Corporate Taxation in Germany and England - Essay Example

Corporation taxes are sometimes misunderstood because of their complexity and continuous scrutiny under the law. European countries have been on a mission to reduce their corporate taxes in the past few years to appeal to foreign investors and to be more competitive in the global market. Germany started off being one of the highest corporate taxing countries and has been in a continuous battle with itself do decrease these numbers. England is also jumping on the bandwagon and following the lead of other European countries to reduce its corporate taxes. Over the years both countries have introduced new tax reforms and Acts to serve the same purpose: to be more competitive in the global market. Decreasing corporate taxations can be quite advantageous to any country. Reduced numbers can mean more foreign investment in the country and a highly competitive business sector and that is exactly what Germany and England had sought out to accomplish. The first reform of the 21st century in Germany was introduced in 2000 and the latest one is being launched this year. Over the years Germany has successfully decreased its tax rates from a high percentage to a medium low percentage and has reaped many benefits. England has also cut down on its corporate tax and has achieved many of its goals successfully. Although there are many criticisms on focusing too much on cutting down corporate taxes instead of other taxes both the countries have accomplished part of the goal they had initially sought out to achieve. Outline/Table of Contents Introduction page 4 German Corporation Tax pages 4 - 17 Image 1 page 6 Image 2 page 7 Image 3 page 9 Image 4 page 11 Image 5 page 12 Image 6 page 13 Image 7 page 17 England Corporation Tax pages 18 - 21 Conclusion pages 21 - 22 Bibliography pages 23 - 30 Comparative Analysis of Corporate Taxation in Germany and England Corporation taxes are sometimes misunderstood because of their complexity and continuous scrutiny under the law. European countries have been on a mission to reduce their corporate taxes in the past few years to appeal to foreign investors and to be more competitive in the global market. Germany started off being one of the highest corporate taxing countries and has been in a continuous battle with itself do decrease these numbers. England is also jumping on the bandwagon and following the lead of other European countries to reduce its corporate taxes. Over the years both countries have introduced new tax reforms and Acts to serve the same purpose: to be more competitive in the global market and keeping their corporations from relocating to lower taxing countries. "Corporations are legally capable associations based on the membership of persons; they are organized on a membership basis and exist independent of the change of the individual members. The legal form corporation is a legal person, whose "body" exists of individual natural or other legal persons." (Definition of corporation and scope of tax liability, n.d.) Only companies registered as joint stock companies or having limited liability are considered corporations whereas partnerships are considered to be small businesses that do not have corporate taxes levied on them. Each individual though has to pay a specific amount of tax on his or her net income. ." (Definition of corporation and scope of tax liability, n.d.) How much a corporation gets taxed within a year depends on its entire net income in the operating cycle and the taxes are levied according to German Acts and laws. (Determination of taxable income, n.d.) "The corporation tax rate for retained and distributed profits is 15 percent (Flat Tax).On the level of the involved parties, a capital gains tax is levied on principle with a tax rate of 20 percent." (Corporation tax rate, n.d.) All the balance sheets and accounts are reviewed for profits and loss for the proper taxes to be levied on the corporations. (Assessment Procedure, n.d.) To relieve the burden from the corporations and the shareholders "the half income system" is implemented and it "achieves removal of the double taxation of distributed profits in a flat-rate form by providing relief both on the corporate level and the shareholder level." (Half income system/distributed profits) "The corporation tax is a particular type of income tax for legal persons, associations and conglomerations of property. Just like income tax, the corporation tax belongs to the direct taxes and is a personal tax which cannot be deducted from the income. Corporation tax and income tax exist concurrently.Profit made by a corporation is therefore counted as part of the basis of charge of the corporation tax of the corporation." (Taxation of Income of Corporations, n.d.) The tax revenue 1999 in percentage by type of tax in Germany is presented below (Endres et al., 2001, p. 4): Every business entity that is registered as a corporation or is limited by shares has to pay a corporate tax. "Like income tax, corporation tax distinguishes between the "unrestricted" liability of residents and the "restricted" liability of non residents." (Endres et al., 2001, p. 11) In other words, a corporation is a business entity with attributes that are quite similar to humans. To be a corporation in Germany and have the appropriate taxes be levied the company has to be