Permanent Establishment and Tax Assessment under German Law
Definition of permanent establishment under German law (section 12 General Fiscal Code)
Permanent establishment shall mean any fixed place of business or facility serving the business of an enterprise. In particular, the following shall be considered permanent establishments:
- the place of business management,
- branches,
- offices,
- factories or workshops,
- warehouses,
- purchasing offices or sales outlets,
- mines, quarries or other stationary, moving or floating facilities for the exploitation of natural resources
- building sites or constructions or installation projects, including those moving or floating, where
- an individual building site or construction or installation project, or
- one of several coexistent building sites or constructions or installation projects, or
- a number of immediately successive building sites or constructions or installation projects last(s) than six months
NB: Permanent establishments and thus taxable presences can be created inadvertently
Definition of a permanent representative under German law (sec. 13 General Tax Code)
Permanent representative shall mean any person who conducts the business of an enterprise in a sustained manner and, in so doing, is subject to its instructions. In particular, permanent representative shall mean any person who, in a sustained manner, on behalf of an enterprise,
- concludes or brokers contracts or solicits orders, or
- maintains a stock of goods or merchandise and makes deliveries from this stock
NB: Agents can create taxable presences of a principal inadvertently.
Tax assessment
An administrative act by a tax office where a tax is assessed (income tax assessment, corporate income tax assessment), typically based upon a tax return submitted by or on behalf of the taxpayer. The tax is paid by the taxpayer.
Self-assessment
A tax return submitted by or on behalf a taxpayer which is treated like a tax assessment (e.g. valued-added tax returns, payroll tax returns, withholding tax return). The tax is paid by the taxpayer
Withholding tax
A flat-rate tax deducted at source by the debtor of a taxable payment on behalf of the taxpayer. The tax is not based upon (net) taxable income, but upon (gross receipts)
‘hidden reserves’: The difference between the fair market value of an asset and the tax book value of an asset
‘white income’: Income that is taxed in no country
‘dry taxation’: tax that is due on unrealized income
‘total period’: the time from inception of an enterprise until its final liquidation
Methods of determining taxable income
3.1 Cash methods
- Income is determined as the difference between cash receipts less expenses paid less amortization/depreciation charge
- Depreciation: Deduction of the acquisition cost of a tangible asset over its useful life
- Amortization: Deduction of the acquisition cost of an intangible asset over its useful life
- Straight-line method: annual deduction = fixed percentage of acquisition cost -> constant amount
- Declining balance method: annual deduction = percentage book value as of the last yearend -> deduction decreases each year
- Method is typically used for other income than business income
- Income can be easily manipulated -> Goldfinger model
3.2 Accrual Method
Income is determined on the basis of a balance sheet and determined as the net increase (net decrease) of the equity minus contributions and less withdrawals
– Typical method for business income
3.3 Book-to-tax adjustments
Definition: A book-to-tax adjustment reflects a difference of the valuation of an asset or a liability for statutory purposes (valuation under IFRS, US-GAAP or German GAAP) and for tax purposes
Typical examples:
- Differences between the fair market value of an asset and the going concern value of an asset:
– Definition of fair market value: The value of an asset on the market
– Definition of going concern value: The value of an asset as part of a going concern (= active enterprise)
Example: Enterprise owns shares and the fair market value has dropped below the acquisition cost as of the balance sheet date – What is the going concern value?
Example: Enterprise owns bonds and the fair market value has dropped below the acquisition costs as of the balance sheet date. – What is the concern value?
Legally defined differences for purely fiscal reasons, such as
– Liabilities that have to repaid from future profits or income
– Accruals for patent infringements
– Jubileee accruals
– Accruals for impending losses
– Assets that exist only for statutory purposes, but not for tax purposes (such as interest in a partnership)
– Pension accruals
3.4 Non-deductible business expenses
NB: Non-deductible business expenses are business expenses, but the law defines that they are non-deductible. Possible reasons may be
Example: Interest deduction at partnership level, general interest deduction, debt push-down structures:
– The desire to disallow a tax deduction for private consumption
Examples: Gifts, entertainment expenses, hunting and fishing
– The desire to disallow a tax deduction for criminal activities
Example: Bribery
– Consistency
Examples: Tax charges, incidental charges
3.5 Excursus: The constructive dividend
Definition:
– A decrease in net equity or a lost increase in net equity
– because of a transaction
– disguised as a transaction under the law of obligations,
– which is actually a transaction under company law
Formal reason: The failure to define the rights and obligations between a company and shareholder prior to the transaction
Material reason: The compensation is not commensurate (not at arm’s length)