Tax Policy Demands for Economic Growth in Germany

In recent years, there have been numerous efforts to promote climate protection goals and advance digitalization through tax incentives. One need only recall the proposal for a "climate protection investment premium."

Tax incentives can indeed be an appropriate means for this purpose. However, due to strict EU state aid regulations, they often cannot be implemented in a legally secure manner. For example, in the past, a special depreciation for electric commercial vehicles failed. Additionally, ongoing discussions about possible tax incentives can be counterproductive. Investment decisions by both companies and consumers are postponed due to the uncertain outcome and may then turn out negatively due to price developments.

Family-run businesses rely on long-term planning and need planning security. Therefore, a clear goal communicated to the companies, which economic behavior is promoted by the state, would be desirable. Such a goal should be implemented in regulations valid for several years. Subsidies should be labeled as such and, if necessary, paid directly to companies within the framework of EU legal possibilities. Intended tax incentives should be clearly formulated and carefully examined for their effectiveness. In doing so, compatibility with higher-ranking law, namely constitutional and EU legal requirements, must always be considered.

For companies planning long-term, constant changes in direction are not helpful. They need legally secure regulations with a clearly recognizable scope of application so that entrepreneurial decisions can be made on this basis.

The Corona pandemic definitely had nothing good. However, a tax measure used there showed remarkable effect. The expansion of the loss carryback provided companies with liquidity in a timely manner, which they urgently needed to cope with the crisis.

Due to the multiple economic challenges, more and more companies are slipping into the loss zone. A loss carryback is generally only possible up to 1 million euros. Although losses can be carried back not only to the previous year but also to the year preceding the previous year, this time extension hardly has any effect given the monetary limitation.

To be able to cope with upcoming investments, companies rely on having sufficient liquidity available. Therefore, the possibility of loss carryback should be significantly expanded. For example, with a loss carryback of up to 5 million euros, which should ideally also be enabled for trade tax purposes, liquidity of up to 1.5 million euros could be released in a timely manner for a corporation with an income tax burden of around 30%, instead of 150,000 euros under the current regulation, which only provides for a carryback in the case of corporation tax.

The utilization of carried-forward losses stretched over subsequent years due to the so-called minimum taxation should also be questioned. If a company is back in the profit zone after a loss phase, the timely offsetting of carried-forward losses with then achieved profits serves the stabilization and further recovery of the company.

There should be no divergence of the loss carryforward for income or corporation tax and trade tax purposes, as is currently the case in the years 2024 to 2027. This triggers additional administrative effort and creates a source of error in tax assessment.

Numerous medium-sized companies are structured in the legal form of a partnership, as this legal form, among other things, better meets the powers and responsibilities of the entrepreneurs or the entrepreneurial family than the legal form of a corporation.

There are significant differences between the taxation rules of partnerships and corporations. For example, the determination of profits in partnerships is significantly more complex due to the institution of the so-called special business assets than in a corporation. Although legal relationships between the partnership and its partners are indeed recognized under civil law, they are often neutralized for tax purposes, unlike in corporations. A fundamental harmonization of the two taxation regimes would require a complete overhaul of the German corporate taxation system - a mammoth project that is hardly manageable. Therefore, aligning simplifications should be made, such as dispensing with the institution of special business assets and reflecting the legal relationships between the partnership and the partners for tax purposes, as is the case with corporations.

The current law already provides regulations intended to flatten the tax differences between the legal forms - however, with moderate success so far. The so-called option model, despite improvements, still does not enjoy great popularity. Known obstacles should be removed here. The option of retention relief is also used comparatively rarely, meaning that profits left in the company are subject to a lower tax rate, but these will trigger additional taxes if they are withdrawn later. Here, too, much-criticized stumbling blocks have not yet been eliminated. Such an obstacle for dynamically developing medium-sized companies is that when using retention relief, even a change of form from a partnership to a corporation is no longer possible in a tax-neutral manner, but rather triggers taxes on the retained amounts. Many medium-sized businesses thus find themselves trapped in the existing legal form of a partnership, even though economic reasons suggest a change of legal form or restructuring.

In view of the disruptive economic developments, especially medium-sized companies are required to constantly adapt. Restructurings, such as the reorganization of business areas through spin-offs or the merging of corporate units, may be economically advisable to remain competitive.

To fiscally favor necessary restructurings, the Transformation Tax Act (“UmwStG”) provides regulations that allow tax-neutral measures. However, strict conditions must be met at the time of the conversion and sometimes even afterward. For medium-sized companies, the requirement that a restructuring can only occur tax-neutrally if a so-called partial operation is transferred to another legal entity proves to be particularly obstructive. The undefined term partial operation regularly leads to discussions with the tax authorities in practice. For the company concerned, this results in legal uncertainty or even an obstacle to restructuring if there is a risk of a high tax burden. Although this legal uncertainty can be reduced through coordination with the tax authorities, the ambiguous criteria regularly require a considerable amount of clarification effort.

This should be urgently counteracted by simplifying the conditions for a tax-neutral restructuring. Above all, the requirement for a partial operation should be abandoned. It should also be critically questioned to what extent conditions and lock-up periods that need to be subsequently reviewed are necessary and should be more precisely designed:

The taxation right of the tax authorities is already considered with the continuation of the restructured companies, as long as, for example, there is no threat of a restriction or exclusion of the German taxation right.

