Investment in Germany

Author: | Published: 1 May 2011
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More and more Chinese companies are settling down in Germany and taking it as their headquarters or operating centre for their business in Europe. Germany is located in the centre of Europe. It is the largest economy in Europe and the largest consumer market within the EU. Germany’s ideal location in the heart of Europe creates a multitude of opportunities for European and international business.

In the past, Chinese investors came to Germany, established their own subsidiary and focused on trading with Chinese products in European markets. More and more Chinese companies now enter the German market through mergers and acquisitions, and focus their branches on sectors such as machinery, automotive, telecommunications, renewable energies and consumer products.

We would like to outline the major legal and tax aspects when making an investment in Germany.

Foreign investment in Germany

Foreign investment is welcome in Germany. There are no substantial restrictions on new foreign investments, and no permanent currency controls or administrative controls on such investments. Furthermore, the financial crisis has led to much stricter loan granting policies by the commercial banks. This has caused a few companies to restructure their financing and seek for new sources of capital. And this has opened a window of opportunity for foreign investors to get access to companies, particular in the so-called German 'Mittelstand’ (family-owned businesses).

Foreign investors are subject to the same conditions as German investors when obtaining licences and building permits, or applying for and receiving investment incentives. Where restrictions exist with respect to a particular business activity, such as licensing and notification requirements, such restrictions (with a few exceptions) apply to both German and foreign businesses.

The July 2006 Takeover Directive Implementation Act amended the Securities Acquisition and Takeover Act (Wertpapiererwerbs- und Übernahmegesetz – WpÜG). The WpÜG now also applies to cross-border takeovers.

As the German Federal Cartel Office aims to prevent the establishment of dominant market positions, large firms must get approval by the cartel authority prior to the execution of an acquisition based on certain criteria. M&A transactions above a certain size (essentially, involving companies or corporate groups with a joint worldwide turnover exceeding €500 million (approximately US$683 million)) – and including at least one German entity with a turnover exceeding €25 million and the other entity with a turnover exceeding €5 million – must be cleared and can be prohibited by this authority if considered to be detrimental to competition. EU antitrust laws may pre-empt German antitrust laws or add to it, depending on the transaction.

Furthermore, Germany reserves the right to interdict participation by foreign investors in German entities outside regulated industries under the German Foreign Trade Act (Außenwirtschaftsgesetz) – for example, with the acquisition of interest in German companies and real estate if it deems the participation to be a threat to national security and/or public order. Investors can seek a clearance statement prior to execution of an acquisition. And there are requirements under the Foreign Trade Regulations (Außenwirtschaftsverordnung) to report certain participation or flows of capital for statistical purposes.

When planning an M&A transaction, labour law considerations should also be taken into account. Under a provision in force in one form or another throughout the EU, the purchaser of a business automatically takes over all employment relations associated with it. It makes no difference in this respect whether shares or assets are purchased, although questions arise when not all assets of a business are acquired such as one of several business divisions (branches of activity). Continuation of employment contracts does not ipso facto prevent immediate downsizing following the acquisition, but this must be conducted in accordance with general German labour law legislation.

Furthermore, Germany has an employee co-determination system for virtually all businesses. The system has several variants but the simplest, which involves election by employees, is the works council. The works council has a variety of rights to be informed and to be heard on personnel and other intra-company matters, and some co-determination rights (where their consent is required).

Investment options

If Chinese companies are going to invest in Germany, the following common legal forms could be considered as they allow a limitation of the owner’s liability to the agreed capital contribution.

Limited liability company GmbH

The GmbH is the most common form of business association. It is a corporate entity with its own legal identity, has one or more shareholders, and share capital of at least €25,000. Shares in GmbHs are not certified. The purchase and transfer of shares in an existing GmbH requires an agreement, which must be recorded in the presence of a qualified notary. The management of a GmbH rests with one or more managing directors appointed by the shareholders. The managing directors are subject to close supervision and control by the shareholders and are generally obliged to respect instructions given to them by way of resolutions of the shareholders’ meeting. A GmbH is not obliged to establish a supervisory board, unless this becomes necessary under applicable labour law. The shareholders control the distribution of net earnings.

Limited partnership with corporate general partner (GmbH & Co. KG)

In a limited partnership, there are general partners (Komplementär) with unlimited liability and limited partners (Kommanditisten) whose liability is restricted to their fixed contributions to the partnership. There is no prescribed minimum capital. Although a partnership itself is not a corporate body, it may acquire rights and incur liabilities, acquire title to real estate, and sue or be sued. From a legal perspective, the transfer of interests in a partnership does not generally need to be recorded in the presence of a qualified notary. The GmbH & Co. KG is a limited partnership with, typically, the sole general partner being a limited liability company. It can thus combine the advantages of a partnership with the limited liability of a corporation.

Asset purchase or share purchase

The timeline that has been set for entering the domestic market should not be neglected either. Given this situation, it often might make sense to acquire a business as this would allow a comparatively fast market penetration through the already established organisation of the acquired business.

