Tax Reform Compromise Enacted

The tax reform compromise reached by the parliamentary Reconciliation Committee was passed by both chambers of parliament on December 19. The four bills will therefore take effect on January 1, 2004

The four bills of the tax reform compromise reached by the parliamentary Reconciliation Committee on December 14 were passed by Bundestag and Bundesrat on December 19. Their formal enactment with the signature of the federal president and promulgation are expected well in time for entry into force as of January 1, 2004. They are:

Left-overs from the 2003 Tax Concessions Pruning Act ("Basket II")

Thin capital rules on related-party finance

? The rules will apply to all companies, regardless of ownership or residency

? Partnerships also fall into the net if at least one of the partners is a corporation holding more than 25%

? Companies with a total annual related-party interest expense of no more than ? 250,000 will be exempt

? There will be a common safe haven debt/equity ratio of 1.5:1. The current (2003) 3:1 ratio privileging holding companies will be dropped

? All related party interest expense of financing acquisitions within a group will be a "hidden distribution" by definition.

Loss relief

? The maximum offset in any one year from losses brought forward will be ? 1m plus 60% of the taxable income over ? 1m. In other words, losses brought forward will not shelter 40% of the annual income over ? 1m from immediate taxation

? The restrictions on natural persons on offsetting losses from one source against profits from another are to be abolished

? Silent partnership losses from holdings of one corporation in another can only be relieved against profits from the same silent partnership holding.

Non-deductible expenses directly connected with tax-free dividend income and capital gains

? An amount equivalent to 5% of the tax-free dividend income and capital gains realised by a corporation is to be added back to taxable income. This legal fiction of "directly connected" expense is to be irrefutable even where it is patently false. It extends the 2003 rule applicable to dividends of foreign source only.

Loopholes in The Foreign Tax Relations Act closed

? The passive income attribution rules will henceforth apply even if a double tax treaty would preclude a charge to tax under the Foreign Investment Funds Act if the income were remitted

? An "active" business must henceforth be conducted directly, as opposed to through a subsidiary.

Other...