Germany: BMF guidance on election for corporate tax treatment of partnerships

Guidance on the election (option) for corporate taxation of commercial partnerships

Guidance on the election (option) for corporate taxation of commercial partnerships

The German Federal Ministry of Finance (BMF) on 10 November 2021 issued guidance on the election (option) for corporate taxation of commercial partnerships (Section 1a of the German corporation tax law [KStG]).

Background

The law updating the corporate tax law includes an election for corporate tax treatment of commercial partnerships. Commercial partnerships are thereby allowed the option of being taxed like a corporation without actually changing their legal form. The election for corporate taxation can be exercised for the first time for financial years beginning after 31 December 2021.

BMF guidance

All “commercial partnerships” (Personenhandelsgesellschaften) are within the scope of the election. This applies explicitly also for partnerships involved in purely asset management activities. Companies of comparable foreign legal forms (legal form comparison, operation of a commercial enterprise) are also eligible. Companies without a registered office and management in Germany can also elect for corporate taxation; upon exercising the election, these companies are subject to limited corporate tax liability. The election is also possible if the foreign company generates no German-source income.

The application to exercise the election must be submitted to the competent tax authority no later than one month before the start of the financial year from which the election of corporate income taxation is to apply.

The transition to corporate taxation is considered as a change of form, from partnership to corporation.

  • To exercise the valuation election for German reorganisation tax purposes (change of form at book or interim value), all of the company's functionally material operating assets must be transferred to the fictious corporation. This also includes assets under the ownership of the partner and that are provided to the company for its use (e.g., the business property). These must be transferred separately to the company before the fictious change of form.
  • The fictious change of form due to the option being exercised can also lead to the violation of existing “lockup periods.”
  • Due to the election for corporate taxation, all interests in the opting company will be subject to lockup periods (seven years) if the fictious change of form at book or interim values is enacted. This has the effect of an early sale of interests in the electing company as triggering "taxation of contribution profit" (i.e., the hidden reserves in the "transferred" assets are to be taxed retroactively at the date the election is exercised).
  • Exercising the option results in any loss carryforward (for trade tax) of the electing partnership being forfeited. This also applies for the interest carryforward and any EBITDA carryforward in the context of the interest limitation rules (Zinsschranke).

A company that has elected for corporate taxation is, for purposes of taxation, treated equally according to taxation of income of a corporation. The partners of the company opting for corporate taxation are treated like corporate shareholders that are not personally liable, and the ownership interest in the opting company is treated like a shareholding in a corporation.

Other measures provide rules with regard to the following:

  • EU directives: The electing company is not a beneficiary company of the Parent-Subsidiary Directive or the Interest and Royalties Directive.
  • Income tax treaties: The electing opting company is entitled to treaty benefits as "company" within the meaning of an income tax treaty and is resident in Germany if its place of management is in Germany.
  • Tax group: An electing company can be a controlling entity but not a controlled entity. Already existing tax groups between the electing company as controlling entity and its controlled entities will be continued.
  • Partners' profit shares: These shares are deemed distributed, and partners must pay tax on these profit shares only when they are withdrawn or their payment can be demanded.

Reversing the election from corporate taxation back to transparent taxation as partnership also requires an application to be made no later than one month before the beginning of the financial year in which the opting company is for the first time no longer to be taxed like a corporation. The termination of the election for corporate taxation is treated as a fictious change of form from corporation to partnership.

Reversing the election or other termination of the option of corporate taxation within seven years generally leads to a violation of the lockup period regarding the interests subject to the qualifying period and triggers taxation of contribution gains.

Read a November 2021 report [PDF 355 KB] prepared by the KPMG member firm in Germany

 

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