Germany Must Counter U.S. Tax Cut or Risk ‘Falling Behind’

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By Jabeen Bhatti

Germany must move to counter the newly reduced corporate tax code in the U.S. to remain competitive in the global market by joining with France in harmonizing corporate tax treatments across the bloc, analysts say.

It also must focus on realizing the European Commission’s capital markets union to remove investment barriers between member nations and diversify funding, they added. But making the necessary changes will require uniting countries with their own tax policies and priorities—and smoothing divisions within the German government.

“The risk is that if the tax reform gamble in the U.S. is successful, then Europe really runs the risk of falling behind,” Carsten Brzeski, chief economist at ING-DiBa in Frankfurt, told Bloomberg Tax. “To start catching up from having fallen behind is much more complicated than really reacting proactively right now, at least by harmonizing taxes in the Eurozone and in Europe.”

The U.S. cut its corporate tax rate to 21 percent from 35 percent in the 2017 tax act ( Pub. L. No. 115-97). The European Union has been leery of certain provisions in the law, like the base erosion and anti-abuse tax, which some finance ministers have warned may break international trade rules.

‘United European Response’

Angela Merkel’s conservative Christian Democrats’ proposed “Grand Coalition” with the left-leaning Social Democrats—expected to be approved in early March—outlined its tax commitment in its Feb. 7 coalition agreement.

“We support a common, consolidated tax base and minimized rates for corporate taxes, but it must be a guiding principle that the country where earnings occur is also the country where taxation occurs,” the document said. “We want to take on this initiative with France, including a united European response to international changes and challenges in this area, not least in the USA.”

But despite commitment to such measures on both the German and French sides of the Rhine, implementing European harmonization is no easy feat, given discord within the bloc, Brzeski added.

Myriad differences in tax treatments across the EU make it extremely difficult to bring everyone in line, especially European tax havens such as Ireland, or Eurosceptic regimes such as Poland or Hungary, he said.

“If the next German government would really work together with France to put Europe at the forefront and use the current threat coming from the US reforms to actually get more tax harmonization in Europe, that would really be the big thing that’s needed,” he said.

Attractive Reforms

The U.S. tax act applies an adjusted tax rate of 13.125 percent until 2026 to an American corporation’s foreign-derived intangible income. That rate, combined with an overall lower corporate rate, encourages U.S.-based corporations to sell products abroad and license intellectual property to foreign nationals, according to an EY report on its implications.

Many German multinationals with a presence in the U.S. could benefit from the rate reductions and full expensing measures outlined in the legislation, Kais Mouldi, a partner with PwC in Hamburg, told Bloomberg Tax in an email. The tax act includes full expensing for five years.

Still, others fear they could be disadvantaged as compared to U.S. competitors, given some of the law’s anti-base erosion measures that explicitly target multinationals.

“Since there is good reason to believe that German multinationals will benefit most from the tax reform if they expand their operations in the U.S., politicians as well as industry representatives are concerned that German and foreign companies will shift investment from Germany to the US,” Mouldi said. “Fewer investments could weaken economic growth in Germany.”

European Approach

Economists and tax attorneys say Europe must present a unified response to U.S. tax reform, as opposed to Germany challenging the measures unilaterally—especially given the political volatility in Berlin.

Germany’s Grand Coalition government won’t be cemented until the beginning of March. The coalition, however, isn’t a given since 46 percent of party supporters have said they view another Grand Coalition negatively, according to a February survey by German pollster infratest dimap with opponents pushing to get others on their side.

And even if it is approved, it doesn’t mean the government is prepared to get aggressive on tax policy, attorneys said.

“That government, unlike the American government, is unwilling to commit to tax reductions,” Oliver von Schweinitz, a partner with GGV law firm in Hamburg, told Bloomberg Tax.

Berlin’s Options

Without willingness on the domestic side for tax reforms, the likely solution for Germany would be to focus on OECD base erosion and profit shifting (BEPS) strategies already in effect, and to finish implementing the European Commission’s capital markets union action plan to dismantle barriers for capital investment within the Eurozone, Von Schweinitz added.

“Both the OECD’s proposal on direct treaty-benefits in cross-border investments (TRACE), as well as the capital markets union, offer a way to give the industry something without a reduction in rates,” he said.

Germany would be well served to take a few simple domestic actions as well, Mouldi said, some of which are already discussed in the current coalition agreement, such as the gradual abolition of Germany’s 5.5 percent solidarity surcharge or increased investments in digital infrastructure.

“German policy makers should try to keep Germany attractive as a business and investment location. Possible carrots could include, for example, the repeal of the solidarity surcharge, or the introduction of accelerated deductions for investments,” he said.

Harmonizing Tax Treatments

Outside of adhering to pan-European strategies either already in place or in the works, Brzeski said the future German government under Merkel would be well-served to embrace Franco-German plans to harmonize corporate tax structures within the Eurozone.

Even so, both countries must be wary over such moves being seen as a Franco-German attempt to get ahead of their European partners in the bloc, he added. On the flip side, the threat of becoming irrelevant on the heels of the US tax overhaul may be large enough to catalyze change.

“The worst thing now would be if Germany, maybe together with France, starts to outperform other European partners,” Brzeski said. “You really have to tackle this at a European level because I think this is Germany’s best way forward to gain or maintain international competitiveness.”

To contact the reporter on this story: Jabeen Bhatti in Berlin at correspondents@bloomberglaw.com

To contact the editor on this story: Penny Sukhraj at psukhraj@bloombergtax.com

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