1. German Business Tax Reform 2008 Wilma Ehlert (Certified Tax Adviser) Benno Lange (German CPA, Certified Tax Adviser) DHPG Dr. Harzem & Partner KG, Bonn/Gummersbach NEXIA European Tax Group Meeting Lisboa, September 28, 2007

2. Folie 2 © DHPG 2007 Overview German Business Tax Reform 2008 I.Survey II.Tax Law Changes for corporations and partnerships III.Counter-Measures for Financing

3. Folie 3 © DHPG 2007 I. Survey Background of the Business Tax Reform

4. Folie 4 © DHPG 2007 I. Survey Background of the Business Tax Reform - European company tax rates 2007 -

5. Folie 5 © DHPG 2007 I. Survey Effective Dates Calendar year taxpayers: January 1, 2008 Deviating fiscal year: FY 2007/2008 Changes in taxation of dividends and interests: January 1, 2009

6. Folie 6 © DHPG 2007 II. Tax Law Changes for corporations and partnerships A.New Regulations for corporations B.New Regulations for partnerships C.Summary

7. Folie 7 © DHPG 2007 1. Taxation of the corporation Trade tax Base rate trade tax5 %3,5 % Municipal levy rates200 – 500% Trade tax9,10 – 20,00 %7,00 – 17,50% Present rateNew rate Corporate income tax 25 %15 % Solidarity surcharge5,5 % Combined rate26,38 %15,83 % Rate cuts Total company taxes33,08 – 41,10 %22,83 – 33,33 %

8. Folie 8 © DHPG 2007 1. Taxation of the corporation 2007 Earnings before taxes100,00 Municipal levy rate trade tax 400 %- 16,67 Basis for corporate tax83,33 Corporate tax + Solidarity surcharge- 21,98 Company taxes-38,65 Earnings after taxes61,35 Company taxes Trade tax is not deductible any more Application for reducing the prepayments is possible 2008 100,00 - 14,00 100,00 -15,83 -29,83 70,17

9. Folie 9 © DHPG 2007 2. Taxation of the shareholder 26,3828,4923,74 Income tax 45 % + Sol. Surcharge 26,3826,5922,16 Income tax 42 % + Sol. Surcharge Flat WHTScale Tax rate 100,0060,0050,00 Subject to income tax 100,00 Dividend income PrivateBusiness* 200920082007 Income tax on dividends - individuals Maximum income tax rate 42 %, `Rich people‘s´ income tax rate 45 % (taxable income > 250.000 €) Flat withholding tax: income related expenses are not deductible will also be applied on capital gains on the disposal of shares 100,00 * Without trade tax

10. Folie 10 © DHPG 2007 3. Overall view 20072009 Business*Private Earnings before taxes100,00./. Taxes on Income- 38,65- 29,83 = Earnings after taxes61,3570,17 Taxable income shareholder30,6842,1070,17./. Income tax + Sol. (45% / WHT)- 13,81- 19,99- 18,51 Net income shareholder47,5450,1851,66 Total tax52,4649,8248,43 Total tax * Without trade tax

11. Folie 11 © DHPG 2007 II. Tax Law Changes for corporations and partnerships A.New Regulations for corporations B.New Regulations for partnerships C.Summary

12. Folie 12 © DHPG 2007 Trade tax  Lowering of the trade tax base rate from 5 % to 3,5 %  Elimination of lower base rates for low level earnings (until 2007: 0 – 4% on earnings up to 72.500 €)  Elimination of trade tax deductibility Income tax  `Rich people‘s´ income tax rate 45 % also on business income  Income tax reduction by trade tax credit –Increase of trade tax credit to multiplier 3,8 on the basis for trade tax (until 2007: 1,8) –Limitation of maximum credit to actually payable trade tax  Preferential taxation on retained earnings 1. Survey

13. Folie 13 © DHPG 2007 2. Taxation without preferential taxation of retained earnings 1,74 1,51Solidarity Surcharge+ 33,4429,01 Income tax partner= 20082007 47,4445,68 Total tax 7,50 Trade tax credit 2007: 5% x 83,33 x 1,8./. 45,0035,00 Income tax 86,0083,33 Earnings after trade tax= 14,0016,67 Trade tax (400 %)./. 100,00 Earnings before taxes (45 %)(42 %) Taxes on business income 13,30 Trade tax credit 2008: 3,5% x 100 x 3,8./.

