Growth Opportunities Act - changes to the preferential treatment of retained earnings

On March 22, 2024, the Federal Council approved the Mediation Committee's compromise proposal on the Growth Opportunities Act.
The Growth Opportunities Act also revised the structure of the preferential treatment of retained earnings in accordance with Section 34a (2) EStG.

I. Previous regulation

The aim of Section 34a EStG is to put the taxation of co-entrepreneurships on an equal footing with corporations and to promote the reinvestment of profits in the company. Profits that are not withdrawn can be taxed at a preferential retention tax rate of 28.25% (plus solidarity surcharge and, if applicable, church tax) upon application (Section 34a (1) sentence 1 EStG). Section 34a para. 2 EStG regulates the calculation of the non-withdrawn profit as the profit determined in accordance with Section 4 para. 1 sentence 1 or Section 5 EStG (tax balance sheet profit) reduced by the positive balance of withdrawals and contributions in the financial year. Taxpayers whose share of the calculated profit is more than 10% or exceeds EUR 10,000.00 are eligible to apply. If the tax-privileged profits are withdrawn in subsequent years, this leads to subsequent taxation of 25% (plus solidarity surcharge and, if applicable, church tax) in accordance with Section 34a (4) EStG. Subsequent taxation occurs in accordance with Section 34a (4) and (6) EStG in the following cases:
  • Excess withdrawals (i.e. the balance of the profit calculated in accordance with Section 4 (1) sentence 1 or Section 5 EStG less the withdrawals and plus the contributions for the financial year is negative);
  • Sale or discontinuation of a business (Sections 14, 16 (1) and (3) and 18 (3) EStG);
  • Contribution of a business or co-entrepreneurial share to a corporation;
  • Change of legal form of a partnership into a corporation;
  • Transfer of a business or co-entrepreneurial share to a corporation pursuant to Section 6 (3) EStG in accordance with Section 1 (1) KStG;
  • Transfer of a business or co-entrepreneurial share to a co-entrepreneurship for no consideration, insofar as corporations pursuant to Section 1 (1) KStG are involved;
  • Profits are no longer determined in accordance with § 4 para. 1 sentence 1 or § 5 EStG;
  • Application by the taxpayer.

II Current regulation in practice

In practice, the regulation has so far met with little approval. There are several reasons for this:
 
  1. The tax balance sheet profit is decisive, so that the taxable income is generally higher than the profit eligible for preferential treatment, as non-deductible operating expenses such as trade tax, for example, are not eligible for preferential treatment because they have to be added back off-balance sheet. This means that all off-balance sheet corrections are not taken into account for the preferential treatment.

  2. If the advance income tax payments are paid from the company's assets or if the shareholders receive advance distributions to pay the advance income tax payments, withdrawals are made which also reduce the profit eligible for preferential treatment.

  3. If the top tax rate is applied, the tax burden on the preferential profits is around 35% and therefore around 5% higher than for corporations.

  4. The total tax burden, taking into account the subsequent taxation, is 0.5% worse when applying the top tax rate than with full taxation at the standard tax rate. The lower the tax rate of the taxpayer, the greater the disadvantage, as the tax rates within the scope of the taxation of retained earnings are not progressive.

  5. The excess withdrawals must be determined annually. This means that any transfers made in the current year must be subject to subsequent taxation. Only then can non-retained profits from the past be withdrawn without subsequent taxation. Under-withdrawals in previous years are not offset against over-withdrawals in subsequent years.

  6. In the case of partial transfers, whether free of charge or in accordance with Section 24 UmwStG, there is currently no pro rata subsequent taxation or pro rata transfer of amounts subject to subsequent taxation. A transfer of the amounts subject to subsequent taxation only takes place if an entire business or co-entrepreneurial share is transferred free of charge. This means that arrangements with only pro rata transfers can be used to delay subsequent taxation. (previously a plus point)

  7. In accordance with Section 37 (3) sentence 5 EStG, the benefits of Section 34a EStG cannot be taken into account when calculating income tax prepayments. This leads to a liquidity disadvantage until the income tax is assessed.

III. Changes due to the Growth Opportunities Act

The amendments to the government draft of August 30, 2023 were adopted as follows
 
  1. The profit eligible for preferential treatment (previously the tax balance sheet profit) is increased by the trade tax. However, other non-deductible operating expenses are still not taken into account.

  2. Withdrawals for the payment of personal income tax that arise in accordance with Section 34a (1) EStG are not taken into account when determining withdrawals (Section 34a (12) sentence 2 EStG-E). Withdrawals are primarily deemed to be used to pay these amounts up to the amount of income tax within the meaning of Section 34a (1) sentence 1 EStG-E and the solidarity surcharge payable thereon.

  3. The catalog of subsequent taxable events has been expanded:
    - Inclusion of a co-entrepreneur in an existing sole proprietorship against payment;
    - Sale of part of a co-entrepreneur's share;
    - Contribution of a business unit or part of a co-entrepreneur's share;
    - Transfer of a business unit or part of a co-entrepreneur's share to a corporation pursuant to Section 6 (3) EStG without payment in accordance with Section 1 (1) KStG; - Transfer of a business unit or part of a co-entrepreneur's share to a co-entrepreneurship without payment if corporations are involved pursuant to Section 1 (1) KStG. 1 KStG;
    - Transfer of a part of a business or part of a co-entrepreneur's share to a co-entrepreneurship for no consideration, insofar as corporations under Section 1 (1) KStG are involved;
    - Inclusion of a co-entrepreneur in an existing sole proprietorship for no consideration, if the transfer is made to a corporation under Section 1 (1) KStG.

    This means that pro rata transfers/disposals also lead to pro rata subsequent taxation. The basis for the pro rata subsequent taxation is the share of the transferred business assets in the business assets of the legal predecessor prior to the transfer. In the case of sole proprietorships, the business assets are the equity capital; in the case of co-entrepreneurships, the proportionate total hand capital, the capital of the special and supplementary balance sheets. The aim of this regulation is to prevent structuring options in which business assets are transferred down to a dwarf share and this has not previously triggered any subsequent taxation.

  4. In the case of partial transfers such as:
    - transfer of a co-entrepreneur's share to a natural person free of charge,
    - incorporation of a natural person into an existing sole proprietorship free of charge and
    - contribution of part of a co-entrepreneur's share at book value in accordance with Section 24 UmwStG
    , the amounts subject to subsequent taxation will in future be transferred pro rata to the legal successor, who must continue them. Here too, the proportion of the transferred business assets to the business assets of the legal predecessor prior to the transfer is decisive for the proportionate subsequent taxation.

  5. The application for retention tax relief can be submitted until the income tax assessment becomes final. Previously, this could lead to a high credit balance of interest on refunds if the application was submitted very late (e.g. as part of a tax audit). The new Section 34a (1) sentence 3 EStG-E now stipulates that the subsequent application is classified as a retroactive event within the meaning of Section 175 AO. This means that interest will only begin to accrue 15 months after the end of the year in which the application was made.
 
The amendments will apply for the first time from the 2024 assessment period.
 
If you have any questions or require further information, please do not hesitate to contact us on 02204 9508- 100.
Beatrice Lückert
Authorized signatory, tax consultant, LL.M. Accounting and Taxation, CVA | + posts