PRIVATE COMPANY LIMITED BY SHARES
AN ANALYSIS OF TAX ACCOUNTING RULES IN THE UNITED
KINGDOM AND GERMANY
by
Thilo Grabo
Table of Contents
I
TABLE OF CONTENTS
ABBREVIATIONS...V
1.
INTRODUCTION ... 1
1.1.
PURPOSE OF STUDY... 1
1.2.
SCOPE OF THE OBJECT OF INVESTIGATION ... 3
1.3.
OUTLINE OF THE STUDY ... 3
2.
FUNDAMENTALS... 5
2.1.
INSTRUMENTS FOR THE EXECUTION OF INTERNATIONAL TAX COMPARISON... 5
2.1.1. PREFACE ... 5
2.1.2.
QUALITATIVE METHODS OF INVESTIGATION ... 6
2.1.2.1.
COMPARISON OF LEGAL RULES ... 6
2.1.3.
QUANTITATIVE METHODS OF INVESTIGATION ... 7
2.1.3.1.
CASUISTIC SIMULATION OF ASSESSMENT ... 7
2.1.3.2.
COMPARISON OF TAX RATES ... 8
2.1.3.3. ANALYSIS
OF EMPIRICAL DATA... 9
2.1.3.4.
EFFECTIVE TAX RATES ... 9
2.1.4.
CHOICE OF A PARTICULAR INVESTIGATION METHOD ... 11
2.2.
THE TAX SYSTEM AND INFLUENCES OF TAXATION ... 13
2.2.1.
PRINCIPLES OF TAXATION... 13
2.2.2.
SOURCES OF THE TAX LAW... 13
2.2.3.
GENERALLY ACCEPTED ACCOUNTING PRACTICES... 16
2.2.4.
OBJECTIVE AND PURPOSE OF THE COMMERCIAL AND THE TAX BALANCE
SHEET ... 18
2.3.
CHARACTERIZATION OF THE CORPORATION TAX ... 21
2.3.1. PERSONAL
TAX
LIABILITY ... 21
2.3.2.
BASIS OF ASSESSMENT FOR THE CORPORATION TAX ... 23
2.3.2.1.
ADJUSTING THE ACCOUNTING PROFIT AND VALIDITY OF THE
AUTHORITATIVE PRINCIPLE... 23
2.3.2.2.
SCHEME FOR THE CORPORATION TAX COMPUTATION ... 25
2.3.3.
PERIOD OF DETERMINING INCOME FROM TRADE ... 28
2.4. FURTHER
PROCEEDING ... 29
Table of Contents
II
3.
COMPARISON OF CORPORATION TAX ASSESSMENT BASES I: BALANCE SHEET
ITEMS ... 30
3.1. PREFACE ... 30
3.2.
CONCEPTUAL FRAMEWORK AS CORE ELEMENT FOR THE DETERMINATION OF
INCOME ... 30
3.2.1. BASIC
ASSUMPTIONS ... 30
3.2.2.
QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS ... 32
3.3.
GENERAL TREATMENT OF BALANCE SHEET ITEMS... 36
3.3.1. RECOGNITION
CRITERIA ... 36
3.3.2. VALUE MEASURES ... 39
3.4. ASSETS
SIDE ... 48
3.4.1. INTANGIBLE
ASSETS (NON-CURRENT) ... 48
3.4.1.1. DEFINITION... 48
3.4.1.2. RECOGNITION ... 51
3.4.1.3. MEASUREMENT... 51
3.4.1.4. EXCURSUS:
DISPOSALS ... 55
3.4.1.5. MAJOR
SIMILARITIES AND DIFFERENCES... 55
3.4.2. TANGIBLE ASSETS... 58
3.4.2.1. PREFACE... 58
3.4.2.2. PROPERTY... 59
3.4.2.2.1. DEFINITIONS ... 59
3.4.2.2.2. RECOGNITION... 61
3.4.2.2.3. MEASUREMENT... 61
3.4.2.2.4. EXCURSUS:
DISPOSAL ... 63
3.4.2.2.5. MAJOR
SIMILARITIES AND DIFFERENCES ... 64
3.4.2.3.
MACHINERY, PLANT AND EQUIPMENT... 66
3.4.2.3.1. DEFINITON... 66
3.4.2.3.2. RECOGNITION... 70
3.4.2.3.3. MEASUREMENT... 70
3.4.2.3.4. EXCURSUS:
DISPOSAL ... 76
3.4.2.3.5. MAJOR
SIMILARITIES AND DIFFERENCES ... 78
3.4.3.
INVESTMENTS IN SECURITIES ... 82
3.4.3.1. DEFINITION... 82
3.4.3.2. RECOGNITION ... 82
3.4.3.3. MEASUREMENT... 84
Table of Contents
III
3.4.3.4. EXCURSUS:
DISPOSAL ... 87
3.4.3.5. MAJOR
SIMILARITIES AND DIFFERENCES... 88
3.4.4.
TRADING STOCK (INVENTORIES) ... 90
3.4.4.1. DEFINITION... 90
3.4.4.2.
RECOGNITION AND MEASUREMENT ... 92
3.4.4.3.
SELLING AND PROCESSING... 96
3.4.4.4. MAJOR
SIMILARITIES AND DIFFERENCES... 96
3.4.5. TRADE
RECEIVABLES... 98
3.4.5.1. DEFINITION... 98
3.4.5.2. RECOGNITION ... 99
3.4.5.3. MEASUREMENT... 99
3.4.5.4. MAJOR
SIMILARITIES AND DIFFERENCES... 102
3.5. LIABILITIES
SIDE ... 103
3.5.1. PROVISIONS ... 103
3.5.1.1. DEFINITION... 103
3.5.1.2.
RECOGNITION AND MEASUREMENT ... 107
3.5.1.3. MAJOR
SIMILARITIES AND DIFFERENCES... 111
3.5.2. LIABILITIES ... 114
3.5.2.1. DEFINITION... 114
3.5.2.2.
RECOGNITION AND MEASUREMENT ... 116
3.5.2.3. MAJOR
SIMILARITIES AND DIFFERENCES... 122
4.
COMPARISON OF CORPORATION TAX ASSESSMENT BASES II: ITEMS OF INCOME
STATEMENT ... 125
4.1. PREFACE ... 125
4.2. REVENUES... 125
4.2.1.
GENERAL TREATMENT OF REVENUES ... 125
4.2.2. REVENUE
INCOME... 128
4.2.3.
OTHER OPERATING INCOME ... 129
4.2.4.
INCOME FROM FINANCIALS AND INVESTMENTS ... 134
4.2.5.
CHANGE IN INVENTORY/ CAPITALISED SERVICES ... 139
4.2.6.
EXCURSUS: CHARGEABLE GAINS ... 140
4.3. DEDUCTIONS ... 142
4.3.1.
GENERAL TREATMENT OF DEDUCTIONS... 142
4.3.2.
EXPENDITURE OF PURCHASED GOODS, RAW MATERIALS AND SUPPLIES ... 145
4.3.3. PERSONNEL
EXPENDITURES ... 146
Table of Contents
IV
4.3.4. DEPRECIATION/
CAPITAL ALLOWANCES... 147
4.3.5.
OTHER OPERATING EXPENDITURES ... 148
4.3.6.
EXPENDITURE FROM FINANCIALS AND INVESTMENTS ... 160
4.3.7. DIRECT
TAX ... 162
4.3.8.
OTHERS: EXPLICIT NON-DEDUCTIBLE OR RESTRICTED EXPENDITURES ... 163
4.3.9. CHARGES
ON
INCOME (DONATIONS) ... 164
4.4.
EXCURSUS: TREATMENT OF LOSSES ... 165
5.
COMPUTATION OF TAX LIABILITIES ... 169
5.1. CORPORATION
TAX ... 169
5.1.1. PREFACE ... 169
5.1.2. TAX
RATES ... 170
5.1.3.
SPECIAL TAX RELIEFS... 175
5.2.
TRADE TAX (ONLY IN GERMANY) ... 177
5.2.1. PERSONAL
TAX
LIABILITY ... 177
5.2.2.
MODIFICATION OF TAX ASSESSMENT BASE... 177
5.2.3.
SPECIAL FEATURES OF DETERMININING TRADING PROFIT ... 178
5.2.3.1.
ADDITIONS ... 178
5.2.3.2.
REDUCTIONS TO TAXABLE BASIS... 180
5.2.4.
CALCULATION OF TRADE TAX ... 181
5.2.5.
EXCURSUS: TREATMENT OF LOSSES ... 182
6.
SUMMARY AND CONCLUSION IN TERMS OF THESES... 184
6.1. PREFACE ... 184
6.2.
BALANCE SHEET ITEMS ... 185
6.3.
ITEMS OF THE INCOME STATEMENT ... 191
6.4. TAX
RATES... 198
6.5. FINAL
WORD... 202
ANNEX... XVI
LIST OF LITERATURE ... XLV
LIST OF LEGAL SOURCES...LIX
Abbreviations
V
ABBREVIATIONS
ACCA
Association of Chartered Certified Accountants (UK)
AG
Aktiengesellschaft
(German Stock Corporation)
or Application Guidance
AIA
Annual Investment Allowance
AO
Abgabenordnung
(German Tax Code)
approx. approximately
Art. Article
ASB
Accounting Standards Board
ATC
Annotated Tax Cases (GEE & Co. (Publisher) Ltd., South
Quay Plaza, 183 Marsh Wall, London E14 9FS)
b/f brought
forward
BAK
BAK Basel Economics
BB
Betriebs-Berater (Business Advisor magazine)
BBK
Buchführung, Bilanzierung, Kostenrechnung
(Accounting and Cost Accounting magazine)
BC
Basics for Conclusions
BDI
Bundesverband der Deutschen Industrie
(Federal Association of the German Industry)
BewG Bewertungsgesetz
(German Valuation Law)
BIM
Business Income Manual (HMRC)
Abbreviations
VI
BMF
Bundesminister der Finanzen
(German Federal Minister of Finance)
BTC
British Tax Cases (CCH Editions Ltd., Telford Road, Bicester,
Oxon OX6 0XD)
c/f carrying
forward
CA
Capital Allowance Manual (HMRC)
CAA
Capital Allowances Act (UK)
CEMA
Customs and Excise Management Act (UK)
Cf.
Confer
CFM
Corporate Finance Manual (HMRC)
CGM
Capital Gains Manual (HMRC)
CIRD
Corporate Intangible Research and Development Manual
(HMRC)
CTM
Company Taxation Manual (HMRC)
DBW
Die Betriebswirtschaft
(Business Management magazine)
DRS
Deutscher Rechnungslegungsstandard
(German Accounting Standard)
DV Durchführungsverordnung
(German Implementation Regulations)
e.g. for
example
EATR
Effective Average Tax Rate
EBITDA
Earnings before Interest, Tax, Depreciation and Amortisation
EMTR
Effective Marginal Tax Rate
Abbreviations
VII
ErbStDV Erbschaftsteuerdurchführungsverordnung
(German Inheritance and Gift Tax Law Implementation
Regulation)
ErbStG Erbschaftsteuergesetz
(German Inheritance and Gift Tax Law)
EStDV
Einkommensteuerdurchführungsverordnung
(Income Tax Implementation Regulation)
EStG
Einkommensteuergesetz
(German Income Tax Law)
EStH
Einkommensteuer-Hinweise
(German Income Tax Ordinance)
EStR
Einkommensteuerrichtlinie
(German Income Tax Guidelines)
et al.
and others
et. seq.
and the following (singular)
et. sqq.
and the following (plural)
etc.
et cetera
F.
Framework
FA
Finance Act
FGO
Finanzgerichtsordnung
(German Code of Practice for Financial Courts)
FIFO
First-in, First-outMethod
FRED
Financial Reporting Exposure Draft
FRS
Financial Reporting Standard
FRSSE
Financial Reporting Standards for Smaller Entities
Abbreviations
VIII
FY Financial
Year
FYA
First Year Allowance
GAAP
Generally Accepted Accounting Practices
GBP
Great Britain Pound
GewStDV Gewerbesteuerdurchführungsverordnung
(German Trade Tax Implementation Regulation)
GewStG
Gewerbesteuergesetz
(German Trade Tax Law)
GewStR Gewerbesteuerrichtlinie
(German Trade Tax Guideline)
GmbH
Gesellschaft mit beschränkter Haftung
(German Limited Liability Company)
GmbHG
Gesetz betreffend die Gesellschaften mit beschränkter Haftung
(German Law on Limited Liability Companies)
HGB
Handelsgesetzbuch
(German Commercial Law)
HICP
Harmonised Index of Consumer Prices
HM Her
Majesty
HMRC
Her Majesty's Revenue and Customs (UK)
i.e.
that is
IAS
International Accounting Standard
IASB
International Accounting Standards Board
ICTA
Income and Corporation Taxes Act (UK)
Abbreviations
IX
IDW
Institut der Wirtschaftsprüfer
(Institute of German Certified Public Accountants)
IFRIC
International Financial Reporting Interpretations Committee
IFRS
International Financial Reporting Standard
IHTA
Inheritance Tax Act (UK)
INA
Interpretation Act (UK)
ITC
Irish Tax Cases (Government Publications, 1 and 3, G.P:O.
Arcade Dublin 1)
ITEPA
Income Tax (Earnings and Pensions) Act (UK)
ITTOIA
Income Tax (Trading and Other Income) Act (UK)
KPMG KPMG
Deutsche
Treuhand-Gesellschaft
KStDV Körperschaftsteuerdurchführungsverordnung
(German Corporation Tax Implementation Regulation)
KStG
Körperschaftsteuergesetz
(German Corporation Tax Law)
KStH
Körperschaftsteuer-Hinweise
(German Corporation Tax Ordinance)
KStR
Körperschaftsteuerrichtlinie
(German Corporation Tax Guidelines)
LIFO
Last-in, Last-outMethod
LStDV
Lohnsteuerdurchführungsverordnung
(German Wages Tax Implementation Regulation)
LStH
Lohnsteuer-Hinweise
(German Wages Ordinance)
Ltd
Private Company Limited by Shares (UK)
Abbreviations
X
MTR
Marginal Tax Rate
MU Monetary
Units
NJW
Neue Juristische Wochenschrift
(Weekly Journal of Legal News magazine)
no. number
OECD
Organisation for Economic Co-operation and Development
p.
page or paragraph
p.a.
per annum
PCTCT
Profits Chargeable to Corporation Tax
Plc
Public Limited Company (UK)
pp.
pages or paragraphs
pt.
point
PVPTR
Present Values of Potential Tax Refunds
QBD
Queen's Bench Division
R & D
Research and Development
RPI
Retail Price Index
sc.
so called
Sch.
