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1 Germany Promotes Competition with Shift to Territorial Taxation System 1 (2012)

handle is hein.taxfoundation/ffddhxz0001 and id is 1 raw text is: TAX(;. %
November 15, 2012
No. 337
Germany Promotes Competition with Shift to
Territorial Taxation System
By
Tax Foundation Staff
This is the fourth case study in a series on territorial tax systems in other countries. The intent of the study is
to see what lessons the U.S. can learn from other countries' experiences and to evaluate the validity of some
of the fears critics express when discussing what would result if the U.S. were to move to a territorial system.
Germany has successfully implemented a system of taxation of foreign earnings, which is driven by two principles:
competitive neutrality and simplicity.-Jorg Menger, German tax professional, 20111
Since 1920, the German corporate tax system has exempted foreign dividend income to some degree. In
1954, Germany initiated a tax treaty system whereby dividends originating within treaty-partner countries
became fully exempt. To simplify this regime and to comport with rulings of the EU Court of Justice, in
2001 Germany reformed its system to terminate international expense allocation requirements and to allow
deductions for all expenses related to exempt foreign income. To compensate the government for allowing
deductions for costs related to tax-exempt foreign income, Germany reduced the exemption for foreign
income to 95 percent, allowing tax on the residual five percent.
Active income generated by controlled foreign corporations and passive income that is subject to tax rates
greater than 25 percent in the original jurisdiction are eligible for exemption.' Also, income generated by
foreign branches of German companies is exempt from German tax as long as the branch resides in a treaty
1 How Other Countries Have Used Tax Reform to Help Their Companies Compete in the Global Market: Hearing Before the H.
Comm. on Ways andMeans, 112h Cong. (May 24, 2011) (statement ofJorg Menger, International Tax Partner, Ernst & Young
LLP), It:iIwww.gpo.gov/tdsys/pkg/C  R&- 112hbrg72 -10/pdf/(HG 1R i2hhrg7251 O.pdf [hereinafter Menger Statement].
2 It has become standard practice among territorial systems for deductions of expenses related to foreign income to be allowed. As
of 2007, only three EU countries disallowed deductibility of costs related to tax-exempt foreign dividends. See Michael P.
Devereux et al., Final Report: Project for the EU Commission (TAXUD/2005/DE3 10) (Sept. 2008), at A-18,
http://ec.europa.euiraxa-ion customs/resources/documents/taxation/gen infoleconomic analysis/economic snadies/effecrdve leve
Is _: )t:,L._df.
See Joint Committee on Taxation, Background and Selected Issues Related to the U.S. International Tax System and Systems that
Exempt Foreign Business Income (May 20, 2011), at 26, htpcivv- .j( .gov/pd.bl h ations.hnl?func-starr ov, &id =2793
[hereinafter JCT, Background].

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