date | theme

May 5, 2021 | GmbH & Co KG in Austria: 25% tax at German bodies!

8 October 2021 | Establishment in Spain: only 25% tax for German partnerships

12. October 2022 | Corporate tax in the USA as tax design (this contribution)

With a classic medium-sized business model, you can use the favorable taxation with 21% corporate tax in the USA for corporate taxation. However, the shareholders also benefit from this, because on a personal level taxes are neither in the USA nor in Germany. This requires a GmbH & Co. KG in Germany and an LP as a subsidiary in the USA. GmbH & Co. KG is subject to limited taxation in the USA thanks to the transparent taxation of LP. Since it is a corporation from the point of view of the US financial authorities, it pays corporate tax in the USA. Further taxes, however, do not apply because the double taxation agreement between the USA and Germany prevents this.

In this post, we want to focus on corporate tax in the USA. This specifically involves discussing ways in which corporate tax in the USA can be used to shape the taxation of companies in Germany. This model is also called the SME model. The SME model can also be set up in combination with other jurisdictions, for example in Spain or Austria. Here, however, we want to investigate to what extent this can also be implemented in the USA.

In the USA, as in Germany, there is a corporate tax. They call it a corporate tax. It taxes corporations, in particular corporations. In the USA, the corporation thus falls under taxation by means of corporate tax. However, the option for corporate tax can also exist for hybrid companies. This includes all legal forms that as an S-Corporation can choose taxation by corporate tax. An example of this is the LLC, which can be taxed directly with corporate tax in the USA using the “check-the-box” procedure. Or they are penetrated in a transparent way by treating them as partnerships in order to tax them at shareholder level.

Now one more point that matters in the end and is aimed at the middle class model: the tax rate on the corporate tax in the USA. It is only 21% at federal level. In comparison, German entrepreneurs have to expect a corporate tax of about 30%. The fact that you save even more than the difference of 9% in the end makes things all the more exciting.

The partnerships that are taxed transparently in the USA also include the Limited Partnership, LP for short. An LP is a partnership in which at least one General Partner participates in the company as a personally liable partner. The shareholders who are only liable with their contribution, on the other hand, are called limited partners.

The LP thus corresponds to the German KG. General Partners are known to us as general partners at the KG in this context. We know the limited partners, however, under the name Kommanditist. Also in Germany, the taxation of such a partnership takes place at the level of the shareholders. It is irrelevant whether the shareholders participate in the partnership as a full shareholder or with limited liability.

By the way, as a shareholder of an LP, you also have to expect a total tax burden of about 50% in the USA. However, this varies greatly depending on the residence of the shareholders in the USA. Because in the USA, taxes are incurred on the one hand at the level of the federal government, on the other hand at the level of the federal states. Local taxes can also be added.

First we need a GmbH & Co. KG in Germany. The point here is that the GmbH & Co. KG in Germany is taxed as a partnership at the shareholder level. But even at this point, a very important point is expressed, which is of great relevance for our SME model. Because from the point of view of the US tax authority IRS, the GmbH & Co. KG is a hybrid company. Finally, the General Partner in GmbH & Co. KG is a limited liability GmbH. Why this applies to taxation by means of corporate tax in the USA, we explain immediately.

In a second step, GmbH & Co. KG now establishes an LP in the USA. For this purpose, a state is a suitable location in which there is no additional corporate tax in the USA at the state level. However, this is only the case in a few states. These include Alaska, Florida, Texas and Wyoming. Alternatively, you can also choose a state in which the tax rate is only low. In addition, it must be ensured that no or only low corporate tax is incurred at the level of the municipality in which LP is to operate.

Now the LP can begin to generate commercial profits. What you should know about starting and running a US company, we have explained in separate articles (establishing US companies, hiring employees in the USA).

At this point we solve the first puzzle in connection with the SME model. Why does the partnership LP incur corporate tax in the form of corporate tax in the USA? Quite simply: because LP is transparent as a partnership, taxation in the USA is aimed at the shareholders of LP. And this is our German GmbH & Co. KG. In this respect, GmbH & Co. KG is subject to limited taxation in the USA. Taxation thus penetrates the LP.

As we have already indicated, the US financial authorities consider the GmbH & Co. KG as a corporation. Therefore, taxation takes place in the form of corporate tax in the USA. The fact that GmbH & Co. KG in Germany, on the other hand, is considered a pure partnership is irrelevant to the US tax authorities.

Next we come to the question of whether taxes on US profits are also incurred in Germany. Fortunately, we can clearly rule out this assumption. Because between the USA and Germany there is a double taxation agreement (DTA) that serves to avoid double taxation in both countries. Here the regulations in Article 7 DTA are decisive. Similarly, it states that commercial profits are subject to taxation in the country in which the tax substrate was created. In our design model, this state is the USA. In addition, the other state, in this case Germany, then undertakes to exempt from taxation the profits, which are normally also subject to tax there. Germany thus exempts the profits already taxed in the USA from its own taxation. For this reason, it remains the taxation with 21% corporate tax in the USA.

All that remains is to transfer the profits. On the one hand, LP transfers its profits to GmbH & Co. KG. This process is tax-free as a profit distribution, because the LP as a US partnership does not transfer dividends as capital income.

After the money has been received in the account of the Deutsche GmbH & Co. KG, we can make the next profit distribution to their shareholders. However, since this is a pure distribution of profits from already taxed profits, this is only another payment that is not subject to taxation as in the case of a dividend subject to capital gains tax. After all, from the point of view of the German financial authorities, GmbH & Co. KG is a partnership, not a capital company.

Also relevant is the fact that none of the requirements of § 50d paragraph 9 EStG are met, according to which additional taxation would otherwise occur. This risk is also averted by the SME model with the corporate tax in the USA.

As already mentioned, the SME model can be used in many ways to help companies and entrepreneurs save taxes. This is a recognized, legal tax design model. All national tax laws apply here. After all, taxation also takes place exactly where the entrepreneurial activity is located. So mailbox companies that fabricate a supposed business operation in tax havens are not in play here. The substrate to be taxed is actually present and is subject to taxation. Furthermore, no exceptions under German tax law apply to this design model. Consequently, all provisions of the double taxation agreement for the exemption of profits in Germany must be observed. Otherwise, double taxation would take place in both countries.

Again, this cannot be in the interest of the two states. This is all the more true because both Germany and the US want to act as pioneers of globalization. The fact that a German company then uses the possibilities to exercise the cheaper corporate tax in the USA is just a legal side effect of international networks of order. Who knows, maybe one day US companies will come up with the idea of using future changes in tax law in one of the two states to set up a company according to the medium-sized business model in Germany?