a German resident or acquire dual residency. These corporations are taxed 25% on their entire income including business done in and outside the country. Once the tax is levied the remaining income can be distributed to the shareholders as dividends. Next, the shareholders must pay a tax on the dividends collected because the dividends come from a corporation. (Endres et al., 2001, p. 11) "However, domestic double or multiple taxation is avoided by a provision in the Corporation Tax Act exempting dividend income from corporation tax and by the rule of the Income Tax Act which reduces the dividend income chargeable to income tax to only one-half of the amount actually received. As the table above shows, this leads to the overall burden directly and indirectly borne by the natural person shareholder once he has received his dividend being approximately similar to that which he would have paid had he earned the income in his personal capacity and charged it to income tax as business profits." The ultimate tax burden on dividends is presented below (Endres et al., 2001, p. 11): "Reforms on corporate tax and nonwage labor costs will further improve Germany's position as a market place." (Axarloglou, 2006) Another incentive for Germany to implement a Tax Reform Act was to follow other Eastern European countries in order to cajole and coax foreign direct investment to come into the country and the continent. "In an international investment environment, there are a variety of taxes that might apply to any particular investment by a multinational corporation. Taxation overall appears to have catalytic effects on total FDI flows and FDI flows to MOS, but much weaker effects on FDI flows to MIS." (Axarloglou, 2006) Small and medium size enterprises dominate Germany's business sector and are of huge of importance to the economy as a whole. "Small and medium-sized businesses alone provide work for 70 % of all employees and train 82 % of all apprentices. SMEs account for 64 % of the gross value added by all businesses and 52 % of total investment in the economy." (From the 2000 Tax Reform, 2008, p. 1) AS business law commands the form of a business entity dictates what rights it has, what rules and regulations it has to follow and how it is going to be taxed. "Almost 83 % of enterprises in Germany are organized as unincorporated companies or sole proprietorships, whereas joint stock companies subject to corporation tax account for more than 15 % of all businesses." (From the 2000 Tax Reform, 2008, p. 1) According to the German tax policies, they are "designed to do justice to both groups and in particular to provide a framework which promotes their competitiveness while avoiding differences in their tax burdens as much as possible." (From the 2000 Tax Reform, 2008, p. 1) Whereas when we look at the image below "Corporate structure and the reform of corporate taxation: the number of unincorporated enterprises liable for the payment of income tax is five times higher than that of incorporated enterprises liable for the payment of corporation tax." (From the 2000 Tax Reform, 2008, p. 1) "The German taxation environment has fundamentally changed with the acceptance of the Tax Reduction Act by the Bundesrat on July 14, 2000" (Endres et al., 2001, p.3) An announcement by Chancellor Gerhard Schroeder 7 months earlier led to the Tax Reduction Act. On December 21, 1999 Chancellor Schroedor (quoted in Shackelford, Maydew & Lang, 2001, p. 11) announced "the biggest and most far-reaching tax-reform package in the history of the federal republicthis is an issue of how Germany holds up against foreign competition." He proposed to cut down on corporate taxes and change the system of taxation. (Lang, Maydew & Shackelford, 2001, p.11) The purpose and the goals of this tax reform were defined by Germany's Finance Minister, Hans Eichel (1999, quoted in Lang, Maydew & Shackelford 2001, p. 11) as "strengthening the Germany economy's ability to compete on an international basis. The high German tax rates by international comparison are to be reduced and the determination of taxable income is to be adjusted to international standards. Corporations and their shareholders are to receive a common flat corporate tax rate of 25 percent." The Impact of German Tax Reform Act on taxation of investment fund (Klinger & Manske, n.d.) was "not only a drastic reduction of tax rates, but also a change to the German corporation tax system, which affects the taxation of investment funds in Germany." Tax rates on retained earnings and distributed earnings of 30 and 40 percent fell to a flat 25 percent. (Klinger & Manske, n.d.) "The flat rate of 25% will also apply to German branches of non-resident corporations and to foreign corporations operating through German partnerships that are at present subject to a 40% tax rate" and "the solidarity surcharge of 5.5% on corporate tax will remain unchanged, so that the effective corporate tax rate will be 26.4%."