the option model under the Corporate Income Tax Modernisation Act.
Since most companies in Germany are organised as partnerships, there has long been an effort to open up the corporate income tax option to these companies. The hoped-for advantage is that the retention burden of currently 15 % with regard to corporate income tax should also be open to partnerships. So far, this has not been possible for partnerships, as they are considered transparent for income tax purposes. With regard to trade tax, both company forms are treated equally, as the partnership is also considered a taxable entity for trade tax purposes.
Accordingly, on 17 March 2021, the Federal Government launched a draft law entitled “Law on the Modernisation of Corporate Income Tax”. It is expected that the draft law will be implemented before the next Bundestag election.
According to the Federal Government’s intention, partnerships would be able to exercise the option for corporate income tax from 1 January 2022 (§ 1a KStG draft). This would mean that the entire Corporation Tax Act would apply to partnerships. At the level of the partnership partner, this has the consequence that his profit distributions from the partnership will be treated as dividends for tax purposes in the future. In individual cases this can be advantageous but also disadvantageous. The dividend is indeed taxed at a privileged rate of 26.375%. However, it contains the possibility of offsetting losses from other types of income, which is not the case with partnerships.
Under civil law, this does not change the fact that it is a partnership. This means that the general partner is liable without limitation and the limited partners are liable only to the extent of their contributions.
The option is exercised by application. This must be submitted before the beginning of the respective financial year: in the case of financial years with the same calendar year, this means by 31 December 2021, 0:00 hours, if the option is already to apply for the 2022 financial year.
The option can also be reversed by means of a so-called re-option (section 1a (4) KStG draft). Both the option and the re-option are treated as a change of legal form within the meaning of the Reorganisation Tax Act (section 1a (2) and (4) KStG draft). Thus, the respective regulations from the Reorganisation Tax Act apply. In this context, the so-called seven-year period pursuant to section 22 para. 1 of the Reorganisation Tax Act, according to which the re-option can potentially lead to a disclosure of hidden reserves, must be taken into account.
In principle, the proposed reform is nothing more than a simplified perception of the already existing instruments of the Reorganisation Tax Act. In this respect, the reform is less groundbreaking than the title might suggest. The possibility for a corporation to optimise for tax transparency like a partnership still does not exist after this reform.
We would be happy to calculate the consequences for your company of exercising the option.