It makes sense not only internationally to shift profits between individual company locations. Also nationally, in Germany this offers itself. The reason for this is that the municipalities are free to choose their trade tax occupants. Therefore, the business tax burden is different in the municipalities. We explain which design models exist for national profit shifting and which are the most sensible.

1st Significance of National Profit Shifting

Profits can not only be moved abroad. It can also make sense nationally to shift profits from one community to another community. This is due to the differences between the business tax levies set by the municipalities. It therefore makes sense to transfer the profits of the company to a municipality with a low business tax levy (so-called low tax municipality).

In this domestic profit shift, the reduction in the overall tax burden is in part greater than in cross-border profit shifts. Furthermore, it is generally easier to achieve a national profit shift than a cross-border one, because many tax correction rules apply only to cross-border situations.

Business tax for the different legal forms

The different business tax rates have a very different effect on the tax burden in the individual legal forms.

For corporations, the trade tax burden varies between 7% (3.5% (tax figure) * 200% (lowest charge)) and 17.15% (3.5% * 490%). This results in a tax reduction potential of up to 10.15 percentage points in relation to the business income in the case of the accumulation of profits. In the case of distribution, the maximum possible tax reduction potential is reduced to 7.47 percentage points. The business tax paid by the limited company leads to a corresponding reduction in the distribution of profits. If the shareholders are natural persons holding their shares in private assets, the business tax of the limited liability company is partially compensated by a decrease in the withholding tax levied on income from capital assets.

In the case of sole proprietorships and partnerships, on the other hand, at the level of the owner or shareholder, the trade tax is neutralized by the tax reduction for commercial income (§ 35 EStG) in a flat-rate form. The tax reduction is in principle 3.8 times the trade tax measurement amount, but a maximum of the trade tax paid. As a result, the effective business tax burden is the lowest for a lifting rate of 380 %. Compared with the charge of 490 %, the tax reduction potential for sole proprietorships and partnerships is thus a maximum of 3,85 percentage points.

3rd Overview of Profit Shifting Models

The aim of the national profit shift is to shift profits from a high-tax community to a low-tax community. The possible configurations can be divided according to whether a displacement of functions is necessary or whether no displacement is necessary.

In the case of the actual relocation of operational functions to a municipality that has set a low business tax levy, it must be ensured that the profit made is actually taxed in this municipality. This presupposes that decomposition is avoided. This is achieved by moving the entire business to a low-tax community or by setting up a subsidiary there.

If operational functions are not to be relocated, it is decisive whether the municipality in which the undertaking providing the service is located has a higher or lower lifting rate than the municipality in which the recipient is located.

4. Shifting profits by relocating functions

4.1. Shifting profits by relocating the entire business

Often not practical is the first design model. The basic possibility to shift profits is to carry on business in a municipality that has set a lower business tax rate. From a tax point of view, it therefore makes sense to relocate the entire business activity to a municipality where the business tax rate is low. In order to maximise the benefits of the low business tax levy, it is necessary to ensure that the profit generated by the functions under consideration is fully taxable in the municipality in which the company is established. It is therefore necessary to avoid decomposition.

Therefore, it proves to be less adept to establish a permanent establishment in a low-tax municipality and to maintain the company headquarters in a municipality with a higher tax rate. Then the differences in business tax levies can only be partially exploited. The reason for this is that the success of the company due to the dismantling is partly taxable in the municipality with the higher lifting rate. However, it remains a tax saving, albeit a small one. This can be further increased by different design models within the framework of a decomposition.

The positive tax rate effect is also not offset by negative income tax effects. There are no hidden reserves to be dissolved, because the transfer of the registered office of a company within Germany is possible while continuing the book values. The continuation of the book value even reinforces the tax rate advantages in connection with current taxation by virtue of the fact that the hidden reserves contained in the transferred assets, including (proportionate) goodwill, are taxable on their dissolution in the municipality, which has a lower tax rate.

4.2. Shifting profits by involving a subsidiary

4.2.1. Effects on business tax

It may be natural, however, that not the entire company should or can be relocated to another municipality. In this case, it is appropriate to shift a partial function. The latter can take over a subsidiary which operates its company from a municipality in which a low rate applies.

The subsidiary may be set up at the commencement of business or may be created by spin-off of a branch of business from an existing company. However, the hive-off of subsidiaries into a subsidiary, which then acts as a body, is less suitable. This is due to the fact that the law then fabricates a business premises and is thus again associated with dismantling. Thus, the national tax differential cannot be exploited in its entirety. This is due to the fact that the profit generated by the outsourced functions probably represents a higher share of the company’s separately determined total profit than the share of the wages paid. Without an organization, on the other hand, the higher share of profit in the low-tax community is taxable.