(Klinger & Manske, n.d.) Earlier German residents were taxed three sevenths of the dividends they "received from German corporations. Therefore, for a German resident taxpayer, the German corporation tax levied at the level of the German corporation was treated in a similar way to a prepayment of tax by the investor, provided the income was distributed by the corporation." (Klinger & Manske, n.d.) According to the Tax Reduction Act this system will be replaced with the half-income system. (Klinger & Manske, n.d.) The following image shows the effect of the tax reduction that begun with the Tax Reform Act in 2000 in Germany to have the 5th highest percentage reduction in corporate rate. (Atkins & Hodge, 2005, p.2) "Perhaps the most important aim of the act was to reduce the tax burden on German business in order to enhance its competitiveness internationally." (Endres et al., 2001, p. 21) The new rates of taxation on the German corporations are presented below (Endres et al., 2001, p. 21): "Natural persons, include sole traders and members of partnerships, will enjoy three successive reductions in their income taxes rates by 2005, when the rate scale will run between 15% and 42%." (Endres et al., 2001, p. 22) The breakdown is presented in the form of an image below (Endres et al., 2001, p. 22): "According to Jrg-Dietrich Kramer, previously of the Bundesfinanzakademie, Brhl, Germany at one time operated an imputation system that did indeed provide individual resident German shareholders with a 100% credit for the corporate tax paid by a German company on the profits out of which dividends received by such shareholders were paid." (Webb, 2007) As earlier noted in the previous system of taxing corporations and shareholders ended up paying more taxes. With this new reform Germany has switched to a classical method of taxing corporations which means that corporations and shareholders get taxed separately. The shareholders can also get relief from double taxation by implementing this act which allows the shareholder to only be taxed on have the dividend income compared to the entire income that was taxed before. This principle is called the "half income" method and helps reduce the burden on the shareholders and the corporations. (Endres et al., 2001, p. 22) "Unwanted accumulations of tax burdens between the company originally earning the income and the natural person ultimately receiving the dividend are avoided by exempting dividend income in the hands of companies from corporation tax altogether." (Endres et al., 2001, p. 22) Just like it is important to bridge the gap between the rich and the poor for a sound economy the Tax Reform sought out to equalize the amount of tax small business and large corporations would pay. As it was noted earlier the majority of the taxes were being paid by the small businesses and not the corporations. "Sole traders and natural persons as members of partnerships were thus allowed a generalized credit of the trade tax paid by their business against their income tax due on its profits, so that they can benefit from the corporate tax reform to roughly the same extent as corporations and their shareholders do." In order to help the citizens and the businesses they had to allow "a deduction from the income tax due of 9% of all but the smallest trading incomes. For members of partnerships, the deduction is established centrally for the partnership and will then be divided among the partners in profit sharing ratio on the same lines as the division of taxable income. This is documented towards each partner and his or her own tax office in a formal notice of "uniform and individual notice of allocation" issued by the tax office responsible for the affairs of the partnership." (Endres et al., 2001, p. 22) Serge Foucher (quoted in Endres et al., 2001, p.25), the Executive Vice President & Chief Financial Officer of Sony Europe said that, "Thanks to the 2000 taxation reform, tax conditions have improved noticeably and have become appreciably more transparent. We welcome this step and would like to express our hope that investment conditions in Germany will improve even further within the foreseeable future." Professor Bernd Fahrholz ((quoted in Endres et al., 2001, p.29) commented that "The corporate tax reform was an important step in eliminating the reform backlog in Germany. Taxation rates are internationally competitive at last. Of particular importance are the incentives to abolish Germany Inc." There are many rebuttals to the two former comments regarding the German tax reforms that started in 2000 and have been going on till today. Werner Stuffer is "a prominent figure in the international tax community. He is vice president of international taxes at Siemens, the multinational electronics and electrical engineering company, with activity in more than 190 countries, 400,000 employees worldwide and revenue of EUR 72.4 billion in 2007." (Tackling Global Concerns, 2008) The positive impact according to him is in line with what the other two observers said previously. He agrees that Germany needed this Tax Reform to be more competitive worldwide and move down a few notches on the corporate tax ladder from very high to about mid level. He disagreed on the funding methods of the tax reform and said that it is one of the negative aspects of the tax reform. (Tackling Global Concerns, 2008) "For example the reform has resulted in negative business restructuring rules in Germany, which are not in line with the international standards on business restructurings. The government has introduced new tighter limitations on the transfer of loss carry forwards, making restructurings in a group very difficult." (Tackling Global Concerns, 2008) He also continues by pointing out how