Germany’s Tax Proposals: Enhancing Loss Treatment but Dropping the Super-Deduction

Germany‘s finance minister, Christian Lindner (FDP), recently unveiled significant elements of the federal government’s tax reform proposal. With an estimated fiscal cost of EUR 6 billion, the proposal will comprise over 50 policy changes aimed at improving the country’s taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. system. Two key provisions include enhancing the treatment of corporate losses and introducing an investment premium for energy- and resource-saving projects. Additionally, the proposal hints at provisions for accelerated depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. for small investments, although details regarding this aspect are yet to be disclosed.

For policymakers in Germany, corporate taxation stands out as a promising area for reform. In the 2022 International Tax Competitiveness Index, the country ranked 15^th among 38 OECD countries overall, but only 30^th in the corporate tax category, indicating room for improvement.

Improvements in Loss Treatment

The federal government’s proposal seeks to extend loss carrybacks from two to three years, while also doubling the maximum amount from EUR 10 million to 20 million. Furthermore, it would lift the 60 percent cap on taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. exceeding EUR 1 million for time-unlimited carryforwards.

Loss carryover provisions allow businesses to either offset current year losses against future profits (carryforwards) or current year losses against past profits (carrybacks). Since profitability can vary significantly over the time frame of an investment or the business cycle, carryover provisions allow businesses with cyclical or uneven income profiles to even out their risk and income, making the tax code more neutral across investments over time.

For example, pharmaceutical companies typically undergo lengthy periods of research and development (R&D) investment before reaping the financial rewards from their products. When loss offsets are absent from the equation, the burden of corporate income taxation disproportionately deters investments in industries characterised by such variable income profiles. Ideally, a sound tax code should allow businesses to carry forward their losses for an unlimited number of years, ensuring that a business is taxed on its average profitability over time.

During economic downturns, loss carrybacks are also a quick and effective method to provide liquidity to businesses with a recent track record of past profitability.

Recent economic research suggests that when the carryback period is extended by one year, businesses put more than 10 percent of their additional resources into risk-oriented investments like research and development (R&D). This effect is more pronounced in countries with higher corporate tax rates.

Currently, 15 out of 38 OECD nations provide more generous carryforwards than Germany, while only three—Estonia, Latvia, and Canada—offer more generous carrybacks. With the reforms that Lindner is proposing, Germany is set to join the top 10 countries offering unlimited carryforwards and become more aligned with Canada in terms of carrybacks.

Two of the three countries leading Germany in carrybacks, Estonia and Latvia, operate cash-flow corporate tax systems, which allow for unlimited income smoothing by only taxing profits upon distribution. Canada, on the other hand, provides three years of carrybacks without any maximum amount. Germany’s favourable current rank in terms of carrybacks is a result of recent policy developments. In 2020, the maximum amount for carrybacks was increased from EUR 1 million to 10 million, and in 2022, the carryback period was extended from one to two years.

Dropping the Super-DeductionA super-deduction is a tax deduction that permits businesses to deduct more than 100 percent of their eligible expenses from their taxable income. As such, the super-deduction is effectively a subsidy for certain costs. This policy sometimes applies to capital costs or research and development (R&D) spending.

The current tax reform proposal departs from the coalition’s previously agreed-upon super-deduction for climate and digitisation-related investments. Instead, the current proposal introduces an ‘investment premium’ equal to 15 percent of the cost of investment in ‘movable economic goods in the areas of energy and resource efficiency’ with a cap set at EUR 30 million per company and year.

A super-deduction would allow businesses to deduct more than 100 percent of their investment costs from their future taxable income, counteracting the tax system’s bias against long-term investments. In contrast, an investment premium applies to short- and long-term investments equally, thus doing little to alleviate the tax system’s short-termism.

To design a more future-oriented tax system that promotes economic growth, the federal government should therefore instead consider comprehensive improvements to cost recovery, such as full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. for capital investments, which would allow businesses to deduct 100 percent of their investment expenditures from their taxable income. Further, there are good reasons for such a proposal to include a broad base of investment classes, not just qualified investments into energy- and resource-saving plans.

For one, there are already effective environmental policies in place, such as the Emissions Trading System (ETS), which caps greenhouse gas emissions across the European Union. Cap-and-trade systems like the ETS are not just a more efficient policy option to direct investment into the reduction of greenhouse gas emissions, but they also conflict with other policies to redirect investment towards the same goal. Since the greenhouse gas emissions under the ETS are determined by the number of available certificates, policies that do not alter that number will not lead to a reduction in overall emissions; it will merely shift them to less valuable uses.

Second, comprehensive improvements to cost recoveryCost recovery is the ability of businesses to recover (deduct) the costs of their investments. It plays an important role in defining a business’ tax base and can impact investment decisions. When businesses cannot fully deduct capital expenditures, they spend less on capital, which reduces worker’s productivity and wages. would encourage a broad range of valuable long-term investments, not limited to a narrow range of qualified energy- and resource-saving plans. This could include, but is not limited to, investments in robust infrastructure, climate change adaptation, and other areas. Generally, limiting cost recovery improvements to a narrow base will curtail innovation.

In 2023, the German tax system allows businesses to recover 84.7 percent of the net present value of investments into machinery and equipment, 87 percent for intangible assets, and 39.1 percent for industrial buildings. This compares to OECD averages of 84.9, 74.9, and 48.9 percent, respectively. In contrast, implementing full expensing or neutral cost recovery would put Germany among the more growth-oriented tax systems in the OECD.

Although details of the full reform plan are still forthcoming, the government can build upon its commitment to accelerate depreciation for small-scale investments as a starting point.

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