Explained for freelancers and the self-employed: the new corporate tax changes in depth

This year saw Germany elect a new government, and as to be expected, the tax changes were certainly less than the sweeping round that came into effect in 2021. That said, there was a key change to the corporate tax that is worth delving into. One of the deterrents of incorporating a business or partnership, or changing the formation, was how that it would increase the tax burden or in the very least complicate it.

For those who have or will consider a change from freelancer to corporation, or evolve business partnerships - here is the overview of these changes. Let’s start with a more formal introduction to these changes.

With the "Law for the Modernization of Corporate Income Tax Law" (KöMoG) of June 25, 2021, an option for corporate taxation was introduced. Commercial and partnership companies are thus given the opportunity to be treated like a corporation for income tax purposes without actually changing their legal form.

Above all, this is intended to strengthen the international competitiveness of medium-sized family businesses in the legal form of a limited partnership or a general partnership. The background to this is that partnerships are treated as independent tax subjects under trade tax law. For the purposes of income taxation, however, these are exclusively those directly or indirectly involved in it.

In individual cases, this could lead to sometimes considerable deviations in the tax burden and bureaucratic effort compared to corporations.

Partnerships entitled to the option

Only companies that can change their legal form in accordance with the Transformation Tax Act may make use of the option. Sole proprietorships are also excluded. Partnerships (limited partnerships, general partnerships and comparable foreign companies) and partnership companies, as well as their shareholders, are given the opportunity to be treated in terms of income tax and, consequently, procedurally like a corporation or its non-personally liable partner.

Accordingly, these associations of persons have been included in the list of corporations, associations of persons and estates. Civil law companies (GbRs) are currently not allowed to use this option.

Requirement to apply

In order to make use of the option, the partnership must submit an application to the tax office responsible for the separate and uniform determination. The application is irrevocable and must be submitted as a data record in the specified form via the Internet at the latest one month before the start of the financial year from which taxation is to take place like a corporation. A retroactive application is not possible.

The right to choose is to be exercised uniformly by the partnership concerned, for example, the consent of all shareholders is required, subject to deviating provisions in the articles of association. There is no provision for the shareholder to choose individually for his or her share.

Consequences of exercising an option

The transition from the taxation of partnerships to corporate income taxation is treated as a change of form. This change of legal form is by the application to exercise the option - without retroactive taxation in order for the process to be tax-neutral. It is particularly relevant that no functionally essential operating principles may be retained.

This includes, for example, the special business assets owned by a partner under civil law. This would (initially) have to be transferred separately to the partnership. As a result of the change of form, analogous to a "real" change of form, there should be subsequent taxation of any retained amounts.

The effects of an option are basically limited to income taxes (corporation tax, income tax and trade tax) for the company and its shareholders. An opting company is taxed in the same way as a corporation, which is basically to be seen separately from the level of the shareholders. After exercising the option, the latter are treated like the non-personally liable partners of a corporation.

Ultimately, all regulations of the Corporate Income Tax Act that refer to corporations or corporations apply. In terms of civil law, however, the company remains a partnership.

The civil law liability of the partners for the corporation and trade tax owed by the commercial or partnership company based on the option remains unaffected. If the partners are unrestrictedly liable under civil law, this also applies to the corporation tax and trade tax debts of the commercial or partnership company. If necessary, the partners can also be liable.

Exercising the corporate income tax option can also have indirect effects on other regulations, provided that they refer to income taxation, even if they are not income taxation regulations. Therefore, regardless of whether there is an accounting obligation under commercial or company law, the profit of an opting company must always be determined by comparing the portfolio. This ensures that all opting companies, including partnership companies, are treated like corporations in this respect.

Application, and reverting to original form

There is no binding period for exercising the option. However, the application for the option back must be submitted in accordance with the rules for exercising the option of corporate taxation before the start of the financial year from which taxation is to take place again according to the transparency principle. This results in a minimum term of one year.

As in the case of exercising the corporate tax option, there is no retroactive tax effect for the option back. The application for the option back must be submitted to the tax office that would be responsible for accepting the corporation tax return of the opting company at the time of submitting the application.

The return option is triggered without the need for an application, even if the conditions for exercising the option no longer apply. This is particularly the case if a commercial partnership is converted into a civil law partnership or if there is no longer any corporation tax liability in the country in which the opting company is managed.

Since sole proprietorships do not exercise the option, taxation in accordance with corporate income tax principles will also be terminated without an application if the partnership is terminated under civil law due to the departure of the penultimate partner. If the penultimate shareholder leaves during the year, a separate transfer balance sheet must be drawn up for this point in time. The return option counts as a change of form, which is taxable.

Initial application period

The application can be submitted for the first time for financial years beginning after December 31, 2021. Companies with fiscal years in the same calendar year that want to use the option for 2022 must submit the application by November 30, 2021 at the latest.

The Federal Ministry for Finance has now outlined all of the particular the application requirements and application form, assessment options, supplementary and special balance sheet problems, the consequences for the income tax group and the return option and similar.

They have also published the draft of a general administrative regulation on the revision of the corporation tax guidelines 2022. The new version takes into account the legal changes that have taken place in the meantime, in particular the corporate income tax law, and adjustments to current case law. 

It is worth noting that after overwhelming feedback from engagement with businesses across the country, a correct step is being taken towards neutrality of burdens for companies of different legal forms. From the point of view of many companies, however, important corrections to the draft law were unfortunately no longer made in the legislative process, such as the establishment of the option for sole proprietorships and civil law companies (GbRs) or the cancellation of the obligation to immediately post taxation of profits that were previously made within the framework.

Hopefully this changes in the coming years. The impacts of Corona remain to be seen, and maybe it has not been growing expressly on your mind. But with these changes, it may be more possible to create a different circumstance with your business - so time to get the calculator out, and see how it looks on the balance sheets!