important it was to eliminate other taxes along with the corporate tax and that "the German tax authorities have missed the chance to introduce a significant change to the tax regime. They failed to get rid of trade income tax implemented by municipalities. Germany has a dual system of federal and city taxes. The authorities had a great opportunity to eradicate city tax, which would be a necessary move to reduce tax complexity. Of course, there are political implications as to why this has not happened. City taxes are an easy way to make revenue." (Tackling Global Concerns, 2008) Another criticism of the corporate tax system in Germany is related to cross-border fiscal unity. Cross-border fiscal unity means that a company in its home country can transfer its profits to a subsidiary that might be located in a foreign country to prevent being taxed according to the home country laws. In Germany, cross-border fiscal unity has many restrictions and is "scrutinized in the light of European law and ECJ case-law." (Cross-border fiscal unity, 2006) Under the European Community treaty each member has the freedom to interact and establish corporations in another EU member state/country. If the restrictions are removed and cross-border fiscal unity is established it will be possible to "transfer taxable proceeds from Germany to a foreign country and prohibit Germany from taxing these proceeds or to utilize losses of foreign subsidiaries in Germany." (Cross-border fiscal unity, 2006) "The Tax Reform Act 2008 features numerous corporate and personal income tax changes. The first of a two-part series focuses on the general systemic changes introduced, the corporate income tax rate reduction, the municipal business tax calculation, the retention privilege for partnerships and the new dual-income tax system." (Resch, 2008, p.99) The new tax reform is expected to increase tax revenues and decrease corporate taxes even further. (Wehnert & Wolff, 2007) "Today, the average combined corporate income tax and trade tax rate for corporate taxpayers is around 39 percent. As trade tax rates are set by municipalities, the exact rate depends on the municipality where the business is located. After the tax reform 2008, the combined average corporate income tax and trade tax rate will be around 29 percent. Whereas trade tax rates will stay more or less unchanged, the corporate income tax rate will be reduced from 25 percent currently to 15 percent." (Hillen et al., 2001, p. 1) Although all the tax reforms are supposed to be beneficial to the shareholders and citizens, a report in the Wall Street Journal (Kerpen, 2007) notes that, "France and Germany, traditional bastions of big government, exclude 95% of corporate capital gains from taxation." The impact on the effective tax burden of corporations is outlined in the following table (Kluetgens & Ponicke, 2006): "Statutory corporate tax rates have been lowered in the United Kingdom and elsewhere While the United Kingdom was early in cutting tax rates and had strong tax competitiveness, others have caught up. And some countries now have considerably lower tax rates, even after the recent announcement to cut the UK statutory corporate tax rate from 30% to 28% in 2008." (Tax competition, 2007) These tax cuts have been attracting more "investment and capital, and they pose a threat to America's economic competitiveness." (Corporate Tax War, 2007, p. A20) "A U.K. resident individual shareholder in receipt of a dividend from a U.K. resident company receives a credit of 1/9 of the dividend and pays tax on the "grossed up" amount of the dividend (i.e., the aggregate of the dividend and the tax credit)." (Webb, 2007) According to a new law shareholders do not have to pay high tax rates and will stick to a basic of 22%. Instead the tax will be levied on a gross total of all the dividends and lesser and reduced tax rate will be applied. (Webb, 2007) "Where such a shareholder is liable to higher rate income tax, he will pay tax on the grossed up amount of dividends received at the rate of 32.5%, but will again be able to set off the tax credit against this liability." (Webb, 2007) "In July 1997, the new Government began a series of reforms of tax credits and corporation tax payments. Payments of tax credits to pension schemes and UK companies were abolished on dividends paid on or after 2 July 1997 and the remaining payments of tax credits were cut from 6 April 1999." (Corporation Tax, 2006) Later Foreign Income Dividends and the ACT were abolished and new system was found to levy taxes. (Corporate Tax, 2006) The United Kingdom like Germany has been revising its corporate taxes and is trying to implement a new system so it can be more competitive in the global financial market. (Corporation Tax Reform, 2002) "Sustainable growth and economic stability are built on the platform of a thriving business sector. For that we need a modern tax system that underpins business competitiveness and raises revenues in a manner that best supports commercial decisions that businesses have to take on investment, on jobs and on legal and operating structures." (Corporation Tax Reform, 2003) The UK has changed many things about its corporation tax since 1997. The tax levied on corporations is now down by 30 percent and small companies have more benefits and enjoy a zero percent rate. (Corporation Tax