14. Folie 14 © DHPG 2007 3. Preferential taxation of retained earnings Effective as of January 1, 2008 or fiscal year 2007/2008 Individual  Sole proprietorships  Individual investor in a partnership, if minimum interest > 10 % or prorated earnings > 10.000 €  Resident or non-resident persons Business, self-employed or agriculture and forestry income Only accrual-basis accounting (not cash-basis accounting) Application filed by each partner for the retained amount

15. Folie 15 © DHPG 2007 Example A is 50 % partner of AB OHG; the second partner is B-GmbH Earnings before trade tax AB-OHG in 2008: 1.000.000 €, Trade tax 140.000 € Prorated earnings A = 500.000 € (Withdrawal./. allocation ) A = 200.000 € A applies for preferential taxation of maximum amount in 2008 3. Preferential taxation of retained earnings

16. Folie 16 © DHPG 2007 Example K € Prorated earnings A 2008500,0./. Trade Tax - 70,0./. Withdrawal- 200,0 Retained earnings230,0 Preferential tax rate 28,25 % + Sol. Surch.- 68,6 Remaining retained earnings161,4 Distributed earnings (trade tax + withdrawals)270,0 Income tax 45 %./. Trade tax credit58,0 Total Taxes 2008196,6= 39,3 % 3. Preferential taxation of retained earnings

17. Folie 17 © DHPG 2007 3. Preferential taxation of retained earnings Continuing Example Earnings before trade tax AB-OHG in 2009: 0 € Withdrawal A = 161.400 € K € Remaining retained earnings 2008161,4 Withdrawal 2009 = distribution- 161,4 Remaining retained earnings 20090,0 Flat WHT 25% + Solidarity Surcharge 200942,6 + Taxes 2008196,6 Total tax 2008 and 2009239,2= 47,8 % Total tax 2008 without privilege taxation237,2= 47,4 %

18. Folie 18 © DHPG 2007 II. Tax Law Changes for corporations and partnerships A.New Regulations for corporations B.New Regulations for partnerships C.Summary

19. Folie 19 © DHPG 2007 III. Counter-Measures for Financing A.Changes in rules for depreciation B.Earnings stripping rules C.Modifications to trade tax addbacks D.Tightened change-of-control rules E.Transfer pricing/base shifting

20. Folie 20 © DHPG 2007 Current regulation: option for depreciation of movable fixed assets  straight-line depreciation  declining-balance depreciation (at most 30 % of residual book value) New regulation  declining-balance depreciation only for assets aquired or produced before January 1, 2008  only straight-line depreciation for assets aquired or produced after December 31, 2007 Changes in rules for depreciation

21. Folie 21 © DHPG 2007 General rule and definitions  replaces thin-capitalization rules (§ 8a KStG)  Net interest expense is deductible only up to 30 % of Tax- EBITDA  Net interest expense = difference between interest income and interest paid  Interest = All interest payments, receipts and/or accruals whether to or from related party or third parties  In the case of group taxation the whole group would be treated as a single entity  Disallowed net interest expense can be carried forward indefinitely Earnings stripping rules (Interest deduction limitation)

22. Folie 22 © DHPG 2007 Earnings stripping rules (Interest deduction limitation) DifferencesCurrent rule: § 8a KStGNew rule: § 4h EStG/§ 8a KStG Creditor shareholder > 25 % related parties back-to-back every type of creditor (shareholder, related party, bank) Borrowercorporationsevery type of business association Save havenEquity-loan-ratio 1 : 1,5 30 % of Tax-EBITDA Exemptionsarm´s-length-test de-minimis-threshold KEUR 250 - de-minims-threshold EUR 1 Mio. not part of a controlled group if part of a controlled group: escape clause ConsequenceInterest is qualified as a hidden profit distribution to shareholder Interest is not deductible, may be carried forward

23. Folie 23 © DHPG 2007 Earnings stripping rules (Interest deduction limitation) interest paid - interest income net interest expense ≤ 0 net interest expense < 1 Mio. EUR not part of a controlled group? Escape clause fulfilled? Interest deduction limitation: only 30 % of Tax-EBITDA deductible, carry-forward of exceeding amount No interest expenses are completely deductible Yes

24. Folie 24 © DHPG 2007 The escape clause  business is part of a group  taxpayer must prove that equity ratio of the business is not more than 1 percent less than that of the controlled group as a whole  equity ratio is calculated according to IFRS (alternatively German or US-GAAP)  corporations additionally: –escape clause only applies if the remuneration on shareholder debt does not exceed 10 percent of the net interest expense –shareholder debt is only counted if shown as liability in the consolidated accounts –escape clause denied even if the 10 percent threshold is exceeded by only one group company Earnings stripping rules (Interest deduction limitation)