Schedule
SCR Small-Companies-Rate
SI
Statutory Instruments
SIC
Standing Interpretations Committee
SORP
Statements of Recommended Practice
Abbreviations
XI
SORP
Statements of Recommended Practice
SSAP
Statements of Standard Accounting Practice
SSCD
Simon's Special Commissioners' Decisions (Lexis Nexis
Buterworths, Halsbury House, 35 Chancery Lane, London
WC2A 1EL)
STC
Simons Tax Cases (Lexis Nexis Buterworths, Halsbury House,
35 Chancery Lane, London WC2A 1EL)
StuB
Steuern und Bilanzen
(Taxes and Financial Statements magazine)
StuD Steuern
und
Studium
(Taxes and Academic Studies magazine)
StuW
Steuern und Wirtschaft
(Taxes and Economy magazine)
TC
Tax Cases, Official Reports of Tax Cases (The Statonery
Office, PO Box 276 London SW8 5DT)
TCGA
Taxation of Chargeable Gains Act (UK)
TEC
Treaty of the European Communities
TL
Tax Case Leaflets (The Stationery Office, PO Box 276,
London SW8 5DT)
TMA
Taxes Management Act (UK)
TR Tax
Rate
TTR
Trade Tax Rate fixed by the Municipality
UITF
Urgent Issues Task Force
UK
United Kingdom of Great Britain and Northern Ireland
UK GAAP
United Kingdom Generally Accepted Accounting Practices
Abbreviations
XII
US
United States (of America)
US GAAP
United States Generally Accepeted Accounting Principles
USA
United States of America
UStDV Umsatzsteuerdurchführungsverordnung
(German Value Added Tax Implementation Regulation)
UStG Umsatzsteuergesetz
(German Value Added Tax Law)
UStR Umsatzsteuer-Richtlinie
(German Value Added Tax Guidelines)
VAT
Value Added Tax
VATA
Value Added Tax Act (UK)
VCM
Venture Capital Scheme Manual (HMRC)
vs. versus
w/o without
WDA Write-Down
Allowance
WDV
Written-Down Value
WiSt
Wirtschaftswissenschaftliches Studium
(Economic Studies magazine)
WP Wirtschaftsprüfer
(German Certified Public Accountant)
Wpg Die
Wirtschaftsprüfung
(Auditing magazine)
Abbreviations
XIII
ABBREVIATIONS: REFERENCES TO LEGISLATION AND OFFICIAL GUIDELINES
Examples:
Business Income Manual,
BIM 31020
(UK) Business Income Manual,
there text number 31020.
CA 2001, p. 23
Capital Allowances Act 2001 (UK),
there paragraph 23.
Capital Allowances Manual,
CA 23410
Capital Allowances Manual,
there text number 23410.
Capital Gains Manual,
CG 5300
(UK) Capital Gains Manual,
there text number 5300.
Commercial Law, pp. 276, 277
(German) Commercial Law,
there paragraphs 276 and 277.
Company Taxation Manual,
CTM 51190
(UK) Company Taxation Manual,
there text number 51190.
Copeman v William Flood & Sons
Ltd (1940), 24 TC 53
(UK) Judicial Decision of 1940,
Official Reports of Tax Cases (TC),
The Stationary Office, PO Box 276, London SW8 5DT,
there file reference 24 TC 53.
Corporate Finance Manual,
CFM 5230
(UK) Corporate Finance Manual,
there text number 5230.
Corporate Intangible Research and
Development Manual,
CIRD 25160
(UK) Corporate Intangible Research and Development
Manual,
there text number 25160.
Corporation Tax Law, p. 1.1-2
(German) Corporation Tax Law,
there paragraph 1, clause 1 and 2.
Abbreviations
XIV
F.25
Framework of International Financial Reporting
Standards,
there text number 25.
FA 1996, p. 84.3
Finance Act 1996 (UK),
there paragraph 84, clause 3.
Federal Finance Court of 19/10/2006,
III R 6/05, Federal Tax Gazette 2007
II p. 301.
(German) Judicial Decision of the Federal Finance
Court of 19/10/2006, file reference III R 6/05,
Publication in Federal Tax Gazette 2007, there Part II,
page 301.
IAS 1.46
International Accounting Standard,
there Standard 1, text number 46.
ICTA 1988, p. 831.1
Income and Corporation Tax Act 1988 (UK),
there paragraph 831, clause 1.
Income Tax Act, p. 6
(German) Income Tax Act,
there paragraph 6.
Tax Code, pp. 11-12
(German) Tax Code,
there paragraphs 11 and 12.
Trade Tax Law, p. 8 no. 12
(German) Trade Tax Law,
there paragraph 8, number 12.
Venture Capital Schemes Manual,
VCM 50300
Venture Capital Schemes Manual,
there text number 50300.
Abbreviations
XV
Sources of Law:
UK Legislation is available at HM Office for Public Sector Information or HMRC
http://www.opsi.gov.uk/legislation/uk.htm
http://www.hmrc.gov.uk/thelibrary/manuals.htm.
UK Judicial Decisions are summarized by
DOLTON, A., KEVIN, W. (2007), Tolley's Tax Cases 2007, London 2007.
German Legislation is available at Federal Ministry of Justice:
http://www.gesetze-im-internet.de.
German Judicial Decisions are available at
Verlag Neue Wirtschafts-Briefe GmbH & Co. KG, Herne, Berlin http://www.nwb.de.
International Accounting Standards/ International Financial Reporting Standards are available at:
http://www.iasb.org.
This work is dedicated to my wife Andrea.
Chapter 1
1
1.
INTRODUCTION
1.1.
PURPOSE OF STUDY
In the discussion of topics relating to corporation law, already from a number of legal form alternatives
within the European Union, the UK Private Company Limited by Shares (also referred to in the following as
Limited or Ltd.) has been emerging as a preferred legal form with limited liability. The Limited may be
presumed the most widespread legal form worldwide as facilitated mainly by the adoption of Anglo-Saxon
law in countries of the former British Empire and the worldwide presence of English language.
1
The growing popularity of Limited in Europe is traceable first to Art. 43 and 48 TEC
2
(freedom of
establishment) while also to the breakthrough verdict of the European Court of Justice on "Inspire Art".
3
This
means that member states are now obliged to recognise the legal form and along with it limited liability of
foreign firms with administrative seat (place of effective management) in their sovereign territory.
4
Irrelevant of whether the place of effective management is within or outside the United Kingdom of Great
Britain and Northern Ireland (in the following as United Kingdom, or UK), establishment and management
of Limiteds has to comply with valid corporation law of the home country. The approach also is referred to
as the theory of establishment. Accordingly, the place of effective management of a Limited can be located
in any European country while maintaining its legal personality.
5
The subject of present study is to examine whether relocating the place of effective management of a Limited
from the United Kingdom to the Federal Republic of Germany (in the following as Germany) is preferable
from tax point of view. In order to avoid double taxation of a company with registered seat in the United
Kingdom while its place of effective management is in Germany, a double taxation treaty has been signed
between the two countries. As far as a company is located in both the countries, as the place of its registered
seat the country is considered in which its actual executive management is located (double taxation treaty
between Germany and the United Kingdom, Art. 2.1) (sc. tie breaker rule). Where actual executive
1
Cf. HECKSCHEN/KÖKLÜ/MAUL (2007), pp. 4-5; JUST (2005), p. 1.
2
Treaty of the European Community.
3
Cf. European Court of Justice of 30/09/2003, C-167/01. Further also European Court of Justice of 05/11/2002,
C-208/00 (Überseering), European Court of Justice of 09/03/1999, C-212/97 (Centros), European Court of
Justice of 27/09/88, 81/87 (Daily Mail).
4
Cf. CLEARY (2006), p. 6; DEGENHARDT (2005), p. 11; HARTMANN (2005), pp. 37-40; LEISSL (2008),
p. 3; SILBERBERG/SCHWENDEMANN (2007), pp. 18-20.
5
Cf. DEGENHARDT (2007), p. 48.
Chapter 1
2
management is located in Germany, the Limited is caught exclusively by German Tax Law
6
.
7
For aspects
unrelated to corporation law, generally the law applies of the country of occupation.
8
With regard to growing mobility of citizens and businesses within the European Union, there is apart from
the competition for the ideal legal form also tax competition for the most attractive business location.
9
Taxation amounts to a key determinant in business location decisions. Taxes do not affect entrepreneurial
decisions only but also competitive status of companies. Countries pursue mostly through attractive tax
policy
10
to direct entrepreneurial decisions of businesses, trying to motivate companies to open up
establishments in their national territory.
11
Accordingly, subject of present study is scientific examination of UK and German Tax Law regulations
concerning Limiteds. Previously published studies on the subject mostly remain restricted to detailed
presentation of corporation law provisions. This study pursues both theoretical and pragmatic research aims.
From theoretical point of view while leaving corporation law regulations largely out of scope, the study
focuses on tax law regulations of relevance to Limiteds located in the United Kingdom and in Germany
respectively as regards tax liability, tax rates and tax assessment bases, with a critical examination of all the
aspects.
12
The aim pursued by the procedure, relevant theses shall be formulated on the preferability of either
country with regard to tax treatment of selected balance sheet and profit and loss items as well as to tax rates.
From pragmatic point of view, the insights gained in the study shall provide the reader involved with tax law
with relevant information on respective tax effects for Limiteds with place of effective management in the
United Kingdom and in Germany respectively and provide decision making references for tax optimisation
and business economic location selection decisions. Moreover, the insights gained in the comparison of legal
standards may serve as references for quantitative examinations of specific case instances.
6
Tax treatment of a Limited with seat in Germany corresponds to treatment of a German GmbH (German limited
liability company), cf. BRINKMEIER/MIELKE (2007), p. 77.
7
Cf. BRINKMEIER/MIELKE (2007), pp. 60-61; HECKSCHEN/KÖKLÜ/MAUL (2007), p. 263;
HERMANN (2008), p. 139; JOHNEN (2006), p. 152.
8
Cf. FRITZ (2008), p. 13.
9
Cf. LEHNER (2007), p. 1.
10
This mostly entails low tax rates that let the country concerned appear as a viable location for investments and
the effect that complex tax assessment bases do not deter investors as much as they are attracted by low tax rates,
cf. SCHNEELOCH (2002), p. 103.
11
Arrival of businesses promotes creation of jobs and higher tax revenues, cf. RUF (2007), p. 1.
12
A tax burden comparison for a concrete tax type in one country with that applicable in another country always
necessitates an examination of applicable tax assessment bases and tax rates, cf. SCHNEELOCH (2002), p. 103.
Chapter 1
3
1.2.
SCOPE OF THE OBJECT OF INVESTIGATION
Subject of present analysis is the legal form of Private Company Limited by Shares
13
. The scope restriction
to a specific legal form facilitates a more detailed presentation of applicable tax regulations from corporate
point of view. Tax treatment of partners is not subject of this study. The analysis further amounts to an
economic examination of operations of at least medium-sized or larger Limiteds. The assessment period is
restricted to calendar year 2008.
Determinants are examined of current and local taxation of Limiteds both for the United Kingdom
14
and
Germany as business locations. Cross-border activities, non-periodical special tax-triggering events in
connection with the act of establishment, dissolution or transformation of legal form, rollover relief
15
and
subsidisation events are excluded from the examination.
The examination scope does not include an examination of tax rates only but also of the relevant tax liability
and of selected assessment bases in the United Kingdom and in Germany respectively. Due to the prevailing
qualitative perspective applied in the examination, definition of the subject scope in terms of qualitative
criteria for examination purposes is not necessary.
16
1.3.
OUTLINE OF THE STUDY
The study consists apart from the introduction of five main chapters. In the following Chapter Two of the
study, references are outlined for conducting international tax burden comparisons. In the process, not just
relevant requirements but also the benefits and drawbacks of each method are described. Subsequently,
selection follows of the analysis method to apply herein. This is complemented by an outline of the UK and
German tax systems and of key determinants that shape the tax law in each case. Finally valid corporation
tax regulations are characterised for the United Kingdom and Germany respectively. This mainly entails a
description of individual tax liability and a breakdown of the broad structure of the tax assessment bases.
In Chapter Three, comparative examination is conducted of tax assessment bases for selected balance sheet
items in the United Kingdom and in Germany respectively. In the first part of the chapter in reference to the
authoritative principle under which tax regulations refer to commercial accounting regulations, initially the
commercial accounting framework concepts are analysed applicable in the countries. In order to avoid
13
The scope of the term of private company limited by shares for purposes herein is explicitly identifiable with
Limiteds established
in England or Wales as in other parts of the United Kingdom, partly different corporation
law regulations apply.
14
The term of United Kingdom for purposes herein comprises Great Britain and Northern Ireland but not the Irish
Republic, the Isle of Man or the Channel Islands, compare also WATTERSTON (2006), p. 2. As far as the
adjective 'British' is used herein, the term also refers only to regions within the United Kingdom.
15
On the subject, compare particularly BLÖDNER/BILKE/HEINING (2007), pp. 407-412; MELVILLE (2009),
pp. 319-321.
16
Cf. also SECTION 2.1.1.
Chapter 1
4
differentiation uncertainties in the second part of the chapter, the general recognition criteria and value
measures are discussed for balance sheet items. In the last and most extended section, finally a qualitative
examination is conducted of balance sheet items from tax point of view. The balance sheet items concerned
have been split for examination purposes generally according to the country between the United Kingdom
and Germany as well according to respective item classes of definition, recognition, measurement and
disposal. In conclusion to each partial examination, key similarities and differences are summarised and
assessed applying qualitative perspective.
In Chapter Four, the comparative assessment is extended to also comprise profit and loss items. The
approach applied refers to the cost method structure, comprising apart from qualitative examination of tax
treatment of selected profit and loss items also an analysis of general treatment of revenues and deductions
respectively. Further the treatment of tax losses is discussed in the United Kingdom and in Germany
respectively.
