­sets, which also in­clude those in the spe­cial busi­ness as­sets of the in­di­vi­dual part­ners.

The con­ver­sion date is the end of the fi­nan­cial year im­me­dia­tely pre­ce­ding the fi­nan­cial year in which the op­tion is ex­er­ci­sed for the first time (sec­tion 1a pa­ra­graph 2 sen­tence 3 Cor­po­rate In­come Tax Act). The­re­fore, in ad­di­tion to an ope­ning ba­lance sheet, a clo­sing ba­lance sheet for tax pur­po­ses must be pre­pa­red for the opting com­pany for the last le­gal se­cond of the pre­vious year and a cor­po­ra­tion tax re­turn and, if ap­plica­ble, a trade tax re­turn must be sub­mit­ted.

Since the ex­er­cise of the op­tion is deemed to be a fic­ti­tious change of le­gal form, a blo­cking pe­riod vio­la­tion can be trig­ge­red with re­gard to va­rious tax-re­la­ted cir­cum­stan­ces (e.g. in the case of a pre­ce­ding trans­fer of a busi­ness, par­tial busi­ness or co-en­tre­pre­neu­rial share wi­thin a pe­riod of five years wi­thout dis­clo­sure of built-in gains.

Fur­ther­more, it should be no­ted that trade tax los­ses that can be car­ried for­ward, los­ses car­ried for­ward by the part­ners as li­mited part­ners as well as in­te­rest and EBITDA car­ried for­ward for pur­po­ses of re­gu­la­ti­ons re­gar­ding in­te­rest bar­riers are lost as a re­sult of the op­tion.

Tax Consequences for the Partnership

The op­ted com­pany is trea­ted like a cor­po­ra­tion for in­come tax pur­po­ses. The­re­fore, the pro­vi­si­ons of the Cor­po­rate In­come Tax Act, In­come Tax Act, Trade Tax Act, So­li­da­rity Surch­arge Act, For­eign Tax Act and Re­or­ga­niza­tion Tax Act ap­ply in par­ti­cu­lar. For the pur­po­ses of the ap­pli­ca­tion of dou­ble ta­xa­tion trea­ties, the opting com­pany also ful­fils the re­qui­re­ments of a cor­po­ra­tion un­der treaty law.

The sale of the sha­res in the opting com­pany or a tran­sac­tion equi­va­lent to a sale wi­thin se­ven years af­ter the con­ver­sion date con­sti­tu­tes a lock-up pe­riod vio­la­tion and re­troac­tively trig­gers a ta­xa­tion of built-in gains, in­so­far as the fic­ti­tious change of le­gal form took place at book or in­te­rim va­lues.

Tax Consequences for Partners

At the share­hol­der le­vel, pro­fit sha­res are only con­side­red dis­tri­bu­ted when they can be wi­th­drawn or their pay­ment can be de­man­ded (sec­tion 1a pa­ra­graph 3 sen­tence 5 Cor­po­rate In­come Tax Act). The de­cisive fac­tor is the­re­fore the pos­si­bi­lity of pro­fit wi­th­dra­wal un­der com­pany law, so that pro­fit sha­res whose pay­ment the share­hol­der can de­mand with the ad­op­tion of the an­nual fi­nan­cial state­ments are deemed to have been dis­tri­bu­ted at that time. If, for ex­am­ple, a se­pa­rate re­so­lu­tion is re­qui­red for pay­ment or wi­th­dra­wal, this is ge­ne­rally not yet a fic­ti­tious dis­tri­bu­tion. At the time of the dis­tri­bu­tion, the opting com­pany must de­clare and pay ca­pi­tal gains tax.

In­come re­cei­ved by the share­hol­der for his work in the ser­vice of the com­pany, which is to be as­ses­sed as ap­pro­priate, leads to in­come from em­ploy­ment.

Termination of the Corporate Income Tax Option

A re­turn of the com­pany to trans­pa­rent ta­xa­tion is pos­si­ble eit­her by ope­ra­tion of law or at the re­quest of the com­pany. The ap­pli­ca­tion for re­ver­sion must be sub­mit­ted at the la­test one month be­fore the be­gin­ning of the fi­nan­cial year in which the com­pany is no lon­ger to be ta­xed as a cor­po­ra­tion. The op­tion is ter­mi­na­ted by ope­ra­tion of law if, among other things, the per­so­nal re­qui­re­ments for the op­tion cease to ap­ply.

A re­troac­tive ef­fect for con­ver­sion tax pur­po­ses is ex­clu­ded in all ca­ses of ter­mi­na­tion of the op­tion. If the fic­ti­tious change of le­gal form has ta­ken place at book or in­te­rim va­lues when the op­tion was ex­er­ci­sed, the re­ver­sal op­tion or other ter­mi­na­tion of the op­tion wi­thin se­ven years leads to a blo­cking pe­riod vio­la­tion and thus to re­troac­tive ta­xa­tion of built-in gains.