Taxation of Corporations and Partnerships in the European Union

These flashcards cover the taxation of corporations and partnerships in the European Union, focusing on key concepts, principles, and examples from Germany and other EU member states.

What types of income are subject to Personal Income Tax (PIT) in Germany?

Income from Forest and Agriculture, Business Income, Income from Self-Employment, Income from Employment, Capital Income, Rental Income, and Other Income.

What are the two key asset allocations for individuals with business income in Germany?

Assets must be allocated to either private or business assets, where those used predominantly for business purposes must be classified as business assets.

What is the principle behind deductibility of business expenses?

Under the net principle, income equals revenues minus expenses, meaning all related expenses can normally be deducted, except certain non-deductible items.

How is profit recognized for tax purposes in most countries?

Profits are taxed when income is accrued, meaning when it is realized (accrual principle) rather than when cash is received.

What are the two forms of goodwill mentioned?

Self-created goodwill and acquired goodwill.

What is the main focus of tax legislation regarding goodwill for acquired assets?

Acquired goodwill is capitalized in the balance sheet and expensed on a pro rata temporis basis.

How does taxation differ between natural persons and corporations in the context of losses?

Corporations are treated as separate entities and losses cannot reduce shareholders' income, whereas partnerships (usually treated as pass-through entities) do allow for losses to affect each partner's taxable income.

What are the common characteristics of tax systems for loss compensation across the EU?

Most EU tax systems allow for loss carry forward and carry back but with various restrictions.

What are the main components to determine the tax burden for corporations in Europe?

Tax base, loss compensation rules, additional local taxes, corporation tax rates, and systems in place.

What happens to dividends when they are distributed from a corporation to shareholders?

Dividends are subject to personal income tax, leading to double taxation.

What distinguishes the classical system of corporate taxation from other systems?

In the classical system, corporations and shareholders are treated as separate tax entities, leading to full economic double taxation.

In what ways can double taxation be reduced for shareholders?

Through shareholder relief mechanisms, partial imputation, or dividend exemptions.

How does the transparency principle affect the taxation of partnerships?

Partnerships are not considered separate taxable entities; rather, each partner is taxed individually on their share of profits.

What is an example of a country that utilizes a flat corporate tax rate?

Romania, which applies a flat tax rate of 16%.

What determines whether the profits of a partnership are taxed like a corporation or like sole traders?

Whether the partnership is treated under transparency or separation principle varies by country.

How are Sole Traders taxed in Europe?

Natural persons such as sole traders are subject to personal income tax on their worldwide income

The Tax base

Income = revenues - expenses

The calculation of the tax base is usually based on GAAP (Generally Accepted Accounting Principles)

Two forms of goodwill

self created goodwill:

immediately expensed.

this is the value your own business builds over time by itself.

• For example: a great reputation, loyal customers, a strong brand name.

• No one “sold” this to you; you created it through good service, marketing, quality, etc.

• Important: In most accounting rules, self-created goodwill is not put on the balance sheet. It’s real in an economic sense, but you don’t record it as an asset.

acquired goodwill:

recognized and expensed on a pro rata tempers basis, regular straight line.

This arises when you buy another business and pay more than the fair value of its net assets (assets minus liabilities).

• Example: The assets of a shop are worth 800,000, but you pay 1,000,000 to buy the company because it has a great name and loyal customers.

• The extra 200,000 you paid is acquired goodwill.

• This is recorded as an intangible asset on the buyer’s balance sheet.

What is a loss set-off?

A loss set-off just means using a loss to reduce a profit for tax purposes.

What is a flat tax rate?

A flat tax rate means the same percentage of tax is charged to everyone, no matter how much they earn or profit. E.g. Romania 16%

What does taxed upon realization mean?

The tax is only charged when something actually happens, not while it’s just on paper.

Applied to CIT (likely a tax on income or gains), it means:

• If an asset goes up in value, but you haven’t sold it yet,
  → the gain is unrealized → no CIT yet.

• When you sell the asset (or otherwise dispose of it),
  → the gain becomes realized → CIT is charged then.

Deductible Expenses:

Non-Deductible Expenses:

Deductible Expenses:

Salaries
Royalties (Royalties = payments you make to use someone else’s intangible asset, for example:

• A brand name or trademark

• A patent (for a special invention/technology)

• Copyright (e.g. software, books, music)

• A franchise name or system (e.g. paying to use a famous fast-food brand)

Non-Deductible Expenses: Distribution of profits means paying out the company’s profit to the owners/shareholders.

Taxation of corporations - separation principle:

distributed profits are taxed twice (on corporate level and on personal income tax)

What does the separation principle mean

The corporation is an operate legal person and is taxed with corporate income tax. Upon distribution, the shareholder is taxed with personal income tax. the (distributed profits) are taxed twice

Corporate Tax Systems 

Classical System

Double Taxation Reducing System

Double Taxation Avoiding System

Double Taxation Reducing System

Double Taxation can be reduced by:

Shareholder Relief: dividends are only partially included into taxable income (Germany) or a reduced tax rate is available (Portugal)

Partial imputation of corporate tax (not used in Europe)

Classical System

double Taxation; distributed profits are first taxed at the corporate level with corporate income tax, distributed profits are taxed at the level of shareholder with personal income tax), Irland, Denmark 

Double Taxation Avoiding System

Dividend Exemption (Shareholders do not pay personal income tax on dividends, only company is taxed (Slovakia)

Full imputation System: dividend of the shareholder + taxed already paid by corporation = grossed-up dividend. The shareholder pays personal tax on the grossed-up amount. Malta