Applicable corporation tax rates in the United Kingdom and in Germany are examined from both the
qualitative and quantitative perspectives in Chapter Five. This also entails an exemplification of the German
trade tax (local business tax). The study concludes in Chapter Six with a summary of the conclusions reached
in form of theses.
Chapter 2
5
2.
FUNDAMENTALS
2.1.
INSTRUMENTS FOR THE EXECUTION OF INTERNATIONAL TAX COMPARISON
2.1.1.
PREFACE
In business location decisions, taxation amounts to a relevant factor. Specifically in two-country
comparisons, the question arises of corporate tax burden. Yet determining the tax burden on a generic lump-
sum basis usually is not possible. Additional variables that enter the taxation formula also have to be
determined. Key variables of relevance in tax burden assessments for comparison purposes are as follows:
17
^ Tax subject
Is the assessment to be conducted for a partnership or corporation? Is it possible to specify corporate legal
form more precisely? Is the tax burden to be determined at corporate or partner level?
^ Assessment period
Are past, current or future tax regulations to be examined?
^ Assessment perspective
Is the assessment to be conducted for a particular enterprise or as a macroeconomic assessment for all
enterprises?
^ Economic activities
Is current taxation at the corporate level or aperiodic special taxation
18
to be examined?
^ Economic activity perspective
Is the assessment to be limited to local domestic taxation or are cross-border activities to be included as
well in the assessment?
^ Comparison scope
Is the comparison to comprise all taxation aspects (tax liability, tax assessment base, tax rate) or focus on
specific partial taxation aspects only?
^ Comparison perspective
Is the comparison to be conducted for average tax rates or marginal tax rates?
^ Comparison reference variable
With which reference variable the identified tax burden is to be correlated with? Is it to be a reference
variable defined by tax regulations or by commercial accounting regulations?
17
Cf.
JACOBS
(2005), p.
28; SCHMIDT/SIGLOCH/HENSELMANN
(2005), p.
454; SMITH
(1991), p.
7;
SPENGEL/LAMMERSEN (2001), p. 223.
18
This includes e.g. circumstances of a change in legal form or business dissolution.
Chapter 2
6
In follow-up to identifying applicable determinants, the method is to be defined for conducting the tax
burden comparison. Consequently in the following parts, common techniques shall be outlined for
determining applicable tax burden. Generally, a differentiation applies between qualitative and quantitative
assessment techniques.
2.1.2.
QUALITATIVE METHODS OF INVESTIGATION
2.1.2.1. COMPARISON OF LEGAL RULES
In comparisons of applicable legal standards, assessment is conducted of local tax regulations by way of
qualitative analysis. Depending on the aims pursued in the comparison, cross-border activities may be
considered as well. The comparisons generally serve the purpose of assessment of current or future corporate
tax position.
The comparisons exceed the scope of a comparison of tax rates only, examining all key determinants as well
that affect the tax assessment base. Local taxation analysis usually entails an analysis of the respective tax
systems and a description of applicable corporation taxes
19
as well as an analysis of tax relevant recognition
and measurement regulations. This includes for instance an analysis of tax treatment of amortization rates for
assets, inventory, provisions, tax deductible expenditures and revenues
20
and tax treatment of losses.
Investment allowances or investment grants
21
that can also be referred to as negative taxes may be
considered as well. A comparison of applicable standards for cross-border activities includes the respective
double taxation treaties, taxes levied at source, types of and prerequisites for tax allowances (e. g. exemption
or compensation) as well as requirements concerning settlement prices.
An analysis of applicable tax regulations is preferential to a comparison of tax rates only as from a
qualitative comparison of legal standards, also specific tax optimization guidelines may be derived. The
relevant drawbacks, the comparison of legal standards only remains limited to a qualitative assessment of
corporate tax position and no average or marginal tax rates are determined either in absolute or percentage
terms. Consequently relying on a comparison of legal standards only, usually no clear, generally applicable
conclusion can be drawn on the preferability of a particular country.
Nevertheless, a tax burden quantification only is possible in reference to analysis of relevant tax regulations.
This makes a comparison of applicable legal standards (qualitative method) a general prerequisite in order to
be able to conduct any specific tax calculations (quantitative methods) in the first place.
22
19
As far as corporate tax burden consists of various profit taxes, additional taxes (such as the German local
business tax) are to be examined as well in addition to corporation tax.
20
This also entails treatment of sales proceeds and dividends.
21
These are invariably state incentives aimed at promotion of specific economic branches.
22
Cf. SCHMIDT/SIGLOCH/HENSELMANN (2005), pp. 455-457.
Chapter 2
7
2.1.3.
QUANTITATIVE METHODS OF INVESTIGATION
2.1.3.1. CASUISTIC SIMULATION OF ASSESSMENT
Prerequisite to quantitative comparison of applicable tax burdens via simulated tax assessment is qualitative
examination in form of a comparison of applicable tax regulations. A tax assessment simulation usually
amounts to a multiple period and/ or dynamic corporate model that refers to company-specific planning and
specific figures.
Hence a multiple period simulation of corporate tax developments depends upon the specific assumptions
made. In the initial step apart from developing necessary insight into the financial structure of assets,
liabilities and capital, particularly assumptions have to be made on the amounts of expected corporate
inpayments and outpayments. Inpayments for all periods within the planning horizon are subject to estimates
in reference to future sales expectations. In the follow-up referring to the sales expectations, future
outpayments for the production factors have to be quantified. This essentially amounts to planning the
following resources: personnel, assets, equity or debt capital and raw materials and consumables. In the
second step from the planned inpayments and outpayments with regard to applicable provisions on
determining taxable income, corporate balance sheet and profit and loss are derived for the periods within the
planning horizon. In the last step, the respective tax assessment bases are derived from the data contained in
balance sheet and profit and loss. By applying the tax rates to the assessment base, tax liability is generally
determined for the respective country. The tax liability then translates into outpayments within the corporate
model. The calculation procedures are generally identifiable with tax calculation techniques defined by tax
authorities.
23
The method advantage is full inclusion of applicable tax regulations (e.g. tax assessment base, tax rate) and
consequently precise calculation of respective tax liability.
24
However, there is also a major drawback in that
the method output is critically dependent upon previously defined model assumptions
25
(see above) and is
only valid for the particular case in question.
26
Usually, no generally applicable conclusions can be derived
from the output.
27
Individual calculation of applicable tax burden additionally entails significant costs which
is why it is recommended to make use of computer software. Another heavy time consuming aspect is the
information gathering effort in order to explore current tax relevant regulations in the countries concerned as
23
Contrary to procedures applied by tax authorities however, this does not amount to taxable income already made
but planned taxable income instead, i.e., a tax target variable.
24
Cf. SCHNEIDER (1990b), p. 539.
25
Another drawback, the model frequently is unable to adequately reflect economic reality. This means that due to
the complex nature of economic environment, model-inherent simplifications are inevitable. Less relevant
regulations should be disregarded for simplicity's and comprehensiveness' sake. On the other hand on overly
excessive simplification of complex interrelationships, there is a risk of errors in judgement,
cf. LAMMERSEN (2005), pp. 52, 286.
26
Cf. SMITH (1991), p. 28.
27
Cf. LAMMERSEN (2005), p. 288.
Chapter 2
8
the information availability usually is restricted and there is no standardized form.
28
However, a note applies
that in an assessment simulation, only the tax burden to taxable income ratio is calculated. As such, this
amounts to determining average tax burden.
2.1.3.2. COMPARISON OF TAX RATES
The comparison of tax rates amounts to a simplified comparison of tax burdens at the corporate level.
Usually in a tax rate comparison, the tax rates are compared applicable under current taxation of earnings. In
the effort, one should make sure that all the applicable corporate profit taxes in the respective country are
included in the analysis. For instance profit taxes for a German enterprise do not include corporation tax only
but also the solidarity tax contribution and local business tax. Where there are interdependencies between the
different types of taxes, the interdependencies have to be accounted for as well. For instance a tax may be
deductible in determining another tax liability or allowable against the other tax. Further where several types
of profit taxes apply, not always identical tax assessment base is employed for determining applicable tax
burden. Existing taxes unrelated to income usually need to be accounted for in tax rate comparisons.
29
Key advantages of tax rate comparisons include non-exhaustive information gathering effort and simple
presentation of output. However, the obvious advantages are opposed by a number of drawbacks the most
poignant among which is non-inclusion of applicable tax regulations in determining the tax assessment
base
30
. As reference variable in the tax rate comparison, an assumption applies of constant profit before tax
in both the countries. Yet the assumption basically does not reflect reality. Realistically, tax regulations in
two different countries and hence also the respective tax assessment bases may be expected to be different.
31
The different tax assessment bases further also mean different temporal relevance of the taxes. It is generally
recognized in economic theory that carrying tax liabilities forward to future periods is preferable to tax
liabilities in earlier periods.
32
However, such tax determinants are not accounted for in pure tax rate
comparisons.
33
In economic reality however, high tax assessment bases do not deter potential investors as much as they are
attracted by low tax rates. Nevertheless, investors should not make business economic decisions on business
locations in reference to comparisons of applicable tax rates only. A comparison of tax rates only may result
in excessive errors of judgement as regards the tax environment.
34
28
Cf. LAMMERSEN (2005), p. 50; SCHMIDT/SIGLOCH/HENSELMANN (2005), pp. 458-459.
29
Cf. SPENGEL/LAMMERSEN (2001), p. 224.
30
For instance in tax rate comparisons, a potentially applicable tax exemption for dividends or sales proceeds is not
accounted for. The same applies to state incentives aimed at promotion of investments.
31
Cf. SMITH (1991), p. 10.
32
Cf. SCHNEIDER (1990b), p. 536.
33
Cf. LAMMERSEN (2005); SCHMIDT/SIGLOCH/HENSELMANN (2005), pp. 453-455.
34
Cf. GUTEKUNST (2005), p. 16.
Chapter 2
9
2.1.3.3. ANALYSIS OF EMPIRICAL DATA
Analysis of empirical data amounts to a simplified method of conducting tax burden comparisons. For tax
burden examination purposes, correlation is conducted of macroeconomic accounting data or published
annual financial statement data
35
. Yet this also means that comparisons can be conducted of past tax burdens
only.
36
The advantage to analysis of empirical data is determining actual tax burden while taking into account the
complete tax system including any applicable special regulations that were exercised as such in the past.
37
Hence a comparison of legal standards is not a prerequisite to applicability of the method.
However, the advantage does not outweigh the drawbacks coupled with practicing the method. For instance
based on macroeconomic accounting data, only average tax burden can be derived for a majority of
enterprises. Yet average tax burden frequently is not applicable as a generic reference to enterprises due to
disregarding the tax optimization options that would otherwise result in a lower tax burden in the particular
case.
38
A tax burden comparison should be conducted from the economic perspective of a particular
enterprise.
39
Moreover, available statistics often are heavily aggregated or do not contain all the necessary
data for determining applicable tax burden. When referring to published annual statements, the tax liability is
correlated with commercial profit. Yet this results in inaccuracies in determining the tax burden as
commercial profit usually does not correspond with tax assessment base
40
.
41
Further it is not always clear
whether the tax liability reported in a financial statement amounts to current taxation only or whether it also
includes tax liabilities of previous periods. Finally due to the reference data employed, the method is not
suited for determining current or future tax burdens.
42
2.1.3.4. EFFECTIVE TAX RATES
The effective tax rate concept does not amount to a full-fledged method of tax burden comparison. Rather,
this is a cash flow-oriented tax measure that reflects the changes in decision making relevant target variables
35
In the effort, both tax liabilities for the total of all enterprises may be examined as well as tax liabilities
differentiated according to branches, business sizes or legal forms.
36
Cf. SPENGEL/LAMMERSEN (2001), p. 224.
37
Cf. HAKIMI (2007), p. 17.
38
Further this usually also amounts to an analysis of local domestic taxation only while disregarding cross-border
activities.
39
Cf. SCHNEIDER (1988), p. 282.
40
Another problematic aspect, subject to domestic taxation in an individual financial statement is global income
that may also comprise for instance foreign income exempted from tax. Accordingly, this leaves the tax rate too
low. For group financial statements, global income is taxed worldwide so that in this case, these are worldwide
tax liabilities as opposed to domestic tax burden, cf. SPENGEL/LAMMERSEN (2001), p. 224.
41
Cf. KNIRSCH (2005), p. 27; SCHNEIDER (1990a), pp. 500-501.
42
Cf. SCHNEIDER (1990b), p. 535; SMITH (1991), p. 3; SCHMIDT/SIGLOCH/HENSELMANN (2005),
pp. 460-461.
Chapter 2
10
as a result of taxation. The target variables generally are identifiable with economic measures
43
such as
present value, accumulated value or yield
44
.
45
Effective tax burden then is determined as a difference
between before tax target variable and after tax-target variable divided by before-tax target variable:
46
Effective Tax Rate = (Target Variable Before Tax ./. Target Variable After Tax)/ Target Variable Before Tax
Depending on the economic aspects examined, differentiation is possible between effective marginal tax
burden and effective average tax burden.
Decision making relevant tax law aspects are quantifiable under model-based simplifications employing the
Effective Marginal Tax Rates method
47
. Under the method, highly simplified finance plans for investment
projects are examined
48
that feature a predefined curve of future payments surpluses. A mathematical
dependency is determined with the method between the target variable before tax and target variable after tax
while also accounting for the financing form and legal form. Further an assumption applies that an investor
only invests capital for as long as the internal yield on the investment matches the capital's real cost. That
means the method reflects the marginal circumstances in which an investment is just made yet or just
refrained from.
49
For a presumed tax rate, the target variable after tax can be calculated accordingly.
The method advantage is in deploying purely economic reference variables by examining cash flows and
internal yield
50
. However, the advantage is opposed by a number of drawbacks. For instance the assumption
of ideal cash flows frequently does not reflect reality and mathematical assessment of effective tax burden is
exhaustive and not readily comprehensible. The method often is able to reflect applicable provisions under
the respective tax law in broad terms only.
