On 29 March 2010, the German Federal Ministry of Finance published its draft of the 2010 Annual Tax Law Act (Jahressteuergesetz 2010 or JStG 2010).

It should be noted that, in addition to specific tax acts which generally only deal with one substantive matter, the German legislature regularly (more or less annually) introduces tax acts which deal with various unrelated matters regarding several types of taxation. These legislative measures, called omnibus acts (Artikelgesetze), tend to be long and complex and therefore need to be reviewed carefully in order to find the potential consequences for the business operations of affected companies.

The draft of JStG 2010 contains proposed amendments for 22 German tax acts. The bill itself contains 151 pages including explanatory statements. The following summary focuses on the most important provisions.

• Foreign Tax Act:

The German Foreign Tax Act (Außensteuergesetz or AStG) contains a provision requiring the addition of a foreign company’s income to a German shareholder’s income if the foreign company is regarded as an intermediate company, a determination which depends on the tax rate applied to the company’s income. If the income tax burden is low (generally under 25%) the company will be regarded as an intermediate company and a proportionate amount of its income will be added to the income of a shareholder who is subject to unlimited tax liability in Germany and holds more than 50 % of the company’s shares. Whether low taxation within the meaning of the legal provision exists depends on the actual taxation of the company in question rather than merely the applicable rates. Furthermore, a shareholder’s right to claim tax refunds or credits will also be taken into account in the determination thereby discouraging the use of group structures to avoid the finding of “low taxation” in regard to a particular foreign company.

• Relocation of Bookkeeping:

The 2009 Annual Tax Law Act contained a provision which allows enterprises to relocate their electronic bookkeeping abroad. For such relocation to be accepted, the following conditions must be met:

· the relocation is to a member state of the EC and/or EEA;

· the state to which the bookkeeping is to be relocated allows the German authorities to recall data;

· information is provided to the tax authorities regarding the location of the data system which conducts the electronic bookkeeping;

· the taxpayer has fulfilled all tax obligations in the past; and

· access to the data is given to the German tax authorities to the fullest possible extent.

The regulation contains an exclusion clause which provides that the German tax authorities may allow relocation even if the first three requirements are not met to the extent that the relocation will not limit German taxation.

The new regulation deletes the obligation to relocate the bookkeeping to EC or EEA member states so that relocation will now be allowed to any country in the world. Additionally, the destination state’s allowance of Germany’s data recall rights — which was seen as the greatest hurdle for taxpayers — will no longer be required.

On the other hand, under the new regulation the basic principle that relocation must not limit German taxation is no longer a condition for the exceptional allowance of relocation but rather a general condition for any relocation.

• VAT Fraud:

Up to now, under German law, VAT fraud to the detriment of other member states would only be pursued by Germany to the extent that the affected state enacted regulations which ensured reciprocal treatment for Germany. Since this provision has never been applied in practice, however, no VAT fraud cases to the detriment of other states have ever been pursued by Germany.

To close this loophole, the currently applicable conditions will be deleted by the draft JStG 2010 with the result that German prosecutors will be free to prosecute cross-border VAT fraud which affects taxes levied by other EU member states without fulfilling any further conditions.

• Inheritance and gift tax:

The new German inheritance tax law which came into force on 1 January 2009 included preferential tax treatment for successions of family businesses. Under the provision, 85% of the inheritance is tax exempt if the heir continues the business for a prescribed period following receipt of the business and meets an employee-retention requirement at the end of the respective time period. The exemption only applies, however, to businesses whose assets consist of at least 50 % productive property which means that investment assets (Verwaltungsvermögen) may not exceed 50% of total assets.

A complete exemption from inheritance tax is granted if the investment assets do not exceed 10% of the total assets, to the extent that other preconditions such as the business continuance and the employee-retention requirements are met.

A special aspect of this investment-asset requirement provides that company participations are regarded as investment assets of the participating business if more than 50% of the held company’s total assets are investment assets. If the held company’s investment assets do not exceed 50 % of its total assets, however, the participation is not regarded as investment assets of the participating business. Companies holding participations in other companies were able to use this provision for tax planning by, for example, transferring their own investment assets into affiliated companies which did not exceed the 50% threshold.

In order to counteract this so-called cascade effect (Kaskadeneffekt), the new regulation would also impose the 10 %-investment-asset requirement on the companies in which the inherited business held participations in order for the participation to be regarded as an operating asset. If the threshold is exceeded, the participation would be regarded as an investment asset thereby increasing the investment asset rate of the inherited business.

This regulation is scheduled to enter into force the day following passage of the JStG 2010.

• VAT:

The new regulation would abolish the so-called Seeling-model which allows a taxpayer who acquires or erects a mixed-use building (business as well as private use) to decide whether or not to treat the entire building as a business asset in which case he can deduct all input VAT paid for acquiring or erecting the building rather than just the input VAT allocable to the business-use section. Subsequent private use of the building is then taxable as goods and services provided free of charge (unentgeltliche Wertabgabe), the annual value of which is determined as one tenth of the value of the costs allocated to the privately used part of the building.

The ability to deduct input VAT which was otherwise non-deductible with “repayment” over a ten-year period essentially granted taxpayers a ten-year, interest-free loan. This result would be eliminated by the proposed amendment which would limit the deductable input VAT to the amount allocable to the business-use part of the building only

The amended regulation would apply to real estate acquired or erected after 31 December 2010.