Corporation Tax Act (KStG)

Basics and importance

Since its fundamental revision in 2002, the German Corporation Tax Act has been the central set of rules for the taxation of corporations and other legal entities in Germany. The continuous development of the law reflects the increasing complexity of international corporate structures and the requirements of the globalized economy in particular. The uniform corporation tax rate of 15 percent of taxable income is supplemented by the solidarity surcharge and trade tax to create an effective tax burden of 30 percent on average, whereby regional differences can arise due to different trade tax rates. The close systematic dovetailing with the Income Tax Act creates a complex system of references and supplementary regulations that are intended to ensure consistent taxation throughout corporate tax law. The fundamental separation principle of corporate tax law leads to a strict tax separation between the company and its shareholders, whereby systematic double taxation is to be avoided by means of suitable mechanisms. The increasing importance of international tax law is manifested in the implementation of the OECD BEPS guidelines and the introduction of global minimum taxation for international groups, which poses new challenges for national corporation tax law. The constant case law of the Federal Fiscal Court and the European Court of Justice is continuously developing the interpretation of corporation tax law and clarifying its application in complex cases of doubt. The ongoing European harmonization of corporate tax law leads to a constant adaptation of national regulations to the detailed requirements of the European Union. The economic importance of the Corporate Income Tax Act is reflected in annual tax revenue of several billion euros, which makes a significant contribution to financing public tasks at federal, state and local level. The increasing complexity of the regulations requires an intensive examination of the tax structuring options and their limits in an international context. The ongoing digitalization of the economy confronts corporate tax law with fundamental questions regarding the recording and taxation of digital business models.

Tax liability and taxable persons

The Corporate Income Tax Act covers all legal entities under private and public law as central tax subjects, whereby in practice the focus is particularly on corporations in the form of GmbHs and AGs. Unlimited tax liability is based on the legal domicile or place of management in Germany, which results in comprehensive taxation of the worldwide income of these companies. The place of management is determined by the center of ultimate management, which can raise complex demarcation issues in times of increasingly decentralized corporate management. The limited tax liability of foreign corporations extends exclusively to their domestic income, whereby the determination of the attribution of income often entails difficult delimitation issues in an international context. The personal tax exemptions for certain corporations, such as charitable organizations or public corporations, are regulated conclusively in the law and are subject to strict earmarking. The law allows group companies to be combined for tax purposes through the institute of a tax group, which enables effective group taxation. The choice of legal form has far-reaching tax consequences that must be carefully considered when planning a company. The transformation of companies is subject to special tax regulations, which are regulated in detail in the Transformation Tax Act. The creation and termination of tax liability are precisely defined and can have considerable tax consequences. The tax registration of branches and permanent establishments of foreign corporations is governed by special regulations that are based on international standards. The documentation requirements for taxable corporations are extensive and require a careful compliance structure. The status determination by the tax office has a constitutive effect and is decisive for tax treatment.

Determination of taxable income

The calculation of taxable income under corporation tax law is based on a complex interplay between commercial accounting and tax law modifications. The authoritative nature of the commercial balance sheet for the tax balance sheet was fundamentally reformed by the German Accounting Law Modernization Act (Bilanzrechtsmodernisierungsgesetz), which has made it necessary to take a more differentiated view of commercial and tax valuation regulations. Hidden profit distributions, which represent a reduction in assets or a prevented increase in assets caused by company law, increase taxable income and are subject to strict review by the tax authorities. The tax corrections to the result under commercial law include numerous additions and deductions, which are regulated in detail in Sections 8 to 8c KStG and are subject to constant further development through case law and legislation. The offsetting of losses is restricted by complex regulations, in particular the provisions on the loss transfer in the event of a change of shareholder, which often lead to difficulties in practice. The interest barrier limits the tax deduction of interest expenses and is intended to prevent excessive debt financing of German corporations. The trade tax additions and deductions must be taken into account when calculating income and lead to a close link between corporation tax and trade tax. Investment income is largely tax-free under certain conditions, whereby the details of this tax exemption are regulated in Section 8b KStG and provide for various exceptions and restrictions. The documentation of the income calculation must meet the strict requirements of the tax authorities and is regularly checked as part of tax audits. The international dimension of income determination is made more complex by regulations on transfer pricing and add-back taxation. The development of new business models, particularly in the digital sector, poses new challenges for traditional methods of income determination. The increasing importance of intangible assets requires special attention in tax valuation and income determination.

Organschaft and group taxation

The consolidated tax group for corporate income tax purposes allows legally independent group companies to be combined for tax purposes, which means that profits and losses can be offset immediately within the group. The conclusion of a profit and loss transfer agreement with a minimum term of five years is a mandatory requirement for tax recognition of the tax group, whereby the actual implementation of the agreement is subject to strict review by the tax authorities. The financial integration of the controlled company requires an uninterrupted majority of voting rights in the controlled company since the beginning of its financial year, which often leads to complex delimitation issues in practice. The loss absorption obligation of the controlling company must meet the requirements of Section 302 AktG in its current version, whereby a dynamic reference in the profit transfer agreement is mandatory. The formal requirements for a consolidated tax group are extremely strict and often lead to disputes with the tax authorities in practice, particularly when formulating and implementing the profit and loss transfer agreement. The tax effect of the consolidated tax group extends to both corporation tax and trade tax, resulting in uniform taxation of the group. The advantages and disadvantages of a consolidated tax group must be carefully weighed up in each individual case, whereby economic and organizational aspects must be considered in addition to tax aspects. The termination of a tax group, whether due to the passage of time or premature termination of the profit transfer agreement, can have considerable tax consequences and must therefore be carefully planned. The parent company is liable for the taxes of the controlled company, which must be taken into account when structuring the group. Cross-border tax groups within the European Union are subject to special regulations and are constantly being developed further by the case law of the European Court of Justice. The structuring options within the framework of the tax group are restricted by numerous abuse regulations, which are intended to prevent purely tax-motivated group structuring. The increasing internationalization of group structures poses new challenges for national tax group taxation and requires an adjustment of the existing regulations.