Asset deals

An asset deal provides the purchaser with the opportunity to buy only those assets actually desired and leave unwanted assets behind, e.g. environmentally contaminated real estate, and, in many cases, unwanted liabilities. Therefore, Asset deals are usually used when acquiring businesses from distressed or insolvent entities.

However, under German law, there are some liabilities that cannot be avoided and have to be passed to the buyer in an asset deal and – except under certain circumstances – in an asset transfer. For example, liabilities with respect to existing employment contracts and several tax liabilities cannot be disclaimed. However, certain exceptions apply to this rule in case the assets are purchased from insolvent entities. Also, certain liabilities are taken over if the acquired commercial business is continued under the same name.

The acquired tangible and intangible assets, including goodwill, are to be capitalised at their fair market value. For tax purposes, goodwill is amortised over a 15-year period. All other assets are depreciable over their useful life. Tax losses and other attributes are not transferred in an asset deal. Asset purchases of a business or a division (branch of activity) are generally not subject to German VAT. Purchases of shares in a corporation or interests in a partnership are tax exempt.

There is no stamp duty in Germany. However, the acquisition of property in an asset purchase is subject to real estate transfer tax on the purchase price allocated to the property. The real estate transfer tax rate is 3.5% (4.5% for Berlin and Hamburg). Furthermore, one has to consider notary fees, which apply for the notarisation of the agreements by which the real estate is transferred.

Share deals

Share deals are often used in straight forward M&A transactions relating to operating entities.

When buying a business, it is necessary to understand the legal form in which it is conducted. A corporation (GmbH) is subject to corporate income tax (CIT; since 2008 15%), solidarity surcharge (5.5% of CIT), trade tax (TT; approximately 14%), and value-added tax (VAT; 19% standard). A partnership (oHG, KG, GbR) is transparent for CIT purposes, but not for TT purposes. Agreements between a partner and its German partnership, e.g. rental agreement, are in principle recognised for tax purposes. However, interest or rental fee deducted at the level of the partnership is added back at the level of the respective partner to determine the income of the partnership and the profit share of the individual partner. An election to treat a partnership as a corporation is not possible for German tax purposes.

In Germany, tax losses may be carried forward indefinitely for both TT on income and personal or CIT purposes. Personal or corporate income tax losses may also be carried back to the previous fiscal year, up to a maximum of €511,500.

Since 2004, the use of tax loss carry-forwards is restricted by a minimum taxation scheme. Only €1 million plus 60% of the taxpayer’s current year income in excess of €1 million can be offset against tax loss carry-forwards. The restriction applies to both CIT and TT.

As of 2008, the use of pre-acquisition losses was virtually excluded by the general change of control rules. These rules lead to a partial forfeiture of loss carry-forwards if more than 25% of the shares in a corporation are acquired directly or indirectly. If more than 50% of shares are acquired, all loss carry-forwards are forfeited.

However, certain exemptions to this general rule have been implemented recently. For example, for share transfers after December 31 2009, unused tax losses of a corporation shall not be forfeited up to the amount of taxable domestic built-in gains of the company at the time of the detrimental change of control.

Real estate transfer tax is triggered when at least 95% of the shares in a company are acquired by one taxpayer – or at least 95% of the interests in a partnership owning real estate located in Germany are transferred, directly or indirectly. For partnerships, any direct or indirect share transfers within a five-year period are added together for this 95% test.

Indemnities and warranties

In a share acquisition, the purchaser is taking over the target company together with all of its liabilities, including contingent liabilities. The purchaser will, therefore, normally require more extensive indemnities and warranties than in the case of an asset acquisition.

According to the German Civil Code, a purchaser forfeits his/her rights and guarantee claims with respect to a defect he is unaware of if gross negligence is involved – unless the defect was intentionally and maliciously kept secret by the seller. The non-performance of due diligence prior to the acquisition of an entity does, however, not generally result in the purchaser being grossly negligent. This would only be the case if the purchaser were not to perform due diligence despite obvious defects of the target or suspicious facts.

In contrast, the vendor may have a pre-contractual duty to inform the purchaser about certain defects of the target according to the German law principle of culpa in contrahendo. This principle implies that a party with important information, to which the other party does not have access, must share it with the other party so that it can contract with sufficient knowledge of the facts.

However sellers, who are usually reluctant to give extensive guarantees, regularly offer the purchaser the opportunity to make his own inquiries into the company. They provide him with information with the intention of not being held liable for risks and defects that were known by the purchaser when making the acquisition. Therefore, due diligence has become market standard for German acquisitions.

Acquisition vehicle

A foreign purchaser may invest into a German target through different vehicles. The tax implications of each vehicle may influence the choice.

Local holding company

A German holding company is typically used when the purchaser wishes to ensure that tax relief for interest on acquisition financing is available. This is to offset the target’s taxable profits or taxable profits of other German companies already owned by the purchaser within a tax consolidation scheme.

Dividends and capital gains derived by a resident corporate shareholder are essentially 95% exempt from CIT irrespective of the participation quota, the holding period, and the source (domestic or foreign). For trade tax purposes, the 95% exemption of dividend income only applies if the domestic investment accounts for at least 15% of the share capital or an equivalent participation quota in the assets from the beginning of the respective calendar year.