51
The method further is limited to marginal circumstances in
which investments pay off or not just yet. Yet in searching for an ideal location, specifically investments are
43
Hence this is a decision making neutral assessment base. Contrary to tax assessment simulation, the target tax
burden is not correlated with tax assessment base but with a neutral assessment base instead.
44
Cf. SPENGEL/LAMMERSEN (2001), p. 225.
45
Marginal tax rates indicate by how many cash units the tax burden changes if the economic reference variable
grows by one cash unit.
46
Cf. NIEMANN/BACHMANN/KNIRSCH (2003), p. 125; SCHNEIDER (1990a), p. 501; SMITH (1991), p. 11.
47
Cf. SCHNEIDER (1990b), p. 537.
48
Cf. SPENGEL/LAMMERSEN (2001), p. 229.
49
Circumstances in which the cost of investment(s) equals return after tax.
50
In the study by KING/FULLERTON, effective marginal tax rates have been calculated for a total of
81 combinations of determinants for corporations. The economic measure in the study was yield on an
investment, cf. GUTEKUNST (2005), p. 46; RUF (2007), p. 43; SMITH (1991), p. 13.
51
Moreover, the calculations due to the complex frameworks of tax regulations as well as different alternative
assumptions (yield before tax, interest structure) always remain limited to different combinations of investment
and finance intentions for specific branches, private or institutional capital providers and capital providers liable
to or exempted from tax. The calculations further do not provide for sufficient interconnection between
regulations and the tax assessment base (e.g. equity financing through provisions, inclusion of sales proceeds
and subsidies), cf. SCHNEIDER (1990a), p. 502; SCHNEIDER (1990b), p. 539.
Chapter 2
11
sought after with positive capital return values.
52
This leaves the relevance of effective marginal tax rates to
business location decisions rather limited.
53
On the contrary under the concept of Effective Average Tax Rates, average tax burden is determined for
profitable investment alternatives with positive capital value.
54
The method has been derived from the
concept of effective marginal tax rates which is why it also employs an investment theory-based concept.
55
In order to avoid economically unrealistic assumptions, simulation models are regularly employed on the
basis of concrete finance plans. The deployment of models that refer to finance plans allows a more detailed
examination of applicable tax system and inclusion of additional economic framework data (e.g. inflation
rate, interest rates). This allows to compute tax consequences for a broad range of combinations. Under the
concept, usually yield is referred to as economic target variable for determining effective tax burden.
56
The method advantage is assessment of several investments that mutually exclude each other. This means an
order of preference can be determined between several investments. Also a plus is comprehensive
examination of economic framework data and of the tax system by deploying finance plans. By means of IT-
based simulation models, meaningful information can be extracted on the working principles of tax systems.
The method is generally suited for decision making relevant tax burden comparisons between two locations.
A significant drawback also here, the relevance of the model output remains limited to the case in
question
57
.
58
2.1.4.
CHOICE OF A PARTICULAR INVESTIGATION METHOD
In the thesis, an examination shall be conducted of current tax regulations for the Private Company Limited
by Shares in the United Kingdom and in Germany respectively. Due to its backward-looking concept,
analysis of empirical data and identification of macroeconomic tax rates is not suited as a reference to base
business economic decisions on. The method is merely able to visualize an already emergent distribution.
Beyond that, the determined average tax burden frequently cannot be applied generically to all enterprises.
52
Cf. SMITH (1991), pp. 15-16.
53
Cf. SCHMIDT/SIGLOCH/HENSELMANN (2005), p. 463; SPENGEL/LAMMERSEN (2001), pp. 223, 229-
230.
54
Cf. GUTEKUNST (2005), p. 29.
55
A model for determining both effective marginal tax rates and effective average tax rates has been developed by
DEVEREUX/GRIFFITH. The model employs as economic measure net present value,
cf. GUTEKUNST (2005), p. 56; LAMMERSEN (2005), p. 84; RUF (2007), p. 57; SPENGEL/
LAMMERSEN (2001), p. 226.
56
Cf. SCHMIDT/SIGLOCH/HENSELMANN (2005), p. 464.
57
Cf. also SECTION 2.1.3.1. The output of effective tax burden measurement serves mainly as a guidance to
political functions. It is of limited value to individual investors as each case is different in terms of applicable
setup of variables, cf. LAMMERSEN (2005), pp. 159, 285.
58
Cf. SCHMIDT/SIGLOCH/HENSELMANN (2005), pp. 463-464; SPENGEL/LAMMERSEN (2001), pp. 223,
227-229.
Chapter 2
12
Tax burden also should be measured rather from the individual business economic perspective as opposed to
macroeconomic perspective.
In tax burden comparisons for business economic decision making purposes, a forward looking perspective
should be applied. Calculation of effective average tax rates (EATR) employing finance plan-based
simulation models is suited for examining location-related tax aspects as well as for determining applicable
tax burden as in departure from casuistic simulation models, the model employs as a decision making
relevant target variable an economic measure. Contrary to calculation of effective marginal tax rates
(EMTR), under this method average tax burden is calculated for investments with positive capital value.
Nevertheless the drawback to forward-oriented quantitative methods, calculation only is possible based on
specific comprehensive model assumptions. Despite taking into account provisions regarding tax liability,
tax assessment base and tax rate, simulations models always are valid only for the particular case in question.
Hence the model output does not amount to conclusions of general relevance valid for all enterprises.
Conclusions of general relevance on the preferability of a specific tax system employing simulation models
are not possible due to the large variety of possible assumptions and combinations thereof.
59
In the
examinations herein, not just a forward-looking perspective shall be employed but they also shall not remain
limited to a single particular case. Consequently, a quantitative analysis of potential tax consequences shall
not be conducted for purposes herein.
Hence the thesis core focus point is qualitative analysis in form of an objective comparison of legal standards
for selected regulations concerning tax assessment base. As part of the thesis, the causes behind particular
tax burden levels shall be examined. This is because only with insight into the interdependencies, decision
makers can make informed decisions. The tax burden amount and structure is shaped by various
determinants. At the national level, the determinants may relate to applicable tax system, combination of
relevant tax types, definition of different assessment bases as well as applicable tax rates. Due to combined
effects of tax assessment base and tax rate, additionally for purposes herein a quantitative assessment is
conducted of applicable tax rates.
The qualitative analysis shall establish insight into the structure of the respective tax system and into
essential tax consequences within a specific tax system that shall be compared in the follow-up with the tax
system of the other country. Based on the comparison, logical conclusions shall be drawn on the preferability
of a particular system that can be used for tax optimization purposes. Beyond that, the conclusions from the
qualitative comparison of legal standards shall establish a reference basis for conducting quantitative
analyses in specific cases.
59
Only wishful thinking coupled with ignorance may mislead into comprising in a single summary tax burden
figure the hardly comprehensible number of tax law provisions and their economic consequences,
cf. SCHNEIDER (1988), p. 290.
Chapter 2
13
As regards the definition of scope of the analysis subject matter and the related definition of key
determinants for a qualitative assessment of legal standards as well as for a quantitative assessment of tax
rates, refer to SECTION 1.2.
2.2.
THE TAX SYSTEM AND INFLUENCES OF TAXATION
2.2.1.
PRINCIPLES OF TAXATION
UNITED KINGDOM AND GERMANY
Taxation generally has to comply with principles of the rule of law. Taxes may only be levied on the basis of
a valid act of law. The law must specify apart from the respective matter of fact circumstances also the legal
consequences relating to taxation so that the taxpayer is able to calculate applicable tax liability and adapt its
actions accordingly (formal component). Taxation further has to be fair and consistent. That means that
comparable circumstances cannot be subject to different taxation.
60
All taxpayers are to be treated equally
before the law and also taxed consistently (material component).
61
Accordingly in the following sections, key
legal sources in tax law are listed governing in the two countries taxation of corporations.
2.2.2.
SOURCES OF THE TAX LAW
UNITED KINGDOM
The UK tax legislation consists of statute law on the one hand and case law on the other.
62
Key tax law
principles are defined by acts of the parliament. Tax law interpretation resides with courts. Court rulings are
binding to all persons. In addition, the UK tax administration (HM Revenue & Customs, HMRC) publishes
comments, brochures and summary publications (statements, notices, leaflets) that exemplify implementation
of the law in practical applications. The publications only provide interpretation by the tax administration,
having no legal backing.
63
The key current acts of law in tax legislation with breakdown according to tax
types are:
^ Corporation Tax:
Income and Corporation Taxes Act 1988 (ICTA 1988)
Capital Allowances Act 2001 (CAA 2001)
Taxation of Chargeable Gains Act 1992 (TCGA 1992)
^ Value Added Tax:
Value Added Tax Act 1994 (VATA 1994)
^ Capital Gains Tax:
Taxation of Chargeable Gains Act 1992 (TCGA 1992)
^ Income Tax:
Income and Corporation Taxes Act 1988 (ICTA 1988)
Capital Allowances Act 2001 (CAA 2001)
60
Cf. SCHNEELOCH (1998), p. 449.
61
Cf. BEECK (2007), pp. 6-7.
62
Cf. TRIEBEL (2006), pp. 5-6.
63
Cf. BERNSTORFF (2006), pp. 9-18.
Chapter 2
14
Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003)
Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005)
^ Inheritance Tax:
Inheritance Tax Act 1984 (IHTA 1984)
^ Tax Administration:
Taxes Management Act 1970 (TMA 1970)
Customs and Excise Management Act 1979 (CEMA 1979)
The acts of law are subject to annual amendments via Finance Acts. Apart from acts of law, Statutory
Instruments (SI) are published on a regular basis that on the one hand describe detailed aspects of the
different acts of law while on the other are a means through which amendments are implemented of
legislational standards.
The United Kingdom further maintains agreements aimed to prevent double taxation, also known as double
taxation treaties, with other countries. Where the taxpayer is liable to income or property taxes in two
countries, double taxation treaties come into play that aim to either completely eliminate or at least reduce
applicable tax liability by way of suitable procedures. Double taxation treaties are treaties under international
law that become legally binding by way of implementation in national law.
64
GERMANY
In Germany, legal sources for taxation entail legal standards, administrative regulations and case law. As
legal standards, tax legislation and appertaining practical implementation regulations are referred to.
Generally, tax provisions are defined in tax legislation. No taxation is permissible without a reference legal
standard. Tax legislation consists of Federal acts of law that are binding to all persons and are subject to
enforcement by national authorities (executive authorities). Federal acts of law are made by legislative
bodies, with the acts first passed by the Bundestag (German parliament) and approved by the Bundesrat
(Federal council, or upper house of the parliament). The acts of law are signed by the Federal President and
announced by way of publication in the German Federal Law Gazette (Bundesgesetzblatt). Tax law is
additionally published in the Federal Tax Gazette (Bundessteuerblatt) Part I.
In the same way as in the UK, Tax Law is subject to steady updates by way of replacements and additions
through one-off or regular annual amendments
65
. Apart from Tax Law, there are a number of legal
regulations published as legal standards by executive authorities (Federal government, state governments or
Federal ministry) (Basic Law, p. 80.1). Purpose of the legal regulations is to exemplify the wording of the
law. The legal regulations are binding to all persons and are regularly adjusted to current legislation. In Tax
64
Cf. also MALLESON (2007), pp. 26-27.
65
This mainly entails annual tax acts, budget supplement acts, acts of law on tax amendment and acts of law under
regional investment aid scheme.
Chapter 2
15
Law, the legal regulations are referred to as implementation regulations (German:
Durchführungsverordnungen, DV).
The key acts of law in tax legislation and implementation regulations applicable in the Federal Republic of
Germany are listed below:
^ Corporation Tax:
Corporation Tax Law (Körperschaftsteuergesetz, KStG)
Corporation Tax Implementation Regulation (Körperschaftsteuer-DV,
KStDV)
Trade Tax Law (Gewerbesteuergesetz, GewStG)
Trade Tax Implementation Regulation (Gewerbesteuer-DV, GewStDV)
Income Tax Law (Einkommensteuergesetz, EStG)
Income Tax Implementation Regulation (Einkommensteuer-DV, EStDV)
^ Value Added Tax:
Value Added Tax Law (Umsatzsteuergesetz, UStG)
Value Added Tax Implementation Regulation (Umsatzsteuer-DV, UStDV)
^ Income Tax:
Income Tax Law (Einkommensteuergesetz, EStG)
Income Tax.Implementation Regulation (Einkommensteuer-DV, EStDV)
Wages Tax Implementation Regulation (Lohnsteuer-DV, LStDV)
^ Inheritance Tax:
Inheritance and Gift Tax Law (Erbschaft- und Schenkungssteuergesetz,
ErbStG)
Inheritance Tax Implementation Regulation (Erbschaftsteuer-DV, ErbStDV)
^ Tax Administration:
German Tax Code (Abgabenordnung, AO)
Code of Practice for Financial Courts (Finanzgerichtsordnung, FGO)
Valuation Law (Bewertungsgesetz, BewG)
Apart from Tax Law and implementation regulations, there are a number of administrative regulations.
Administrative regulations comprise tax guidelines
66
published by the Federal government (Basic Law,
p. 108.7), orders by the Federal Ministry of Finance (Basic Law, p. 108.3), orders and ordinances of
ministries at the Federal and state levels as well as decrees by regional tax offices. Administrative regulations
do not count as legal standards. They are binding on a statutory basis for tax administration only but not for
courts and taxpayers. The principal purpose of administrative regulations is to exemplify legal regulations,
eliminate uncertainties and ensure consistency in application of Tax Law by tax authorities
67
. The tax
guidelines are further complemented by sc. tax ordinances for instance Income Tax Ordinance
66
There are tax guidelines to complement all key acts of Tax Law. Specifically to be mentioned are Income Tax
Guidelines (Einkommensteuer-Richtlinien, EStR), Corporation Tax Guidelines (Körperschaftsteuer-Richtlinien,
KStR), Trade Tax Guidelines (Gewerbesteuer-Richtlinien, GewStR) and Value Added Tax Guidelines
(Umsatzsteuer-Richtlinien, UStR). The guidelines are adjusted to topical legal developments at a frequency of
once in few years.
67
Cf. BEECK (2007), p. 6.
Chapter 2
16
(Einkommensteuer-Hinweise, EStH), Corporation Tax Ordinance (Körperschaftsteuer-Hinweise, KStH) or
Corporation Tax Ordinance (Lohnsteuer-Hinweise, LStH). The ordinances are passed by top tax authorities
at the Federal and state levels with the aim of notifying legal practitioners of case law verdicts, orders by the
Federal Ministry of Finance and other legal sources of tax relevance.
