Taxation of Corporate Taxpayers vs. Income from Partnerships: Criteria and Examples
Taxation of Corporate Taxpayers vs. Income from Partnerships
Criteria
Centralized management:
A corporation is typically represented by its officers, not by the shareholders.
A partnership is typically represented by its partners or one partner elected by the partners.
Limitation of liability:
The shareholders in a corporation cannot be held liable for the corporation’s debts.
The partners in a partnership can be held liable for the partnership’s debts even though limitations on the liability may be in place.
Transferability of shares:
Shares in a corporation are (freely) transferable.
Interest in a partnership can typically not be transferred without the other partner’s consent.
Distribution of profits:
The profit of a corporation are distributed on the basis of a shareholders’ resolution.
A partner in a partnership is free to withdraw the profits from the partnership.
Supply of capital:
A corporation has a statutory minimum capital that needs to be maintained.
A partnership has no statutory minimum capital.
Lifetime:
The lifetime of a corporation is indefinite.
The lifetime of a partnership can depend on the life/the participation of its partners.
Examples in Germany
Private limited company – GmbH
Public limited company – AG
Civil law partnership – GbR
Trading partnership – oHG
Limited liability partnership – Kommanditgesellschaft
Limited liability partnership by shares – Kommanditgesellschaft auf Aktien
Taxation of Corporate Taxpayers
•Taxable income is based upon the corporation’s statutory balance (statutory profit plus/minus book-to-tax differences plus/minus non-deductible business expenses)
•The corporation is the taxpayer
•Since tax is paid at the level of the corporation, (some) tax relief needs to be given to the recipient of a dividend
Taxation of Income Derived from Partnerships
•Taxable income is based upon the partnership’s statutory balance (statutory profit plus/mins book-to-tax differences plus/minus no-deductible expenses
•But: The partnership is fiscally transparent/a pass-through entity
•Therefore: Acquisition of partnership interest is treated like the acquisition of the partnership’s assets which leads to a tax basis step-up
•Therefore: Assets owned by a partner, but used by the partnership are treated as if they were owned by the partnership
•Since the partner is taxed on the income allocation from the partnership, profit withdrawals have no relevance
Tax Planning Strategies Involving Partnerships
•Tax basis step-up/ share deal versus asset deal
•Legal entity rationalization – merger by accretion
•Debt push-down
Tax Treaty
Definition: A tax treaty is a bilateral agreement between two sovereign nations that allocates taxation rights.
In particular,
-There is no such thing as a tax treaty between more than two nations, even though this might be desirable
-In some cases, tax treaties are overruled by supranational law such as EU law
-The negotiation of a tax treaty may take a very long time. Therefore, a tax treaty may not reflect topical developments
-Like any treaty, a tax treaty can be terminated.
-In Germany, a tax treaty is invalid until it has been converted into a law
Purpose of Tax Treaty
Historic Purpose: Avoidance of Double Taxation
-Hence basic rule:
-A tax treaty can never create a taxation right that does not exist under national law
-It can only restrict or remove an existing right to tax
Topical Purpose: Avoidance of Double Taxation and Non-Taxation
-Hence updated rule:
-Countries (Germany in particular) reserve the right to override a tax treaty by an act of law (treaty override)
-A country may regain a right to tax if the other country does not use it (subject-to-tax rule)
-A country may change its method of avoiding double tax depending on the tax charge in that other country (switch-over)
Methods of Avoiding Double Taxation
-Tax exemption: Income that is subject to tax is exempt from income in the other country
-Tax credit method: Income taxed in both countries, but one country grants a tax credit in the amount of the tax paid in the other country
Excursus
Basic freedoms in the European Union
-Freedom of Establishment
-Freedom of Services
-Freedom of Capital Movement
-(Freedom of Movement)
Introduction into Procedural Law
General Background
-The tax office communicates in general statements or via administrative acts
-Administrative acts, in particular, tax assessments can be objected to
-An objection can be raised within one month after receipt of the notice
Finality of Assessment Notices
-Once a tax assessment has been issued, it cannot be changed,
-unless there is rule in the law that allows such changes. The most relevant rules are:
•the ‘obvious mistake’ rule
•the ‘proviso to review’ rule
•the ‘as applied for’ rule’
•the ‘new facts’ rule
•the ‘overriding basic notice’ rule
•the ‘contradictory tax assessment rule’
•the ‘retroactive event’ rule
Appeal (Einspruch)
-Any taxpayer can submit an appeal with respect to an administrative act received, provided that the taxpayer can demonstrate that the administrative act leads to a (financial) burden of some kind
-The procedure is reasonably informal, as long as the taxpayer indicates the administrative act and his/her objections
-The procedure is free
-The tax office needs to review the case in total and can change the assessment for the worse
Court Case (Court of First Instance)
-As a general rule, a taxpayer can only go to court once he/she has submitted an appeal and received a negative decision on that appeal
ØException 1: The taxpayer can bypass the tax office and lodge the appeal with the competent tax court directly. The tax office can then take the case back, though and treat It as a normal appeal
ØException 2: if the tax office does not react to a protest, the taxpayer can bypass the tax office (‘inactivity’)
-The procedure triggers court fees, possibly substantial ones (typically paid by the losing party)
-The court cannot change the assessment for the worse.
Court Case (Court of Second Instance)
-There are only two levels, the competent tax court (in principle, one per federal state) and the Federal Tax Court
-The Federal Tax Court will only look at a case if that review has been allowed by the court first instance
-The court of first instance must allow the review if the case has a fundamental nature or if its judgment contradicts other judgments
-If the court of first instance does not allow the review, the losing party can ask the Federal Tax Court to review the case
-The Federal Tax Court assumes that the facts as presented by the parties are correct and only review the legal analysis
-If the Federal Tax Court assumes the facts to be incomplete, the case is sent back to the court of first instance, sometimes with instructions