The existing tax system could be significantly simplified by largely aligning the tax base for income and corporation tax on the one hand and for municipal trade tax on the other. Currently, the determination of the trade income with its numerous deviations causes enormous tax determination effort. Ideally, the municipal trade tax should even be fully integrated into the income or corporation tax. This would also solve the problem that especially medium-sized companies feel disadvantaged in international competition. Because abroad, our municipal trade tax is regularly an unknown. Whether this endeavor is feasible, however, may be doubtful in view of the municipalities' financial autonomy, which is largely dependent on the municipal trade tax.

At least, the add-backs for municipal trade tax should be significantly reduced. Especially the add-back of financing fees can result in a tax burden, even though a loss was incurred, or a profit was achieved that is lower than the municipal trade tax assessment base in the relevant year. The allowance of 200,000 euros is intended to at least mitigate such distortions. However, especially for larger medium-sized companies, this allowance is often exceeded, resulting in a municipal trade tax burden without a corresponding profit. A simple remedy could be abolishing these add-back regulations that tax substances.

As further relief for companies - at least in terms of bureaucratic effort - it should be examined whether a centrally responsible nationwide body could handle the municipal trade tax assessments on behalf of all municipalities. At the very least, the tax notices should be designed uniformly to enable them to be read by machine.

Medium-sized companies operate across borders. They must therefore comply with complex tax regulations and fulfill extensive reporting obligations both domestically and abroad.

Since 2024, this regulatory complex has become significantly more complicated with the introduction of the global minimum taxation and its national implementation through the Minimum Tax Act. Although this only affects corporate groups with a group turnover of at least 750 million euros in two of the past four fiscal years. However, the Minimum Tax Act makes it clear that domestic regulations are not coordinated in all areas or overlap with the same regulatory motivation.

Keeping an eye on the complexity of international tax law and meeting the requirements poses enormous challenges for medium-sized companies, especially given limited personnel resources in the tax department.

To provide relief, the legislator should urgently review the comprehensive national requirements with cross-border relevance for their necessity in the upcoming legislative period and - taking into account the EU requirements - reduce them. A proposal from the Federal Ministry of Finance gives hope for partial simplifications here. This path should be consistently pursued.

In principle, all national regulations that apply to cross-border situations should be reviewed to determine whether they are still appropriate and necessary. At the EU level, Germany could advocate for simplifications within existing EU directives to create corresponding leeway for national legislators so that no longer necessary regulations can be eliminated. Further tightening for companies should be avoided in any case, as they act economically motivated and not primarily with the aim of reducing their tax rate.

In the tax declaration process, it has long been commonplace for data to be transmitted electronically to the tax authorities. The electronic provision of tax assessment notices, which enables electronic verification of data without media disruption, is waiting in the wings.

However, there are still numerous areas where the digitization of the tax authorities and thus also the data exchange between tax authorities and companies show deficiencies. An obstacle is that different technical solutions are being advanced in the federal states and different communication channels are being used.

For companies operating in several federal states, this results in a significant additional effort and a high susceptibility to errors. If the tax administration of one federal state accepts email communication, another federal state provides a shared data space, e.g., as a SharePoint solution, and tax administrations of other federal states still adhere to postal communication, this not only ties up capacities in the companies but also prevents a media disruption-free, digital processing there.

It is therefore necessary that, despite the responsibility of the federal states in the area of tax administration, uniform digital solutions are sought and provided in order to process the entire tax declaration process uniformly in digital exchange with entrepreneurs. This should range from the transmission of the tax declaration to ultimately the transmission of the audit results, so that data can be processed digitally without media disruption by both the tax administration and the companies. This can save enormous capacities on both sides and accelerate the processes.

Audits that begin years after the tax assessment and extend over several years result in enormous personnel and administrative effort for companies in providing data and answering questions about long-past issues. There is also a lack of legal certainty regarding which tax liabilities are still pending, to what extent interest accrues, and whether subsequent issues are affected by the audit findings.

To counteract this - at least partially - regulations to accelerate audits are to take effect from 2025. In advised cases, audits are to be ordered by the end of the year following the year of the tax assessment. If the audit extends over several tax periods (as is usually the case), the timing of the effectiveness of the most recent tax assessment is decisive for all tax claims. A certain acceleration is also to be achieved by the faster expiration of limitation periods. Nevertheless, audits lasting several years are still permissible. Especially concerning medium-sized companies, we see only little acceleration overall through these measures.

The goal of a timely and swift audit can ultimately only be achieved if auditors switch to a focus audit. The pilot project, whereby a risk-oriented focus audit is possible for the subsequent audit if an effective Tax Compliance Management System is in place, shows a feasible path. It is not about relying on random findings, but rather focusing the audit on error-prone areas with a certain tax risk.

This approach is already proving effective in neighboring countries. For example, the Netherlands use the term "Horizontal Monitoring" to ensure that companies that, in addition to a tax strategy, also present a tax risk analysis, are audited promptly up to "in real-time". Ultimately, this approach is based on the mindset of collaboration instead of the confrontational approach in Germany.

To accelerate audits, all possibilities should be explored to streamline audits. Better cooperation between the auditor and the company and a risk-oriented audit could be the key.