Germany as a tax jurisdiction – current developments affecting the M&A market

​​published on 22 June 2022 | reading time approx. 3 minutes 

Taxation is an essential location-related factor for companies. In M&A transactions, its significance becomes evident, for example, when selecting the location for holding and acquisition companies or when identifying tax optimisation needs or potential of the target, which the buyer factors into the company’s valuation.

What is the stand of Germany in comparison to other countries? Is the new German government providing the right incentives to keep Germany an attractive jurisdiction for M&A transactions?

A global minimum tax

International tax law, in particular, is currently going through a radical change. On the one hand, German tax law is becoming more and more “international” as the OECD, the EU and other inter- and supranational legislative bodies increasingly exert influence on local tax law. On the other hand, individual countries are showing an ever growing focus on their individual needs in order to secure national tax revenue.

Following the OECD's BEPS initiative of 2015, in 2021 136 members of the OECD or G20 ultimately agreed the so-called two-pillar solution – particularly supported by the current chancellor of Germany Olaf Scholz. This is intended to curb the base erosion and profit shifting practices (aggressively) pursued by multinational enterprises (MNEs) and unfair tax competition between countries. The aim of the two-pillar solution is to ensure that MNEs pay an appropriate tax in all countries in which they operate and generate profits.

The time plan for the implementation of the global minimum tax is ambitious. Current discussions in the EU-level point towards an overall goal of enforcing the new standard by 2024.

All corporate groups and their constituent entities with group turnover of at least 750 million euros are affected by the regulations, regardless of their legal form. The minimum tax is primarily levied on the ultimate parent entity, which has to pay the minimum tax for all its low-taxed entities (so-called “income inclusion rule”). In addition, all entities located in the EU may become liable to pay tax under the Undertaxed Payment Rule if the minimum tax imposed on the ultimate parent entity does not result in the minimum tax rate of 15 per cent. This corresponds to the exclusion of the possibility to deduct expenses as tax-deductible business expenses.

For affected companies, the challenge is that they have to learn how to navigate this complex tax project within a very short time. It is clear that these group companies will have to meet considerable additional compliance obligations.  In this case, tax planning and reporting must be expanded and there must be clarifications on whether companies will be able to use their current reporting systems for digital support or whether they will have to implement a dedicated reporting tool for that.
 
As part of tax due diligences, it will therefore be necessary to verify whether these new wide-ranging compliance obligations are fulfilled and whether the reporting meets the extended requirements. Likewise, the determination of the effective tax burden will henceforth be part of the tax transaction advisory service if, for example, the target exceeds the turnover threshold following an acquisition and incorporation into the acquirer's group. For example, to determine the additional tax burden for an ultimate parent entity, it will be required to prepare a comprehensive assessment simulation.

Corporate tax law

As a result of the far-reaching measures to mitigate the consequences of the Covid 19-pandemic and the Ukraine crisis, the German government is facing immense fiscal challenges. With a corporate tax rate at around 30 per cent consisting of corporate income tax and trade tax including a solidarity surcharge, Germany stands in the middle compared to other countries. Dr Florian Neumeier, Head of the Research Group Taxation and Fiscal Policy at the Ifo Institute in Munich, predicted at the 6th International Conference on M&A Dialogue held at the Bayerischer Hof hotel on 24 May 2022 that minimum taxation in Germany would hardly generate any additional tax revenue. The coalition agreement of the new German government has ruled out tax increases.

If – as Dr Florian Neumeier fears – the planned carve-out regulation will further fuel international tax competition, it might force the German government to reduce taxes in order to prevent shifting of “real” business activities to foreign lower-tax jurisdictions. The investment incentive associated with tax cuts is opposed by the aspiration to focus more on the equitable distribution of assets. It is questionable how the German government will master this balancing act.

A look at the USA: With the fundamental U.S. tax reform under President Trump in 2018, the corporate tax rate was significantly reduced at the federal level from 35 per cent to 21 per cent. This – flanked by other measures – demonstrably encouraged capital inflows and investments in the USA. Interestingly, the administration under President Biden now wants to largely reverse this significant tax rate cut (currently the tax rate of 28 per cent is being discussed at the federal level).

It is questionable how the required tax revenue in Germany is to be financed. The need for fundamental corporate taxation also arises in view of further megatrends in society. Demographic change, for example, is pushing pay-as-you-go pension schemes to their limits. Artificial Intelligence complements or replaces human intelligence or manpower. The share of wage tax in tax revenue could decrease if no new service lines are tapped into or promoted, for example, as a result of environmental protection seen nowadays as a critical issue, or if increased local production as a result of the move away from globalisation does not create jobs and thus generate more tax revenue. Corporate taxation must also go in line with these trends in the long term. By introducing the global minimum tax rate, a “first step” has already been taken to at least take digitalization into account. A fundamental and “bold” corporate taxation framework would be desirable but not foreseeable in the short or medium term, especially due to the current political challenges.

The task of decision-makers in the realm of M&A remains to closely follow up on the current implementation of the global minimum tax and the local response to it in the relevant countries in order to be able to react in adequate time and accommodate this in the transaction process by introducing structural adjustments, if necessary.