Germany

Opportunities for
US companies in Germany

As the largest economy in the European Union, Germany continues to be a highly attractive destination for companies from the United States seeking to establish or grow their business in Europe

Boetticher Hasse Lohmann Frankfurt Office

Foreign direct investment – which includes acquisitions, greenfield investment as well as reinvestment by companies in existing German operations – from the US to Germany amounted to $86 billion in 2005, up from $63 billion in 2002. US companies employ approximately half a million people in Germany. Apart from representing Europe’s largest market in its own right, Germany also provides an effective and central base from which to serve both the EU’s “older” member states to the west and the growing markets of the EU’s newest members to the east. For companies considering greenfield investment, Germany clearly cannot match the labour-cost advantages of some of its eastern neighbors. However, many US companies continue to set up manufacturing facilities in Germany, especially in high-technology capital-intensive operations where quality is paramount, as well as in industries such as automotive and renewable energy where Germany represents greater market opportunities.

In recent years, an increasing number of companies have chosen to enter Germany through acquisition. This development has been facilitated by the gradual unravelling of Germany’s traditional structure of industry cross-shareholdings as well as transparent regulations governing the acquisition of German companies by outside investors. Private equity companies have also been quick to take advantage of these changes, and we have witnessed numerous transactions involving the acquisitions of highly specialised German medium-sized (or “Mittelstand”) companies as well as larger household names. Foreign investment has also poured into the German real-estate market, which has attracted foreign investors through relatively low valuations and the promise of stable returns in both the commercial and residential property segments.

These investments have strengthened the economic ties between Germany and the United States, and have reinforced Germany’s position as a stable and profitable investment location. What do companies planning to take advantage of these opportunities need to consider? The following are some important factors and recent changes to take into account.

The German Business Environment

Germany is not known as a low-cost country. Labour costs are often cited as contributing to higher costs, and indeed average total labour costs for German employees were the third highest in Europe in 2005 (Source: Institut der deutschen Wirtschaft Köln). However, it is important to note that while labor costs in some of the EU’s new member states continue to increase at rates of over 10% annually, unit labour costs in Germany have actually fallen over the past five years (Source: Deutsche Bundesbank). It is also worth noting that in Eastern Germany, labour costs are still more than one third below the Western German level. Other cost factors, such as energy, telecommunications and transportation are comparable or even lower than those in other EU countries. A recent study by KPMG found that logistics costs for companies in a sample of German cities were lower than those in comparable eastern European cities, with proximity to major logistics hubs in Germany outweighing lower labour costs in Eastern Europe.

Another frequently held perception is that Germany is a land of regulations, where bureaucracy can sometimes stifle growth, especially with respect to employment. For US companies accustomed to greater flexibility, labour regulations in Germany can seem rigid and biased towards employees. In recent years, the rules governing the employment of part-time or temporary workers have been relaxed, and the number of temporary employees has risen significantly. Companies in both the manufacturing and service sectors are using temporary employees as a way to build greater flexibility into their workforce, a trend that is expected to go on as the German government continues to debate more far-reaching labour market reforms.

Although not as large as the US, it is important to note that Germany too is comprised of states with a strong regional character. The country’s federal structure grants significant political autonomy to state governments in areas such as education. Economically, specific industries have concentrated in different parts of the country, such as the automotive industry in southern Germany or microelectronics in Saxony. Other location considerations, such as the availability of incentives, also vary significantly among regions. These differences can be important to US companies considering where to locate their German operations.

Taxation Aspects of Investing in Germany

Germany’s statutory tax rate for corporations of approximately 38% to 40% (comprising federal corporate income tax, solidarity surcharge thereon, and local trade tax) clearly positions the country as a high-tax jurisdiction. However, investments in Germany may often be structured tax efficiently to reduce the effective tax rate. The tax consequences of a US inbound investment in Germany largely depend on the legal form (eg, corporation, partnership, permanent establishment) and of the type of the business activity carried out in Germany. On this basis, opportunities to lower the effective tax rate include leveraging the investment by debt financing within the scope of the German thin capitalization rules, epitomizing of the transfer pricing regime in a group of companies and/or effectively using tax loss carry forwards. Moreover, German corporate tax law provides for a participation exemption in the amount of 95% of dividends and capital gains received from the sale of shares in domestic and foreign corporations by a corporate shareholder.

US investors in Germany may also benefit from the amended US–German tax treaty which is expected to enter into force in 2007. Under the new treaty provisions, the current 5% withholding tax rate on dividend distributions by a German corporation is reduced to 0% if certain requirements are met. In order to be more competitive in the international comparison, the German government is currently working on a business tax reform to decrease the statutory tax rate to less than 30% for German companies. The government also proposes a number of counter-financing measures, including the introduction of an earnings stripping rule limiting the deduction interest expenses to a certain percentage of the EBIT, as well as changes in the calculation of the trade tax basis. The German business tax reform is intended to take effect in 2008.

Summary and Further Information

Numerous recent reports and studies point to Germany’s recent economic recovery. The Organization for Economic Cooperation and Development (OECD), for example, expects that the German economy will continue to expand in the coming two years. To a large degree, this reflects the prevalent mood in Germany, although some observers are concerned that economic reform may not be moving at a fast enough pace. Nevertheless, it is clear that Germany continues to change in ways that make it more attractive for current and future US investors.

The above information is intended as an overview of just some of the recent developments that should be relevant to potential US investors. For companies seeking more detailed information on how to set up and operate a business in Germany, KPMG provides in-depth publications such as a comprehensive “Investment in Germany” guide, a regular “German Tax Monthly” Periodical as well as frequent studies on industry-specific issues in Germany. These and other English language publications can be found on KPMG Germany’s Internet Site at www.kpmg.de.

Contact details:
Andreas Dressler, Director, Advisory
KPM G Deutsche Treuhand-Gesellschaft
Aktiengesellschaft Wirtschaftsprüfungsgesellschaft,
Marie-Curie-Str. 30, 60439 Frankfurt, Germany
Tel: +49 69 9587 3407
Fax: +49 1802 11991 3722
Email: adressler@kpmg.com

Anja Weiske, Senior Manager, Tax
German Tax Center of Excellence,
KPM G LLP, 345 Park Avenue, New York,
NY 10154, United States of America
Tel: +1 212 954 7952
Fax: +1 212 898 1365
Email: anjaweiske@kpmg.com

 

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