Reform, 2003) Although they "have introduced new flexibility, removed distortions and taken the necessary measures to combat tax avoidance," the United Kingdom feels that there are "further steps needed if we are to ensure that the corporation tax regime meets the challenges of the modern business environment, does not impede the drive to greater economic efficiency, productivity and growth, and keeps pace with European and international developments." (Corporation Tax Reform, 2003) "The majority of firms that operate in Europe are small and medium-sized enterprises. Therefore, it can be said that [their] competitiveness significantly the competitive position of a country's economy as a whole." (The corporate tax system for SMES, 2007, p. 38) In England, according to the ICTA88/S13 smaller companies have to pay a smaller percentage of corporation tax. (Corporation Tax: Small Companies) "Foreign dividends paid to large and medium-sized UK companies will be exempt from UK tax. The required level of shareholding, to qualify for exemption, will be 10%. However, the change will not apply to small businesses." (Taxation of foreign profits, 2007, p.98) According to Alex Pratt (2008) the government actually taxes small firms a lot and says that the "system works against the massive gains the country makes when entrepreneurs are encouraged to do their thing." In other words, people doing their thing by running their own small businesses will actually suffer because of the high rates of taxation. Instead, Pratt (2008) recommends that people should just invest their money for the purpose of buying a bigger home because that way at least you'll be "doubling your money every few years". Corporate taxations for residential multinationals were previously calculated by mixing dividends received from a residential and non residential company and using the average as a percentage for taxation. Now the law has changed and a 45 percent average is the minimum rate of taxation. (United Kingdom: Corporate Taxations for Residential Multinationals.) The introductory line in an article in the Economist (Britain: the other tax rebellion, 2008) says it all, "Taxing multinationals is no easy task, especially if they can leave." Taxing company profits is a competitive business for country governments especially England since corporate taxes account "for about a tenth of all tax collected in the country." (Britain: the other tax rebellion, 2008) Both Germany and England have been on a crusade to decrease corporate tax rates to keep corporations from shifting to foreign countries. In the process, England has had to make a lot of tough calls that might not be beneficial to the corporations after all. "In order to stop companies from moving all their profits beyond the reach of British tax collectors, the government proposes taxing the "passive" income of British firms, no matter where it is earned. And it is this that has caused outrage. Because it would cover, among other things, interest, rent and royalties, it could lead to substantial increases in the amount of tax paid by some firms. One such is Shire, a pharmaceutical company, which has announced a move to Ireland for tax reasons. Another is WPP, an advertising firm, which is threatening to leave." (Britain: the other tax rebellion, 2008) Smiths, an engineering company has shown signs that if the United Kingdom government plans to implement the proposed corporate tax measures it will leave the country. "Smiths, which generates 94% of its revenues overseas, joins a growing list of multinationals to have expressed alarm over the potential changes to the tax regime. Smiths has cut 65 jobs, 40 of which were in the UK. The jobs are being lost from its speciality engineering operation, which makes seals and other equipment for the oil and gas sector, and communications parts for aircraft. Smiths employs 22,000 staff worldwide, 2,900 of them in the UK." (Smiths could lead exodus, 2008, p. 4) After so many threats to leave the country and move to lower taxing neighbors the United Kingdom has finally backed down on the proposed corporate tax changes. (Costello, 2008) Decreasing corporate taxations can be quite advantageous to any country and increase competition. Reduced numbers can mean more foreign investment in the country and a highly competitive business sector. Also businesses are more likely to operate in their home country if the rates are low and not relocate in a neighboring country. Germany and England had sought out to implement competitive corporate tax rates and both have faced some challenges along with many pros. The first reform of the 21st century in Germany was introduced in 2000 and the latest one is being launched this year. Over the years Germany has successfully decreased its tax rates from a high percentage to a medium low percentage and has reaped many benefits. England has also cut down on its corporate tax and has achieved many of its goals successfully even though it has taken back the latest proposal concerning corporate taxations. Although there are many criticisms on concerning cutting down corporate taxes instead of other taxes, not establishing cross-border fiscal unity and not cutting down enough, both the countries have accomplished parts of the goals they had initially sought out to achieve. 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