A further advantage of business tax is, however, once again that the hidden reserves contained in the transferred assets and the goodwill accruing proportionally to a transferred part of the business are taxed at the lower rate at the time they are realised in the municipality.

4.1.2. Negative consequences for corporate tax or income tax?

However, it is also necessary to check whether the positive business tax effects are in contrast to negative corporate tax effects. However, the effects on the taxation of hidden reserves are the same as when the entire operation is relocated. The hive-off to a subsidiary can be carried out tax-neutrally (§ 15 in conjunction with § 11 to § 13 UmwStG or § 20 to § 23 UmwStG). It must be ensured that the hidden reserves are subject to corporate tax at the level of the acquiring company, that the taxation right of the Federal Republic of Germany is not lost and that no consideration is granted or that this consists in company rights. In the case of purely national restructurings, these conditions are regularly met.

As just mentioned, the model is most effective if the subsidiary does not create an organisation. Therefore, at the level of the parent company, 5 % of the profit distributions of the subsidiary company are considered non-deductible operating expenses (§ 8b(5) KStG). This additional burden on dividends weakens the trade tax advantages. Thus, the maximum possible savings decrease from 10.15 percentage points to 8.8 percentage points. This 5 % reclassification of the dividends paid by the subsidiary into non-deductible operating expenses makes it advisable to hive-off only if the lifting rate at the registered office of the subsidiary is less than 458 %, if the parent company has a lifting rate of 490 %.

In addition, it should be noted that the further advantages possible in principle with a trade tax and corporate tax organization must also be dispensed with. However, these advantages are not relevant for the design. The impossibility of offsetting losses is not significant anyway, because it is a question of shifting profits. By concentrating on the profit case, the restrictions on the deduction of interest expenses (so-called interest rate barrier) are also not relevant to the decision. Thus, the loss of further advantages of an organ shaft is not a negative consequence.

4.3. Profit shift through the involvement of a subsidiary

In the case of a partnership, different tax concepts apply to the individual tax types. This can also be exploited in the context of a national profit shift. In the context of income tax, successes at shareholder level are subject to taxation, the so-called transparency principle. On the other hand, the object tax nature of the business tax leads to the business tax being levied at the level of the partnership. The partnership is liable for tax (§ 5 (1) sentence 3 GewStG). It cannot be an organ company. It is therefore possible to obtain the same advantages by setting up a subsidiary as by involving a subsidiary in the absence of a body.

5. Advantages of the subsidiary compared to the subsidiary corporation in the case of profit transfer

5.1. No non-deductible operating expenses

However, a subsidiary has other advantages. Therefore, a subsidiary company is better suited than a subsidiary company. One advantage lies in the fact that, in the event of a repatriation of the profits achieved by the subsidiary, the abovementioned additional burden resulting from § 8b(5) KStG is avoided. In addition, partnerships can deduct an allowance of EUR 24,500 when determining the business income (§ 11 (1) GewStG).

5.2. Special allowances

If the parent company provides services to the subsidiary, such as loans, the remuneration at the second stage of profit determination is included as special remuneration in the business income of the subsidiary. Thus, the special remuneration under trade tax is subject to the conditions applicable to the subsidiary. If the relevant rate for the subsidiary is lower than the relevant rate for the taxation of the parent company, the business tax burden of the entire company can be further reduced. In relation to subsidiaries, there is no such possibility of relocating domestic success.

A further advantage of recording the special remuneration paid to the parent company when determining the business income of the subsidiary is that in this respect the disadvantages arising from the addition of debt capital expenses according to § 8 no. 1 GewStG do not occur: In the case of the subsidiary, an addition is omitted, since the interest and rents are included in the baseline for determining the business income. At the level of the parent company, the special remuneration due to the reduction under § 9 no. 2 GewStG remains out of recognition.

5.3. Transfer of individual goods

Further positive effects can also be achieved when transferring individual assets within the Group group. Both the transfer of individual assets from the parent company to the assets of the subsidiary and, conversely, the transfer of individual assets from the assets of the subsidiary company to the assets of the parent company are carried out at book values (§ 6 (5) sentence 3 EStG). The transfer at book value creates a positive tax rate effect when a group member for whom a high tax rate is relevant transfers assets to a group member for whom a low tax rate applies. These differences in stocks can be used when transferring hidden reserves to or from a subsidiary.

On the other hand, the individual assets transferred are each to be valued at their current value at a subsidiary. Otherwise there will be a correction in accordance with the principles of a hidden distribution of profits or a hidden deposit.

6th Conclusion on the domestic profit shift

Profits can be shifted by shifting operational functions in low-tax communities. It must be ensured that the profit is really taxed in this community. This presupposes that decomposition is avoided. Where a subsidiary is incorporated, care must be taken that it does not constitute a body. A subsidiary company never establishes an organization anyway. But it is not only for this reason that subsidiaries are better suited to reducing trade tax by shifting profits.