On the contrary rulings by German tax courts and the supreme tax court (Federal Finance Court) are legally
binding only for persons and authorities involved in the proceedings but not for tax administration in general.
Hence German Case Law only applies on a case-by-case basis. A court verdict is binding for tax
administration only as regards the particular case concerned as opposed to other cases, even with similar
subject matter. The same applies to subordinated tax courts; these are not bound by the rulings of supreme
tax court in other case instances. Though court rulings are only binding with regard to the case concerned,
German Case Law nevertheless is of great significance not just to further refinement of Tax Law but also and
in particular to tax administration. Tax administration usually applies rulings of Federal Finance Court to
similar cases immediately after publication.
In the same way as the United Kingdom, the Federal Republic of Germany also maintains double taxation
treaties with other countries that regulate tax jurisdiction between the states where multinational tax liability
applies, with the provisions implemented in national law (Basic Law, p. 59).
68
2.2.3.
GENERALLY ACCEPTED ACCOUNTING PRACTICES
UNITED KINGDOM
As UK GAAP in British Tax Law, accounts are referred to of UK-based companies that comply with
relevant provisions of Companies Act (CA 1985, p. 226) and the principle of true and fair view (FA 2004,
p. 50.4)
69
.
According to the lawmaker, the Financial Reporting Standards (FRS) published by the Accounting Standards
Board (ASB) comply with the principle of true and fair view (CA 1989, p. 256).
Apart from published FRS, further regulations of relevance to accounting in British legislation are:
^ Statements of Standard Accounting Practice (SSAP)
^ Urgent Issues Task Force (UITF) Abstracts
^ Statements of Recommended Practice (SORPs)
^ Financial Reporting Exposure Drafts (FREDs)
^ Other Statements by the ASB
70
68
Cf. BIRK (2007), pp. 20-21.
69
Initially, the definition of generally accepted accounting practices was part of ICTA 1988, p. 836A.
Chapter 2
17
Similarly to the US practice, the UK GAAP are not defined by law in the United Kingdom. UK GAAP is
more than just accounting principles defined by Accounting Standards and executive orders. The code also
contains Companies Act regulations and stock exchange regulations as well as other applicable accounting
and industry guidelines.
71
The UK GAAP do not always provide a detailed solution to each particular
accounting issue. Where the UK GAAP contain regulatory gaps with regard to the particular issue
concerned, provisions apply of relevant International Financial Reporting Standards (IFRS) or the
US GAAP. The approach applies as generally accepted best practice in the United Kingdom.
Further by way of Finance Act 2004 and both the 2005 Finance Acts, a ruling was issued on recognition of
IFRS equally to UK GAAP as generally accepted accounting practices for tax purposes. The regulation
became effective for periods starting on or after 1
st
January 2005 (FA 2004, p. 50). However, publications of
the International Accounting Standards Board (IASB) are only accepted as GAAP in British tax legislation
as far as the publications have been recognised each by the European Commission (FA 2005, Sch. 4 p. 25,
49, 50).
72
Accordingly, the following publications enjoy tax relevance:
^ International Accounting Standards (IAS)
^ International Financial Reporting Standards (IFRS)
^ Standing Interpretations Committee (SIC) Interpretations
^ International Financial Reporting Interpretations Committee (IFRIC) Interpretations
73
To sum up, a conclusion applies that the reference base for computing taxable income is commercial
accounting profit determined compliant with generally accepted accounting practices. Hence for tax
purposes, either IFRS or the UK GAAP apply as generally accepted accounting practices
74
.
75
Credit to
growing acceptance worldwide of the international accounting standards, IFRS shall be employed for
purposes herein as reference base for computing taxable income in the UK.
GERMANY
A similar interpretation as to what counts as Generally Accepted Accountings Standards is not necessary in
German legislation. Due to the prevalence of Code Law in German legislation, all accounting regulations are
codified on a statutory basis in German Commercial Law (sc. Handelsgesetzbuch, HGB). The reference base
70
Small enterprises with turnover below GBP 5.6m, balance sheet total below GBP 2.8m and up to 50 employees
(small entities) may apply the Financial Reporting Standards for Smaller Entities (FRSSE) effective 2005.
71
Cf. BUSINESS INCOME MANUAL (2007), BIM 31020.
72
Cf. http://www.hmrc.gov.uk/practitioners/int_accounting.htm; Status: 01/09/2008.
73
As the IASB framework concept does not amount to a standard or interpretation, it has not been included in
European Community Law. Nonetheless, it amounts to a decision making reference in dealing with accounting
issues relating to regulatory gaps within IFRS. In author's opinion, the framework concept also needs to be
observed as part of generally accepted accounting practices in determining taxable income.
74
Cf. HOMER/BURROWS (2004), p. 376; LEE (2006), p. 245; TILEY (2005), p. 393.
75
Cf. http://www.hmrc.gov.uk/practitioners/int_accounting.htm; Status: 01/09/2008.
Chapter 2
18
for computing taxable income is commercial accounting profit that is to be determined compliant with
German Commercial Law provisions.
There is a significant difference between IFRS and German Commercial Law with regard to presentation of
legal standards. IFRS are a typical example of the Anglo-Saxon legal concept of Case Law
76
. The advantage
to Case Law are highly detailed provisions on particular circumstances. Because of this, the regulations are
enormous in volume and within the regulatory framework, there are a number of reiterated definitions and
procedures. German commercial accounting on the other hand is based upon continental European Code Law
under which applicable accounting standards are defined by law. The advantage to the German regulations is
the brevity in wording of legal standards. The disadvantage on the other hand is the need of interpretation of
the regulations. Accordingly in German law, there are a number of comments that elaborate the meaning of
the wording of legal standards
77
.
2.2.4.
OBJECTIVE AND PURPOSE OF THE COMMERCIAL AND THE TAX BALANCE SHEET
The aim pursued by commercial balance sheets usually is dependent upon reference accounting system. Due
to different purposes of commercial balance sheets in the two countries, first the aims are outlined of balance
sheets under IFRS and German Commercial Law respectively. In the follow-up, the aims are exemplified of
tax balance sheets.
UNITED KINGDOM
Under IAS/ IFRS applicable as reference standards in the United Kingdom, the purpose of commercial
accounting statements has been explicitly codified in the framework concept. The purpose of financial
statements is to provide recipients with useful information for decision making purposes (decision
usefulness
) on the corporate asset, financial and revenue status as well as on any changes thereof. The
information provided in the process primarily refers to past events (F.13). The information contained in a
financial statement serves the recipients as a means of reviewing management performance, hence as
reference for follow-up decisions of economic significance (F.14). The recipients mainly comprise potential
and current investors, employees, credit providers, suppliers, customers, national authorities and the public
(F.9). As the recipients are fairly varied, the information contained in a financial statement cannot satisfy
information needs on part of all recipients. Consequently, the framework concept contains a note to the effect
that information that satisfies information needs of investors should generally satisfy also information needs
of other recipients (F.10).
78
76
However, IFRS do not amount to pure Case Law as the different accounting standards exist within a framework
concept that takes precedence.
77
Cf. BUCHHOLZ (2003), pp. 18-19.
78
The assumption is based on the idea that investors provide risk capital to companies, hence are in need of more
comprehensive information compared to other recipients.
Chapter 2
19
The information presented in a financial statement shall enable the recipient to conduct verification whether
the company is able to generate positive balance also in the future (F.15). Consequently, it should be ensured
that the information on assets in the financial statement is complete and accurate to the present point and that
the profit or loss reported reflects reality
79
. Tendentially, IFRS aim at presenting subjective net asset value in
balance sheet, with measurement of balance sheet items in commercial accounting usually at replacement
costs. In compiling preferably realistic financial information, subjective influence on managerial functions
usually can hardly be avoided.
GERMANY
In German Commercial Law, no explicit purpose has been defined of financial statements. Through
interpretation of wording and meaning of and correlations between legal regulations, key aims may be
derived that can be comprised as follows:
^ Documentation function
^ Information and account reckoning function
^ Tax assessment and capital retaining function
The financial statement documentation function can be derived from the wording of the obligation in
commercial accounting to keep accounting records (Commercial Law, p. 238.1). The German lawmaker
requires transparent and complete records of all business transactions that must be comprehensible to third
persons. This ensures that records are compiled that facilitate reconstruction of events and occurrences.
80
The financial statement information and account reckoning function may be derived from correlations
between various commercial accounting regulations
81
. Managerial functions are held annually to give
account of their managerial activities. Accordingly, the financial statement function is to present information
to recipients that facilitates assessment of current corporate financial status. Primary recipients of a financial
statement are current creditors
82
(credit providers, suppliers, customers and employees) as due to their
economic relationship and relationship under obligation law with the company, they deserve particular
protection (protection of creditors)
83
. Secondary recipients comprise shareholders, national authorities, trade
unions as well as potential investors and potential creditors.
84
For corporations, the information function is
defined by Commercial Law, p. 264.2. Under the provision, financial statements shall provide an accurate
79
The principle of prudence is of secondary significance only in this respect.
80
Cf. BITZ/SCHNEELOCH/WITTSTOCK (2003), p. 34.
81
Particularly Commercial Law, pp. 238.1, 242.1-2; cf. BAETGE/KIRSCH/THIELE (2002), pp. 79-82.
82
Cf. BUCHHOLZ (2003), p. 23.
83
In other words, the creditors are intent on the company retaining the ability to pay its liabilities.
84
Cf. BITZ/SCHNEELOCH/WITTSTOCK (2003), p. 39.
Chapter 2
20
account of assets and of financial and revenue status that reflects reality while complying with applicable
quality criteria.
85
Another financial statement purpose is its tax assessment and capital retaining function. As reference in
assessment of profit-dependent income such as dividends and profit-sharing transactions, accounting profit
applies. However, profit distribution to shareholders contradicts creditor interests. Due to the limited liability
provision for corporations, creditors are intent on holding capital, hence minimising profit distribution to
shareholders. The German law on limited liability companies (GmbHG), p. 30.1, explicitly specifies that
assets necessary to hold share capital are not subject to distribution to shareholders.
86
Additionally with
regard to holding share capital, the German principle of prudence is of material significance. Due to strict
application of the principle of prudence, profits are reported tendentially at rather too low amounts and later
than appropriate. As Commercial Law provisions usually refer to objective net asset value, balance sheet
assets to the balance sheet date also are reported tendentially rather too low than too high. For objective net
asset value, value of the different balance sheet items usually can be clearly determined. Only items are
recognised that are supported by positive records at their origin costs or at their respective disposal value,
whichever is lower. The historical cost of purchase amounts to maximum measurement limit for the
purpose.
87
UNITED KINGDOM AND GERMANY
A tax balance sheet compiled in accordance with tax provisions
88
has a different purpose. The primary aim in
Tax Law is to determine taxable income in order to define based on the amount applicable tax liability.
Hence the principal recipient of tax balance sheet is the treasury, i.e., the competent tax office
89
. The key
purpose of levying taxes is procurement of liquid funds in order to perform the functions of the state. Apart
from this fiscal purpose however, non-fiscal aims usually also are additionally pursued. A major non-fiscal
aim is promotion of the economy. By means of the latter using taxation tools, the state aims at accelerating
the growth of the national economy, adjusting the economic growth curve in the short term or promote in the
short or long term specific branches or regions. For the purpose, the enterprises subject to preferential
treatment are usually granted higher depreciation allowances. The higher depreciation option means reduced
taxable income.
90
Yet in order to establish incentives for specific investments, the depreciation only is
85
Cf. COENENBERG (2005), p. 14.
86
Cf. COENENBERG (2005), p. 14; BITZ/SCHNEELOCH/WITTSTOCK (2003), p. 41.
87
Cf. BUCHHOLZ (2003), pp. 28-31.
88
Or a reconciliation between commercial and tax balance sheet.
89
As secondary recipient, also credit providers may be given who are regularly interested apart from commercial
balance sheet also in tax balance sheet on assumption that application of tax provisions results in a more realistic
account of corporate financial status.
90
As a result, current tax liabilities are carried forward to future periods.
Chapter 2
21
implementable by companies that at the same time actually invest. Another non-fiscal aim are tax measures
aimed at the environment.
91
SIMILARITIES AND DIFFERENCES
There are significant differences between the aims of financial statements under British and German
commercial accounting regulations respectively. Under British regulations, the purpose of accounting
records is to provide information with the main focus on investors. The primary aim in financial reporting is
investor protection. On the contrary the German aim in financial reporting is determining distributable profits
while observing the need to hold share capital. Key purpose in the effort is creditor (capital provider)
protection.
92
In Germany, the principle of prudence is of material significance as opposed to the United
Kingdom where actual profit or loss on an accrual basis is a key concern. The outcome of the different aims,
assets and revenues usually are reported at higher amounts under IFRS compared to German Commercial
Law. On the other hand due to prevalent creditor protection in Germany, liabilities in German commercial
accounting are tendentially assigned higher value in relative comparison.
An assumption applies that there are no differences between the British and German aims pursued by tax
balance sheet.
2.3.
CHARACTERIZATION OF THE CORPORATION TAX
2.3.1.
PERSONAL TAX LIABILITY
UNITED KINGDOM
All enterprises whose place of management and control is in the United Kingdom are liable without
limitations to the UK corporation tax on their global income
93
as far as a double taxation treaty does not
specify otherwise. Non-resident enterprises that conduct their operations in the UK via permanent
establishment are liable to corporation tax on their domestic income to a limited extent only
(ICTA 1988, p. 6)
94
. The enterprises liable to corporation tax comprise:
^ Any corporate bodies, especially Ltd and Plc;
^ Any unincorporated associations
95
;
^ Trustees of any authorised unit trust (ICTA 1988, pp. 468.1; 831.1, 832.1-2,).
91
Cf. BITZ/SCHNEELOCH/WITTSTOCK (2003), p. 16.
92
Cf. BUCHOLZ (2005), p. 4; COENENBERG (2005), p. 16.
93
Profits includes both income and capital gains, cf. TILEY (2005), p. 809.