Distributions and shareholder taxation

The taxation of profit distributions follows a complex system designed to avoid double taxation at company and shareholder level through various mechanisms. In the case of private shareholdings, distributions are generally subject to flat-rate withholding tax at a flat rate of 25% plus solidarity surcharge, although it is possible to opt for the partial income method under certain circumstances. In the case of entrepreneurial shareholdings, the partial income method is applied, according to which 60% of distributions are subject to regular taxation, while 40% remain tax-free. Capital gains tax is withheld by the distributing company and paid to the tax office, whereby extensive documentation and reporting obligations must be observed. The international withholding tax regulations are particularly complex, as national regulations as well as double taxation agreements and EU law must be taken into account. The application of double taxation agreements requires special proof in the form of residence certificates and other documents, which are often time-consuming to obtain in practice. The anti-treaty shopping rules are intended to prevent abusive arrangements to obtain treaty benefits and have been continuously tightened in recent years. The documentation of the shareholder structure is becoming increasingly important, particularly with regard to the extended reporting obligations to the transparency register. The refund procedures for overpaid withholding taxes are highly formalized and require careful preparation of the necessary documentation. The liability of the distributing company for withholding tax not withheld or withheld at too low a rate can entail considerable financial risks. The increasing internationalization of shareholder structures leads to increasing compliance requirements for profit distribution. The development of new financing instruments and hybrid structures requires particularly careful examination of the tax treatment of distributions.

Special regulations and procedures

The Corporate Income Tax Act contains numerous special regulations for certain sectors and types of company, which are intended to take account of specific economic circumstances. The taxation of insurance companies is governed by special regulations that take into account the technical provisions and the equity cover capital and are intended to ensure appropriate taxation of the insurance industry. The tax treatment of credit institutions is characterized by special regulations on risk provisioning and the treatment of certain financial instruments, with international accounting standards becoming increasingly important. The transformation of corporations is subject to the complex regulations of the German Transformation Tax Act, which allows tax-neutral restructuring under certain conditions. The use of losses in the event of a change of shareholder is considerably restricted by the provisions of Section 8c KStG, whereby various exceptions such as the group clause or the reorganization clause must be observed. The interest barrier as an instrument for limiting the tax deductibility of interest on borrowed capital requires careful planning of corporate financing and can have a considerable impact on the tax burden. The license barrier limits the deduction of business expenses for license payments to related parties abroad and is intended to curb the shifting of profits to low-tax countries. The documentation requirements for transfer prices have been continuously expanded in recent years and require comprehensive documentation of intra-group service relationships. Tax audits are particularly important for corporations and often lead to lengthy disputes with the tax authorities. The increasing digitalization of business processes places new demands on tax compliance and requires adapted control systems. The international networking of tax administrations leads to an increased exchange of information and increases the pressure on companies to declare their taxes correctly. The importance of tax risk management is constantly increasing and requires the implementation of appropriate systems and processes.

International aspects and developments

The international dimension of corporate tax law is significantly influenced by the introduction of global minimum taxation, which is intended to ensure an effective minimum taxation of 15 percent for international groups with an annual turnover of more than 750 million euros from 2025. The implementation of the European Union’s Anti-Tax Avoidance Directive (ATAD) has led to far-reaching changes in German corporate tax law and significantly expanded the existing regulations to prevent tax avoidance. Additional taxation as an instrument against the shifting of passive income to low-tax countries has been tightened and adapted to international standards, with the complexity of the regulations posing a particular challenge for companies. The transfer pricing regulations are constantly being developed and require increasingly detailed documentation of intra-group service relationships, which leads to considerable practical difficulties, particularly when valuing intangible assets. The application of double taxation agreements is increasingly restricted by substance requirements, which are intended to prevent the structuring of international groups purely for tax purposes. The taxation of the digital economy poses fundamental challenges for traditional corporate tax law, as the previous connecting factors for taxation, such as physical presence, are becoming increasingly less important. The European harmonization of corporate tax law is progressing steadily and could lead to a common consolidated corporate tax base in the medium term. International cooperation between tax administrations is being intensified through the automatic exchange of information and joint tax audits, which further limits the opportunities for international tax structuring. Compliance requirements in international tax law are constantly increasing and require considerable resources in companies. The case law of the European Court of Justice is increasingly influencing the interpretation of national corporate tax law and is leading to a progressive Europeanization of tax law. The future of international corporate tax law will be significantly shaped by efforts to combat aggressive tax planning and the challenges of the digital economy. The complexity of international tax law poses major challenges, particularly for medium-sized companies, and requires intensive engagement with the constantly changing legal framework.