Non-resident intermediate holding company

Interposing an intermediate holding company generally implies an additional layer of taxation on funds repatriated to the investor. A non-resident intermediate holding company may be an option if the country of residence of the investor taxes capital gains and dividends received from abroad. An intermediate holding company resident in another territory could be used to defer this tax and take advantage of a more favourable tax treaty with Germany.

For a German corporate subsidiary, dividend distributions are subject to withholding tax (WHT) at a rate of 25%, increased to 26.38% by a 5.5% solidarity surcharge. The dividend WHT may be reduced to 15.83% if the foreign parent company is not domiciled in a country that has a tax treaty with Germany. If there is a double tax treaty (DTT) or the EU-Parent-subsidiary Directive (EU-PSD) applies, the WHT may be reduced to tax treaty rates or to zero under German domestic tax law. This is provided that the foreign parent company meets the requirements of the German anti-treaty shopping rules, which include a motive test, an income test and a substance test. Should the foreign parent company invest through a German trading partnership, it would generally have a limited tax liability in Germany on its income derived from the partnership. A withdrawal of profits from the trading partnership is not subject to WHT.

In principle, a capital gain on disposal of the investment in a German company is subject to tax in Germany under German domestic tax law. Capital gains tax is mitigated by the German participation exemption rules for corporate shareholders. These principally provide for a 95% tax exemption or by the partial income system for individual shareholders, which provide for a 40% tax exemption if the German company is a corporate entity. A full capital gains tax exemption may be available on the disposal of shares in a company if the DTT gives the right to tax capital gains to the foreign parent company’s country of residence.

Acquisition funding

A purchaser will need to decide whether he/she wishes to fund the acquisition by means of debt or equity. The main concern will often be to ensure that interest on funding can be set off against the target’s profits to reduce the German effective tax rate. Tax deductibility depends on the acquisition vehicle’s legal form and the place of residence, as well as the legal form of the target.

The advantage of debt is the potential tax-deductibility of interest, because the payment of a dividend is not tax deductible at the level of the distributing entity. If debt is used, a decision must be made on which company should borrow and how the acquisition should be structured. To allocate the cost of debt efficiently, there must be sufficient taxable profit against which interest payments can be offset. In addition, consideration should be given to whether relief would be available at a higher rate in another jurisdiction.

Usually, a German corporation is used as the acquisition vehicle for a share acquisition, funding the purchase price (partly) with debt either from a related party or directly from a bank. Interest expenses are fully tax-deductible for CIT purposes with restrictions.

The most common way to deduct interest expenses and to offset them against the target’s taxable income is acquisition through a leveraged acquisition vehicle, followed by the establishment of a tax consolidation scheme (Organschaft). A debt push-down into the target directly may be achieved through a merger of the target into the acquisition vehicle or vice versa. In an asset deal, such an offset could be automatically achieved if the acquirer of the assets/going concern is provided with the acquisition funding.

As of January 1 2008, the German thin-capitalisation rules were abolished and replaced by earnings-stripping rules. These rules generally limit the deductibility of net interest expenses (interest expense in excess of interest income) to 30% of EBITDA for tax purposes. This restriction applies to any kind of interest expense, irrespective of whether it is derived from inter-company financing or third-party debt. The rules apply to the net interest expense exceeding €3 million.

Any interest in excess of the 30% threshold is non-deductible. Excess interest may be carried forward to future tax years, but is subject to change-of-control restrictions that may lead to a (full or partial) forfeiture of interest carry-forwards on a transfer of shares in the respective company. If the net interest expenses will be less than 30% of the tax EBITDA, the unused EBITDA can be carried forward.

Additionally, it should be noted that for TT purposes, the deductibility of interest is further limited by an add-back of 25% of any deductible interest expense that exceeds (together with certain other add-backs) a threshold of €100,000.

Normally a tax-efficient structure requires an appropriate mix of debt and equity so that the interest expense remains deductible under the earnings-stripping rules. In addition, there may be non-tax reasons for using equity.

Final remarks

'How to invest in Germany successfully’ is a complex question and can only be analysed and answered on an individual basis. We hope that the article could provide you with a clear overview and would like to refer to our publication 'Investment in Germany’ edited by KPMG Germany for more information. If you are interested in this book or have questions, please write to de-tax@kpmg.com. It will be our pleasure to help you.

About the author
Oliver Dörfler
Partner, KPMG Germany

Oliver Dörfler is tax partner in the Düsseldorf office of KPMG in Germany. His work covers international corporate taxation with a strong focus on the structuring of inbound and outbound investments, reorganisations, M&A, post-acquisition integration and financing structuring. He leads the China tax competence centre.

About the author
Maximilian Gröning
Partner, KPMG Germany

Maximilian Gröning is one of the founding partners of the German KPMG law firm and is head of its Düsseldorf office. He is advising his clients in all kinds of corporate transactions, in particular M&A and private equity transactions. His work however also covers joint ventures as well as intra group reorganisations. In previous years, he has regularly advised Chinese clients on inbound investments in Germany.