94
Other non-resident enterprises that do not maintain a permanent establishment in the UK are liable to the UK
income tax on their domestic income.
95
Unincorporated associations comprise most clubs and other organisations in which at least two persons
participate, cf. Blackpool Marton Rotary Club v Martin (1988), 62 TC 1986.
Chapter 2
22
Partnerships, local authorities and local authority associations do no count among enterprises liable to
corporation tax.
96
GERMANY
In German Tax Law, the following corporations, associations and trusts with registered office (Tax Code,
p. 11) or place of management and control (Tax Code, p. 10) in the country are liable without limitations to
corporation tax on their global income (Corporation Tax L
aw
, p. 1.1-2; Corporation Tax Guidelines, p. 2) as
far as regulations under a double taxation treaty do not specify otherwise
97
:
^ Corporate bodies
- Corporations, especially "GmbH" (German limited liability companies) and "AG" (German stock
corporations)
- Co-operative societies
- Other corporate bodies, especially incorporated associations
- Business operations of public bodies (Corporation Tax Law, p. 4)
98
^ Unincorporated associations, public institutions, foundations and other special purpose funds
99
^ Mutual insurance companies
Corporations, associations and trusts with neither registered office nor place of management and control in
the country are liable to tax to limited extent only on their domestic income (Income Tax Law, p. 49). Local
authorities and local authority associations do not fall under the scope of Corporation Tax Law, p. 1.1, hence
are liable to corporation tax without limitations. However, they are liable to corporation tax to limited extent
only with their domestic income that is subject to tax deductions (such as dividends and interest)
(Corporation Tax Law, p. 2)
100
.
Individual corporations, trusts and associations may be exempted from corporation tax on an individual basis
or on compliance with specific prerequisites, usually where profit-making economic operations
101
(AO,
96
Cf. Conservative & Union Central Office v Burrell (1981), 55 TC 671.
97
Cf. BORNHOFEN (2008), p. 383; HOFFMANN (2003), p. 48.
98
The relevant prerequisite, the bodies must carry out profit-making operations on a regular basis beyond the
agricultural and forestry branch. No profit-making intent or participation in business transactions apply as
prerequisites. As example, utilities (gas, water, electricity) may be provided in cities and communities,
cf. Corporation Tax Law, p. 4.1-3.
99
However, they are liable to tax only if the income is not directly taxable as income of other taxpayers
(Corporation Tax Law, p. 3).
100
The provision generally applies to all other corporations, associations and trusts that are liable to tax without
limitations.
101
A profit-making economic operation is a regular autonomous operation by way of which income or other
economic benefits are generated and which exceeds the scope of asset management. However, income from
profit-making economic operations is subject to corporation tax only where the income plus turnover tax exceeds
the amount of 35,000 Euro (AO, p. 64.3) No profit-making intent is necessary (AO, p. 14).
Chapter 2
23
p. 14) are excluded.
102
As examples, national authorities, charity associations and political parties may be
given (Corporation Tax Law, p. 5).
A conclusion applies that both the UK Private Company Limited by Shares and the German GmbH are liable
to corporation tax without limitations on their global income as far as their registered office or place of
management and control is in the country and there are no regulations to the opposite under double taxation
treaties. Applied to other forms of corporations, corporation tax liability criteria are very similar in both the
countries.
2.3.2.
BASIS OF ASSESSMENT FOR THE CORPORATION TAX
2.3.2.1. ADJUSTING THE ACCOUNTING PROFIT AND VALIDITY OF THE AUTHORITATIVE
PRINCIPLE
UNITED KINGDOM
The referential status of commercial accounting provisions for determining trade income for tax purposes in
the UK has been historically shaped by Case Law
103
. As the initial reference for tax purposes in Case Law,
balance sheet and profit and loss compiled in accordance with ordinary principles of commercial
accountancy may be considered
104
.
105
The notion of ordinary principles of commercial accounting that
evolved in Case Law was specified in more detail in 1998 by the lawmaker. Accordingly, profits have to be
determined on an accounting basis that amounts to a true and fair view (FA 1998, p. 42). Purpose of the
regulation has been to establish a more comprehensive interconnection between tax legislation and
Companies Act provisions. The notion of true and fair view was replaced in 2002 with the notion of
generally accepted accounting practices (with respect to accounts of UK companies that are intended to give
a true and fair view) (FA 2002, p. 103.5). Ever since the new regulations have come into force, the generally
accepted accounting practices have been applicable as reference for determining tax profits
106
. The scope of
generally accepted accounting practices has been clarified by FA 2004, p. 50 and ITTOIA 2005, p. 25 (as
well as by both FA 2005).
102
However, the exemption does not apply to domestic income that is partly or wholly subject to tax withheld at
source. Corporation tax liability for income subject to tax withheld at source is satisfied by withholding the tax
(Corporation Tax Law, p. 32.1).
103
In accordance with ICTA 1988, s. 70.1 for the purposes of corporation tax income shall be computed on the full
amount of the profits or gains or income, without any other deduction than is authorized by the Tax Acts. Due to
vagueness of the term full amount of the profits, an interpretation was necessary by Case Law.
104
Cf. Lothian Chemical Co. Ltd v Rogers (1926), 11 TC 508: "My Lords, it has been said times without number
that in considering what is the true balance of profits and gains in the income tax acts - and it is not less true of
the Act of 1918 than of its predecessors - you deal in the main with ordinary principles of commercial
accounting... but where these ordinary principles are not invaded by statute they must be allowed to prevail."
Compare also Odeon Associated Theatres Ltd v Jones (1972); Threlfall v Jones (1993), Lloyds UDT Finance Ltd
v Chartered Finance Trust Holdings (2002).
105
A note applies that the accounting principles applicable in the United Kingdom generally are further advanced
by professional practitioners - auditors/accountants. Instead of publishing its own accounting principles, the
lawmaker authorises the principles compiled by professional practitioners.
106
Cf. LEE (2006), pp. 245-246.
Chapter 2
24
Accordingly in the initial step, profit has to be determined compliant with generally accepted accounting
practices as commercial accounting provisions apply as reference in determining tax profit.
107
In the second
step, verification is required whether there are tax provisions stipulating a different method of computing
profit. If this may be answered with yes, adjustment is conducted to accounting profit
108
compliant with the
provisions of Taxes Act. The accounting profit adjusted for tax provisions is referred to as trading income or
tax adjusted trading profit. However, a note applies that not just the trading income schedule but also other
schedules have to be derived from accounting profit.
109
GERMANY
Analogously to British legislation, the process of determining taxable income in German environment also
largely refers to Commercial Law provisions
110
. This authoritative principle is explicitly codified in German
Tax Law (Income Tax Law, p. 5.1). Via the authoritative principle, commercial accounting provisions for
recognition and measurement as well as quality criteria applicable in commercial accounting are of material
significance to determining taxable income. Yet in Tax Law, a number of tax adjustments have to be
observed specifically with regard to measurement that take precedence over Commercial Law provisions
(Income Tax Law, p. 5.6). If there are differences between commercial accounting and Tax Law provisions,
a separate tax balance sheet often is compiled in addition to commercial balance sheet. However, the German
tax office also accepts as in British Tax Law - a reconciliation between accounting profit and tax profit
(Income Tax Implementation Regulation, p. 60.2). Yet a peculiarity in German Tax Law, not just
commercial accounting provisions apply as references for Tax Law, but also vice versa tax regulations may
amount to references for Commercial Law in a sc. reverse authoritative principle. Under the principle, an
optional right under Tax Law may only be exercised if in commercial accounting, it is implemented in
identical manner. In practical applications, optional rights in commercial accounting and under Tax Law
usually are exercised identically for enterprises not subject to mandatory disclosure so that commercial
balance sheet matches tax balance sheet.
From the authoritative principle, six detailed authoritative guidelines can be derived that have to be observed
(Income Tax Ordinance, p. 5.7):
111
^ Statutory capitalisation in commercial accounting becomes statutory capitalisation in Tax Law via the
authoritative principle.
107
Cf. ENGEL/BALMES (2008), p. 1082; HMRC (2007), BIM31001.
108
Reference accounting profit also is referred to as before tax accounting profit.
109
Cf. SECTION 2.3.2.2.
110
Contrary to British Case Law, commercial accounting provisions have been explicitly codified by the German
lawmaker in Commercial Law.
111
Cf. Federal Finance Court of 03/02/1969, GrS 2/68; Federal Finance Court of 25/08/1989, III R 95/87.
Chapter 2
25
^ A prohibition on capitalisation in commercial accounting becomes a prohibition on capitalisation in Tax
Law.
^ An optional right to capitalise in commercial accounting becomes statutory capitalisation in Tax Law.
^ Statutory passivation in commercial accounting becomes statutory passivation in Tax Law.
^ A prohibition to passivate in commercial accounting results in a prohibition to passivate in Tax Law.
^ An optional right to passivate in commercial accounting results in a prohibition to passivate in Tax Law.
In general, a conclusion applies that in determining tax profit, essentially the following procedure is to be
observed:
^ Recognition of balance sheet items compliant with commercial accounting provisions.
^ Measurement of balance sheet items primarily in reference to Tax Law provisions and secondarily only in
reference to commercial accounting provisions.
As regards recognition of costs and revenues, the procedure is comparable to that under British regulations
(see above).
To sum up, a conclusion applies that structure of the authoritative principle with respect to Accounting Rules
in determining taxable income is largely identical in both the tax systems.
2.3.2.2. SCHEME FOR THE CORPORATION TAX COMPUTATION
UNITED KINGDOM
The assessment base for the British corporation tax is referred to as profits chargeable to corporation tax
(PCTCT) and is determined compliant with the provisions of ICTA 1988, TCGA 1992, CAA 2001 as well as
annual Finance Acts (FAs) as far these are not primarily applicable to natural persons. Profit chargeable to
corporation tax equals the total of the different schedules which themselves are split into cases
112
. The key
schedules relevant to calculating corporation tax are summarily presented below
113
:
114
Trading
Income
(Schedule
D
Case
I)
./.
Trading losses carrying forward
+
Income from non-trading loan relationships
(Schedule D Case III)
+
Income from foreign possessions
(Schedule D Case V)
112
The schedule system was fully replaced for income tax purposes in 2005 by Income Tax (Trading and Other
Income) Act 2005. For income tax purposes, income now is split into different classes of income (employment
income, trading income, property income, savings and investment income and miscellaneous income). However,
the tax rules governing the schedules remain more or less in effect, cf. MELVILLE (2007), p. 16; LEE (2006),
pp. 239-240.
113
Cf. MELVILLE (2007), pp. 371-376; INABA/BARNARD (2006), p. 17.
114
Cf. also SECTION 4.4.
Chapter 2
26
+
Miscellaneous
income
(Schedule
D
Case
VI)
115
+
Income
from
property
(Schedule
A)
+ Chargeable
gains
./.
Allowable capital losses carrying forward
./.
Schedule A losses
./.
Deficits on non-trading loan relationships
./.
Trading losses relieved under ICTA 1988, p. 393A.1
./.
Charges on income
=
Profits Chargeable to Corporation Tax (PCTCT)
Income breakdown into schedules generally facilitates application of different assessment provisions,
different tax rates as well of different provisions regarding loss compensation. In British Tax Law however
in income assessment, separate schedules are exclusively referred to with follow-up addition to total income.
However, breakdown into different schedules also entails a disadvantage in that the reference accounting
profit in determining tax profit needs to be distributed among the different schedules. Hence accounting
profit does not apply as reference for Schedule D Case I only. In order to arrive at trading income (or tax
adjusted trading profit) in Schedule D Case I, it is not sufficient for the accounting profit to be merely
applied tax adjustments but also the profit components that serve as references for other schedules need to be
calculated on the basis of accounting profit.
The process of determining trading income compliant with Schedule D Case I shall be examined in the
following discussion and may be exemplified by means of the following simplified scheme:
Accounting Profits (profit before taxation)
./. Income included in the accounts that is not taxable trading income and must be taxed under another
schedule or case
./.
Expenditures not charged in the accounts but allowable for taxation purposes
+
Expenditures not allowable for taxation purposes
+
Taxable trading income not credited in the accounts
./. Capital
allowances
=
Trading Income (or Tax adjusted trading profit)
116
The individual tax adjustments are discussed in more detail in the following parts.
115
Schedule D Case VI means any annual profits or gains not falling under any other Case of Schedule D or any
other schedule, cf. BUSINESS INCOME MANUAL (2007), BIM 80101.
116
Cf. ACCA (2006), p. 13.
Chapter 2
27
GERMANY
The assessment base for corporation tax in German Tax Law is referred to as taxable income (Corporation
Tax Law, p. 7.1). Taxable income is determined compliant with the provisions of Income Tax Law and
Corporation Tax Law (Corporation Tax Law, p. 8.1). Similarly to British Tax Law, the Income Tax Law
provisions are only applicable providing they are actually adequate for use by taxpayers liable to corporation
tax in terms of meaning and purpose.
117
For taxpayers liable to tax without limitation required to keep
accounting records on a statutory basis
118
, all income is subject to treatment as income from trade
(Corporation Tax Law, p. 8.2).
119
Hence in departure from British Tax Law, no accounting profit breakdown
is necessary into different schedules. Accounting profit applies as sole reference in determining taxable
income.
Taxable income for corporations usually is calculated by means of the following calculation scheme:
Accounting profit/ loss (Commercial Law, pp. 238-289)
+/ - Income Tax Corrections regarding recognition and measurement of items
=
Tax profit or loss)
+/ -
Corporation Tax Corrections (Income Tax Law, pp. 4-7)
+
Hidden profit distribution (Corporation Tax Law, p. 8.3)
- Hidden
deposits
+
Non-deductible expenditures (Corporation Tax Law, p. 10; Corporation Tax Law, p. 8a in
conjunction with Income Tax Law, p. 4h)
-
Income from non-deductible expenditures
- Tax-free
revenues
+
Cost of tax-free revenues
+
Any donations (Corporation Tax Law, p. 9)
=
Sum of earnings
- Deductible
donations
=
Sum of total earnings
-
Loss deduction (Income Tax Law, p. 10d)
= Income
-
Tax exemption amount (Corporation Tax Law, pp. 24-25)
=
Taxable income (Corporation Tax Law, p. 7.1)
117
A list of Income Tax Law provisions to be observed in determining corporation tax liability is provided by
Corporation Tax Law, p. 32.