25. Folie 25 © DHPG 2007 Earnings stripping rules (Interest deduction limitation) 20072009 DividendInterestDividendInterest Tax-EBITDA120,00./. Depreciation-20,00./. Net interest expense-100,00 Income after interest100,000,00100,000,00 Taxable corp. tax100,000,00100,0064,00 Taxable trade tax100,000,00100,0064,00 Trade tax addback0,0050,000,009,00 Corp. tax + sol. levy21,980,0015,8310,13 Trade tax (400 %)16,678,3314,0010,22 Taxes on income38,658,3329,8320,35 Spread30,329,48

26. Folie 26 © DHPG 2007 Carry-forward of disallowed interest expense  no time limitation  use is only possible after radical change of profit situation  333 EUR EBITDA necessary to deduct 100 EUR of carry forward  change-of-control rules apply also for net interest expense  no carry-forward after restructuring Earnings stripping rules (Interest deduction limitation)

27. Folie 27 © DHPG 2007 One fourth of the sum of the following payments will be added back in calculating trade income  loan remuneration (e. g. interest)  recurring payments  profit shares of a silent partner  one fifth of rental/leasing payments for movable fixed assets  three fourths of rental/leasing payments for immovable fixed assets  one fourth of royalty payments  de-minimis threshold: 100.000 EUR Modifications to trade tax addbacks

28. Folie 28 © DHPG 2007 Present regulation  § 8 Abs. 4 KStG (CIT Act)  Economical identity is necessary for use of loss carryforward  Economical identity proved by –share transfer test (> 50 % within 5 years) AND –business asset test (predominantly new assets)  applies also for trade tax purposes  not valid for indirect changes in ownership  special rules for corp. under restoration  no exemptions for listed companies  applicable for transfers before January 1, 2008 Tightened change-of-control rules

29. Folie 29 © DHPG 2007 New regulation  § 8c KStG (CIT Act)  harmful share transfers trigger forfeiture of loss carryforward –transfers within 5 years –> 25 %: proportional forfeiture –> 50 %: complete forfeiture –share capital increase = transfer  applies also for trade tax purposes  valid for direct and indirect changes in ownership  no special rules for corp. under restoration  no exemptions for listed companies  applicable for transfers after December 31, 2007 Tightened change-of-control rules

30. Folie 30 © DHPG 2007 Tightened change-of-control rules 100 % 30 % Transfer of 30% Tax loss carryforward (CIT and trade tax) = 1 Mio. EUR Consequence: Forfeiture of tax loss carryforward (30% of 1 Mio. EUR = 300.000 EUR) and current loss until harmful share-transfer for CIT and trade tax purposes 100 % Example: Direct transfer

31. Folie 31 © DHPG 2007 Tightened change-of-control rules Tax loss carryforward (CIT and trade tax) = 1 Mio. EUR Consequence: No harmful transfer because only (30 % of 70 % =) 21 % of the shares are transferred Example: Indirect transfer M (non resident) T-GmbH (loss carryforward) H (resident) 100 % 70% New shareholder 30 %

32. Folie 32 © DHPG 2007 New rules for transfer pricing  Priority methods for transfer pricing –Comparable uncontrolled price method –Resale price method –Cost plus method  Other methods can be used if standard methods are not applicable –Transactional net margin method –Profit split method –Comparable profit method is not allowed  If no comparable data is available (base shifting?): hypothetic arm´s length test Transfer pricing/base shifting

33. Folie 33 © DHPG 2007 Range of comparative values  Federal Tax Court (BFH) decision in 2001: –there is not one arm´s length transfer price, but always a range of those –every transfer price within this range is arm´s length –if the effective price is outside the range, the boundary value is used for taxation  New regulations as of 2008 –only narrowed range is arm´s length –if the effective price is outside the narrowed range, the median is used for taxation Transfer pricing/base shifting

34. Folie 34 © DHPG 2007 Documentation duties introduced in 2003  facts and circumstances documentation  appropriateness documentation Changes to documentation requirements  Exceeded documentation requirements for base shifting, R & D activities and cost sharing agreements  Time limit for submission of documentation is reduced from 60 to 30 days for extraordinary transactions  Correction of transfer price possible if foreign related party does not submit supplementing information Transfer pricing/base shifting

35. Folie 35 © DHPG 2007 New rules for base shifting  Exit tax charges for transfer of business functions –Transfer includes all risks and opportunities relating to the function (e. g. production, distribution) –Individual components have to be evaluated as one package (transfer package) –Arm´s-length-price: profit potential, determined by discounted cash flows –Provision for retrospective adjustment  Problems: –taxation on synergy effects –no OECD-rules for base shifting yet –violation of EU law? Transfer pricing/base shifting