118
This specifically entails corporations.
119
Cf. also Federal Constitutional Court of 15/01/2008, 1 BvL 2/04.
Chapter 2
28
The calculation scheme has been explicitly codified in Corporation Tax Law, p. 29.1
120
. Except the fact that
in British Tax Law, accounting profit applies as reference for several schedules, the procedure in calculating
tax assessment base is very similar
121
. Reference value for calculating tax assessment base in both the tax
systems is accounting profit. By applying tax adjustments to the amount, the result is tax assessment base for
corporation tax purposes.
2.3.3.
PERIOD OF DETERMINING INCOME FROM TRADE
UNITED KINGDOM
Financial year for corporation tax in the UK is from 1
st
April to 31
st
March of next year (INA 1978, Sch. 1,
ICTA 1988, p. 834.1). Financial year is denoted by the start of the period; for instance financial year 2006
starts on 1
st
April 2006 and ends on 31
st
March 2007.
122
An accounting period may not span more than
12 months
123
. Where an accounting period wholly matches the financial year, for taxation of profits
chargeable to corporation tax only provisions and tax rates applicable in the period may be referred to.
Where an accounting period does not wholly match the financial year, i.e., the accounting period exceeds
31
st
March (end date of financial year), the profits chargeable to corporation tax for the accounting period
have to be divided between two financial years. The profit breakdown is highly significant if there are
differences in tax provisions, particularly tax rates, between the two financial years due to legislation updates
(ICTA 1988, pp. 8.3, 12.1, 72)
124
.
125
GERMANY
The German corporation tax also is an annual tax. However, the financial year in German Tax Law matches
calendar year (from 1
st
January to 31
st
December) (Corporation Tax Law, p. 7.3).
126
Analogously to British
legislation, the accounting period may not exceed the length of 12 months (Income Tax Implementation
Regulation, p. 8b; Commercial Law, p. 240.2)
127
. The accounting period signifies the period for which
120
The presented scheme is a simplified instance applicable to corporations.
121
Accounting profit in German Tax Law directly determines the tax assessment base. On the contrary in British
Tax Law, it determines the tax assessment base indirectly only as accounting profit is split into several
schedules. Tax adjustments then are conducted within the different schedules. By adding the separate adjusted
profits for the different schedules, the result is corporation tax assessment base. Irrelevant of whether accounting
profit determines the final tax assessment base directly or indirectly, in both the tax systems accounting profit
may be termed authoritative for determining taxable income.
122
Cf. WILLIAMS/MORSE (2004), p. 211.
123
Where the accounting period used by an enterprise is longer than 12 months, it needs to be split into two or more
accounting periods.
124
Cf. Marshall Hus & Partners Ltd v Bolton (1981), 55 TC 539.
125
Cf. INABA/BARNARD (2006), pp. 17-19.
126
German corporation tax generally is levied in form of quarterly advance payments (Corporation Tax Law, p. 31;
Income Tax Law, p. 36), cf. SCHEFFLER (2007), p. 199.
127
Accounting periods in excess of 12 months are not permissible in German Commercial Law.
Chapter 2
29
enterprises usually compile financial statements. Mostly, the accounting period matches the calendar year.
However, also an accounting period may be chosen that is different from calendar year
128
. Nevertheless in
departure from British Tax Law, profit does not have to be split between two accounting periods but is
taxable compliant with provisions applicable in the calendar year in which the accounting period ends
(Corporation Tax Law, p. 7.4; Income Tax Law, p. 4a).
2.4.
FURTHER PROCEEDING
In this Chapter, common tools have been outlined for conducting tax burden comparisons. Beyond that as the
assessment method, qualitative assessment has been defined of applicable legal standards combined with a
quantitative comparison of tax rates. In a preliminary step to the comparison of legal standards, the different
tax systems have been outlined along with an examination of applicable corporation taxes.
In examining corporation taxes, also the composition of the different tax assessment bases has been outlined.
In the following Chapters for purposes of examinations herein, the tax assessment base for each country is
split into selected partial assessment bases. As in British Tax Law, the tax assessment base already is split
into different schedules, in the following parts for each type of income, its assignment to a specific schedule
is indicated.
Consequently in Chapter 3, selected balance sheet items and in Chapter 4 selected profit and loss items are
examined for their consequences to the respective tax assessment base in the country concerned.
Subsequently in Chapter 5, an examination is conducted of tax rates. The examination of assessment bases is
necessary due to the assumption that even for identical business transactions, there are differences in
assessment bases between the United Kingdom and Germany. The differences shall be determined applying
qualitative methods as part of the survey and assessed via conclusions on the preferability of either tax
system.
The aim in the following examinations is qualitative analysis of tax assessment base. Due to applicable
authoritative principle under which tax balance sheet refers to commercial balance sheet in both the
countries, in the following Chapters commercial accounting regulations are exemplified only where there are
no tax regulations to different effect. Hence as far as there are tax regulations that take precedence by
overriding the commercial accounting regulations (overriding principle), explicitly only the tax regulations
are presented.
128
The provision applies to corporations only. For all other types of enterprises, fiscal period matches calendar year.
Chapter 3
30
3.
COMPARISON OF CORPORATION TAX ASSESSMENT BASES I:
BALANCE SHEET ITEMS
3.1.
PREFACE
UNITED KINGDOM AND GERMANY
Prior to examining in the following sections of this Chapter tax treatment of selected balance sheet items in
terms of applicable reference values and measurement, first in subsequent part both the general commercial
accounting framework and general treatment of balance sheet items shall be exemplified. Due to referential
status of commercial accounting regulations with regard to determining taxable income for tax purposes in
both the countries, knowledge of the framework concept as well as of general treatment of items is of
significance now just with respect to potential gaps in applicable legislation but first and foremost facilitate
comprehensive insight into the subject matter of this Chapter.
3.2.
CONCEPTUAL FRAMEWORK AS CORE ELEMENT FOR THE DETERMINATION OF
INCOME
3.2.1.
BASIC ASSUMPTIONS
UNITED KINGDOM
Basic assumptions comprise the principle of accruals basis and the principle of going concern.
The principle of accruals basis entails a temporal and matching accrual component in British Law. Temporal
accrual means that business events and other occurrences are reported in the period of occurrence as opposed
to periods in which there are inflows or outflows of means of payment or equivalents thereof (F.22,
IAS 1.25). If costs and revenues relate in an indirect relationship only and if the costs result in economic
benefit that spreads over several periods, the costs are recognised in profit and loss applying systematic and
adequate assignment procedures (F.96). As far as the costs do not generate future economic benefits, they are
recognised in profit and loss with immediate effect (F.97). Costs and revenues that apply continuously over a
specific period of time are to be recognised proportionally in each partial period (e.g. rent, interest). Where
costs and revenues relate in a direct relationship, they are to be reported under the matching principle in the
period in which also the corresponding revenues apply. This may also comprise outstanding revenues (F.76).
However, the matching principle does not allow for accruals to be applied to balance sheet positions that do
not comply with the definition of assets and liabilities (F.95).
129
129
Cf. KIRSCH (2007), pp. 18-19.
Chapter 3
31
GERMANY
In German legislation, costs and revenues also are to be recognised in profit and loss irrelevant of the actual
point of payment (Commercial Law, p. 252.1; Income Tax Law, p. 5.5)
130
. Period-specific expenses and
income are to be accrued as far as they constitute costs or revenues for a specific period after the balance
sheet date (Commercial Law, p. 250.1-2).
131
Expenses and income that cannot be assigned to specific
revenue under either temporal or matching principles are to be reported in the period of actual occurrence.
Contrary to British legislation, the matching principle entails period-relevant recognition of actual revenues
and of related costs; under the realisation principle, corresponding costs are only matched with actual
revenues in the period. However, it should be noted that the matching principle only enjoys limited
significance in assigning costs in case of doubt as in German legislation, economic cause applies as key
assignment criterion. The ban on recognition of outstanding profits does not automatically mean that only
actual losses can be reported. The recognition-of-loss principle explicitly stipulates early recognition of
outstanding losses as costs in the profit and loss statement (Commercial Law, p. 252.1). The approach is
traceable to the principle of prudence in measurement implemented in German Commercial Law.
UNITED KINGDOM AND GERMANY
The going-concern principle applies both in British (F.23, IAS 1.23-24) and German legislation (German
Commercial Law, p. 252.1). As concerns the aspect, no material differences apply between the two
legislations. According to the principle in balancing accounts, the assumption of going concern for a
foreseeable period applies.
132
Specifically, it is supposed that the company management does not intend nor
is forced to fully or partly discontinue business operations. The going-concern principle refers to the idea that
individual assets and liabilities are to be assigned different values on going concern assumption as compared
to the event of discontinuing business operations. A potential value measure for a certain or likely
discontinuation of operations is the net sales proceeds (fair value) less sales cost (costs to sell).
133
Depending
on circumstances in each particular case, this may amount to sales proceeds for the individual assets sold or
in case of ownership transfer of the entire business the total sales proceeds.
134
The specific recognition and
measurement values in such case are usually dependent upon the disruption intensity and disruption speed.
135
130
In order to keep the treatise simple, no accruals are considered for non-material amounts, cf. also Federal
Finance Court of 28/09/1967, IV R 284/66.
131
Cf. BITZ/SCHNEELOCH/WITTSTOCK (2003), p. 229; BAETGE/KIRSCH/THIELE (2002), p. 110.
132
According to IAS 1.24 in conducting going concern estimates, the company management should always refer to
a period of at least 12 months.
133
Cf. BAETGE/KIRSCH/THIELE (2002), p. 107.
134
Cf. BITZ/SCHNEELOCH/WITTSTOCK (2003), pp. 231-232. There is an upper limit equal to historical cost of
purchase/cost of conversion applicable to the amount of sales proceeds less costs to sell in German Law.
135
Cf. KIRSCH (2007), p. 19.
Chapter 3
32
3.2.2.
QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS
UNITED KINGDOM AND GERMANY
In order for the information contained in annual statement to be relevant to the recipient for decision making
purposes, the statement must comply with specific quality criteria. The key requirements comprise
understandability, relevance, reliability and comparability; the criteria are briefly outlined in the following
parts according to their respective interpretation in British and German accounting guidelines.
The principle of understandability is defined in F.25 and IAS 1.46 in British Law. Under the principle, the
information contained in an account statement shall be presented clearly to the extent that a recipient
136
with
adequate knowledge of the trade conducted, of economic framework conditions and of relevant legislation
should be able to comprehend the information presented on thorough lecture. However, it is not acceptable to
exclude information of specific relevance to some recipients only because of limited comprehensibility to
other recipients.
The German legislation does not explicitly provide the principle of understandability aimed at recipients of
account statements with adequate level of competence. Nonetheless, such principle can be derived from the
wording of Law through hermeneutics. In German Law, both the principle applies of clarity and transparency
in presenting account statements (German Commercial Law, p. 243.2) as well as the requirement to design
accounts so as to a competent third party
137
be able to gain insight into the business transactions in due time
(German Commercial Law, p. 238.1-2).
138
Nevertheless, prerequisite to such easy understandability is a clear
a transparent presentation of accounts in the statement. Also, this implies that apart from accounts, also the
relevant account statements need to be structured so as to a competent recipient be able to comprehend the
information presented.
139
The principle of relevance is not formally established in German Law. In British legislation, the principle of
relevance is an integral part of the framework concept (F.26-28), relating closely to the principle of
136
According to F.9 et seq., the pool of recipients entails investors, employers, credit providers, creditors,
customers, governments, the public and managerial functions. However, the key purpose of an account statement
is to satisfy information needs on part of investors presuming their information needs are equivalent to those of
most other recipients. In prevailing opinion despite the lack of formal definition in German Law, this group falls
within the above pool, cf. BAETGE/KIRSCH/THIELE (2002), p. 90; MEYER (2007), p. 34; BITZ/SCHNEE-
LOCH/WITTSTOCK (2003), pp. 34 et seq. Nonetheless, an account statement should primarily satisfy
information needs on part of creditors as opposed to those of investors. The perspective is traceable to the
prevalent principle of prudence in German legislation; firms should rather count themselves too poor than too
wealthy, cf. LÜDENBACH (2004), p. 44.
137
The notion of competence and/or adequate knowledge lacks legal definition in either of the two countries.
Clearly, basic commercial accounting and tax accounting knowledge is not sufficient. It may be assumed that the
pool of persons comprises accountants, auditors, tax advisors and external auditors.
138
Essentially, the quality requirements implemented in German Commercial Law also apply in Tax Law
accordingly, cf. German Tax Code, pp. 140-141.
139
Cf. HAYN/WALDERSEE (2004), p. 61; BAETGE/KIRSCH/THIELE (2002), p. 101.
Chapter 3
33
materiality
140
(F.29-30). Under the principle, information only is relevant if actually referred to in economic
decisions on the recipient side by aiding in the assessment of past, current or future events, or by validating
or revising past judgements.
Information relevance is dependent upon the information type and materiality. Information is material if by
its omission, or incorrect presentation, a recipient's decision is affected in the end effect. Materiality depends
upon the position's size or the extent of error that may result from potentially misrepresenting the
information. Consequently, materiality is to be interpreted instead of a specific quality requirement as a
qualifying or threshold value the information must contain in order to be useful.
In British Law, information only is useful if reliable. That means that the recipient should be able to rely on
the information as free of any substantial errors and distortions (F.31). The principle of reliability leads
indirectly to a specification of relevance as information, even though relevant, may at the same time contain
uncertainties in terms of form and presentation that are misleading to the recipient (F.32). As an example,
indication may be given of disputed claims for damages. Apart from that, reliability is specified in more
detail through auxiliary principles of faithful presentation, economic perspective (substance over form),
neutrality, prudence
141
and completeness
142
(F.33-38).
In British Law, the principles of relevance and reliability are limited in applicability through the restrictions
of timeliness, balance between benefit and costs and balance between qualitative characteristics concerning
account statements (F.43-45). No similar restrictions apply in German Law. The lack in German Law of a
temporal restriction that would provide for balancing between timely reporting and availability of reliable
information is traceable to applicability of specific statutory recognition provisions. Such statutory
recognition provisions are unknown under the IAS principles applicable in the UK; in case of doubt, national
regulations take precedence. Economic considerations in providing information generally count in German
Law among principles that lack formal definition, being applicable in balancing accounts. Examining quality
requirements
143
is an unknown aspect in German Law as in the latter, all quality requirements are applicable
on an equal basis; there are no aspects of superiority or inferiority. The lack of bias towards any single
principle may be exemplified as the "Eiffel tower principle": in balancing accounts, all the applicable
principles are equally important as are the tower columns. A statement's relevance can only be ensured if the
140
The principle also is not explicitly provided in German Commercial Law. Merely internal guidelines applied by
some corporations stipulate that for processes of lesser significance, no consolidation is required. Still in
practical use, the principle of materiality finds application complemented by the principle of prudence and the
principle of completeness.
141
That means that in applying freedom of judgement, a certain care should be exerted so that assets and/or
revenues are not reported at excessive values while costs and liabilities too low. However, a prudent approach
conflicts with creation of hidden reserves, overvaluation of provisions or with reporting assets and/or revenues at
intentionally low values, or costs and liabilities at intentionally high values (F.37).
142
Completeness applies within the limits of materiality and economic viability.
143
For target conflicts between the different quality requirements under British Law, an adequate balance between
the requirements should be pursued in order to comply with account balancing targets.
Chapter 3
34
different principles are each sustained by (all) other principles and if there is no principal column that can be
omitted in the decision making process.
144
The principle of reliability along with its auxiliary principles is unknown in German Law. However, there is
a large variety of principles of equal weight that roughly amount to an equivalent of the British principle.
These comprise the principle of accuracy (German Commercial Law, p. 239.2), the principle of prudence
(German Commercial Law, p. 252.1) and the principle of completeness (German Commercial Law, p. 239.2,
p. 246.1). The principle of substance over form, though not formally defined, usually also finds application
in German account balancing procedures.
145
Under the principle of accuracy, all the information in an account statement should hold true. However, the
term of truth should not be equated to absolute truth or absolute accuracy. Rather, the principle is to be
interpreted in the sense that all the information contained in an account statement should be objective and/ or
intersubjectively verifiable.
146
Account statement accuracy also relates to the principle of prudence. In
German interpretation, a prudent assessment also invariably results in correct presentation of account
statement information.
147
Compared to British Law, the principle of prudence
148
enjoys a significantly higher
priority in German Law.
149
Analogously to British Law under the principle of completeness, the information contained in an account
statement should be complete; that means the account statement should comprise all the assets, liabilities,
accruals, costs and revenues. Even though not explicitly stipulated by Law, the principle of completeness
finds application in account balancing procedures complemented by principles of materiality and economic
viability.
150
Under the British principle of comparability, all the information contained in an account statement should be
comparable over periods of time and between establishments in order to be able to assess any changes in
asset, finance or income structure. Account statement comparability applies if measurement and presentation
of business events and occurrences is conducted on a regular basis and the recipient is kept informed of
144
Cf. BAETGE/KIRSCH/THIELE (2002), p. 115.
145
Cf. HAYN/WALDERSEE (2004), p. 59.
146
Objective presentation of information means in British Law that the information is presented from an unbiased
perspective and free of misinterpretation. Credible presentation of information is also prerequisite to
intersubjective verifiability.
147
Cf. MEYER (2007), p. 42.
148
Under the principle of prudence when in doubt, firms should rather value their assets too low and their liabilities
too high. The approach results in creating hidden reserves not immediately identifiable by the account statement
recipient. From the statement period perspective, prudent assessment reduces profit with the consequence of
reduced dividend potential, compare BAETGE/KIRSCH/THIELE (2002), p. 113. The prevalent creditor
protection in German legislation is mainly traceable to consequent application of the principle of prudence,
cf. LÜDENBACH (2004), p. 44.
149
Cf. HAYN/WALDERSEE (2004), p. 69; BAETGE/KIRSCH/THIELE (2002), p. 120.
150
Cf. BAETGE/KIRSCH/THIELE (2002), pp. 103-104.
Chapter 3
35
applied balancing and measurement methods as well as of any changes thereof and of the resulting
consequences. In order to ensure regular comparability, an account statement must contain apart from current
period information also information on prior periods. The principle of comparability should not be treated
separately from the principles of relevance and reliability as it is not just for the sake of comparability alone
why irrelevant or unreliable information should not be presented. Vice versa, obsolete balancing and
measurement methods should not be maintained once there are more relevant and reliable alternatives (F.39
et sqq.; IAS 1.36 et seq.). Moreover, the recognition and measurement methods are applicable on a steady
basis except a standard provides for a specific classification of material facts that allows using different
methods (IAS 8.13). Consistency also comprises consistency in reporting (IAS 1.38).
A statutory principle of comparability also is formally defined in German Law. The principle splits into
formal and material consistency. Formal consistency comprises balance sheet continuity (German
Commercial Law, p. 252.1) and reporting consistency (German Commercial Law, p. 243.2, p. 265.1). Under
the provision of balance sheet continuity that is not explicitly provided in British Law, the balance sheet as at
fiscal year start should be identical to summary balance sheet for previous fiscal year. Under reporting
consistency, maintaining position names, structure and differentiation of positions applies in order to ensure
comparability of account statements over a number of years.
151
Moreover, the account statement should also
include prior fiscal year amounts (German Commercial Law, p. 265.2). Under material consistency,
measurement methods should be applied on a continuous basis. A departure from measurement consistency
only is allowed and preferable if by maintaining consistency, other quality-related principle under German
Law would be violated (German Commercial Law, p. 252.2).
152
A permanent application of the optional
recognition principle is not required in German Law. If optional recognition applies, it may be implemented
in various ways.
153
Apart from that in German legislation, the principle of individual measurement is implemented. No similar
principle is explicitly provided in British Law even though it can be derived from the framework concept and
from the different standards. The German principle essentially provides that assets and liabilities as at the
day of closing accounts are subject to individual measurement (German Commercial Law, p. 252.1). There
are exceptions from the rule of individual measurement for inventories (German Commercial Law, p. 240.3-
4, p. 256), for lump sum adjustments to receivables and for provisions for warranty obligations. A number of
exceptions from the principle of individual measurement apply also in British Law.
Both the legislations operate with the principle of key date valuation under which all the value changes up
until the key day should be recognised in balance sheet. For the purpose, a differentiation applies between
151
Cf. BUCHHOLZ (2005), p. 30.
152
In both the legislations, inconsistencies shall be explained and elaborated in annex to balance sheet.
153
Cf. BUCHHOLZ (2005), p. 29. In specific cases, also a statutory requirement applies to apply the optional
recognition principle on a permanent basis, cf. BAETGE/KIRSCH/THIELE (2002), p. 104.
Chapter 3
36
adjusting and non-adjusting events. Adjusting events
154
result in recognition in balance sheet while for non-
adjusting events
155
, no adjustment is allowed (German Commercial Law, p. 252.1; IAS 10.8 et seq.).
Both in British and in German Law, compliance with applicable accounting guidelines while applying
quality-related criteria generally results in account statements that accurately reflect the actual corporate
asset, finance and income structure (German Commercial Law, p. 264.2; F.46). In British Law, the approach
does not apply if the company management concludes that compliance with the guidelines would result in a
failure to produce accurate results while also failing to establish a representation that would adequately
reflect actual status (overriding principle). Justification should be given for any such departure from
accounting guidelines. Moreover, the departure consequences are to be quantified (IAS 1.17). In German
Law, a departure from applicable accounting guidelines is not permissible. In case the account statement
does not provide an adequate representation of corporate asset, finance and income structure, merely relevant
notes are to be given in annex to balance sheet (German Commercial Law, p. 264.2).
On the whole, a conclusion applies that a number of principles in British Law are equivalent to those in
German Law. Nevertheless, significant differences apply in relative weight of the different principles. For
instance the principle of prudence and the principle of accruals basis enjoy a higher significance in German
Law compared to British Law. Moreover, both the systems feature different principles. For instance in
British Law, the principle of neutrality is explicitly provided in order to prevent that available freedom of
judgement is misused in designing balance sheets to serve particular ends. The German lawmaker on the
other hand explicitly provides the rule of individual measurement in order to prevent value compensations
for assets. Another difference applies in the wording of the principles. While in German Law, the principles
refer directly to account statement, their British counterparts invariably use more generic wording.
156
3.3.
GENERAL TREATMENT OF BALANCE SHEET ITEMS
3.3.1.
RECOGNITION CRITERIA
UNITED KINGDOM
Concrete balancing guidelines for specific assets and liabilities in British and German Law generally refer to
respective accounting standards and regulations (including interpretations thereof). Where there are guidance
gaps in applicable legal standards, generic balancing guidelines need to be referred to. Generic balancing
guidelines define in general terms what positions qualify as assets and liabilities respectively and hence are
to be recognised in balance sheet. It should be noted however that such generic balancing guidelines do not
154
An example of adjusting event is learning about insolvency proceedings involving a customer initiated after the
balance sheet date that usually indicates an impairment loss on trade receivables at the balance sheet date.
155
A non-adjusting event for instance is a drop in market value of a financial investment between the balance sheet
date and the account statement publication date. That means the value loss for the financial investment was not
yet present at the balance sheet date but only occurred later.
156
Cf. BUCHHOLZ (2005), p. 220.
Chapter 3
37
always necessarily match the specific regulations applicable in commercial accounting as the lawmaker may
prohibit recognition of activatable balance sheet positions or allow or stipulate recognition of non-activatable
positions depending on circumstances. Due to general applicability of trade balance as reference for tax
balance sheet, the generic balancing guidelines are also relevant from tax point of view.
As the starting point for determining taxable income in the UK is the trade balance result which in turn is
determined in reference to generally accepted accounting standards as published by IASB, the guidelines
provided within the IASB framework are key for balancing account statement positions.
157
The generic balancing guidelines within the framework concept comprise a two-phase procedure that
facilitates recognition of balance sheet items; this comprises assets, liabilities and equity. Additionally, the
framework concept also provides guidelines concerning recognition of costs and revenues.
In the initial phase of the procedure, a verification is implemented as to whether the balance sheet items
comply with the following definitions provided by the framework concept.
By definition, an asset applies where the firm has acquired legal or economic title over a tangible or
intangible resource as a result of prior business transaction or event, being able to draw future economic
benefit from the resource. The benefit may comprise inflow of means of payment or equivalents thereof or
effectively preventing outflow of such means. However, it should be noted that in order to recognise an asset
in balance sheet, the asset definition given above must be complied with. An outflow of means (spending)
alone classifies as auxiliary criterion only (F.49a; F.53 et seq.; IAS 38.8).
A liability is a present obligation from past business transactions or events on complying with which an
outflow of means may be expected that amounts to economic benefit. Liabilities do not only result from
legally effective contracts or statutory regulations but also from voluntary obligations. A particular
characteristic of obligations entered on a voluntary basis, there is no legal title on part of third persons to
receive the service or performance in question (for instance provisions for entertainment expenses).
Recognition is not preconditioned by a liability estimate if the remaining criteria under F.49b are complied
with (F.49b; F.60 et seq.; IAS 37.10).
The difference amount between assets and liabilities is referred to as equity (F.49c; F.65 et seq.).
158
Apart from compliance with the definitions, balance sheet items need to additionally comply with specific
cumulative recognition criteria (F.83).
157
Cf. SECTION 2.2.3.
158
Further more detailed classification of equity is allowed, thus ensuring adoption of national reporting provisions.
Chapter 3
38
An asset or liability is to be recognised in balance sheet if
^ it is likely that the firm may expect inflow or outflow of economic benefit(s) as a result of such recognition
and
^ the cost of purchase or cost of conversion for the item can be reliably determined (F.83, F.89).
159
The framework concept does not provide an answer as to how to define a sufficient likelihood. KIRSCH
presumes that the likelihood should be above 50 percent.
160
Moreover in determining the value of an asset or
liability, the principle of reliability should be observed. For reliably determining the value, also a reliable
estimate may be used.
161
GERMANY
Contrary to British balancing guidelines in German Law, there is no explicit definition of assets, liabilities or
equity. German Commercial Law, p. 266.2-3 merely provides a listing of account statement positions subject
to recognition as balance sheet items. In response, generic balancing guidelines have been developed for use
in the German environment; these are classifiable into activation and passivation guidelines.
The activation principle for recognition of assets refers to the idea of applicability to settle liabilities. Hence
a vital criterion for asset recognition is that the assets may be converted into cash in dealings with third
persons and thus utilised to settle liabilities. Accordingly, a recognisable asset needs to be utilisable as is.
This applies if the asset is convertible into cash by disposing of/ selling the asset, assigning title over the
asset to third persons, conditionally ceding title or by way of legal enforcement.
162
Contrary to the British
perspective on recognising accruals, the asset is interpreted as quantity in stock at any given point. The asset
ability to generate future surplus on payments is irrelevant for the purpose
163
.
164
As under British regulations,
no such utilisability is required for asset recognition; the asset side in an British balance sheet usually ends
up higher than under German balancing regulations.
165
159
In verifying compliance with the recognition criteria, the principle of materiality needs to be observed, compare
F.84.
160
Cf. KIRSCH (2007), p. 27.
161
If impossible to make a reliable estimate, the position is reported in profit and loss, with additional note in annex,
compare F.85-86.
162
Cf. BAETGE/KIRSCH/THIELE (2002), pp. 125-129; HAYN/WALDERSEE (2004), p. 65.
163
Cf. BUCHHOLZ (2005), pp. 220-222.
164
Balancing guidelines developed by tax lawmakers do not refer to the idea whether an asset is convertible into
cash individually but stipulate the asset transferability instead along with the business. Under the interpretation,
an asset has to comply with the criteria of utilisability as is and item identifiability. That means than not just
tangible items and titles, but also circumstances, options and economic benefits are activatable. Nevertheless,
measurable and identifiable items are not always automatically utilisable as is and can only be used for liability
settlement purposes on selling the entire business. Items utilisable as is on the other hand are always measurable
and identifiable. In author's opinion, the interpretation in tax accounting should be rejected.
165
Exceptions comprise e.g. current deferred taxes, internally generated assets and derived goodwill,
cf. WINKELJOHANN (2005), p. 66.
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