GroKo exploratory talks: Critical comments on the planned abolition of the flat-rate withholding tax on interest

The CDU/CSU and SPD have Exploratory paper decided to abolish the flat-rate withholding tax (tax rate of 26.375% including solidarity surcharge) for interest income. Instead, interest is to be taxed at the full personal tax rate (tax rate of up to 47.475% including solidarity surcharge) - an increase in the tax rate of up to 21.1% points would be the result. This is justified by the fact that the introduction of the international exchange of information has made tax evasion more difficult and thus removed the basis for the flat-rate withholding tax. This fails to recognise that there were considerably more good reasons for the introduction of the flat-rate withholding tax at the time, cf. the altii blog on an initiative of the state of Brandenburg from 2016.

The planned application of the progressive tax rate to interest income should be rejected for the following reasons in particular:

• Significant demarcation problemsThe current equal treatment of all capital income leads to a considerable simplification effect. From the investor's point of view, capital income taxation is decision-neutral, as it makes no difference whether the investor earns dividends, interest, capital gains, income from derivatives, etc. If the final withholding tax on interest were to be abolished, this would result in considerable demarcation problems, as it would first be necessary to define what is to be categorised as harmful, higher-taxed interest. Interest can easily be converted into other types of capital income using suitable financial instruments. Conversely, in the case of losses, it will be more interesting to realise losses from interest-bearing securities in order to achieve offsetting possibilities at the normal tax rate (see loss offsetting below).
• Deduction of income-related expensesIf interest is taxed unfavourably at the full tax rate, the tax-reducing deduction of income-related expenses associated with the interest must also be made possible. This is not possible in the case of income subject to final withholding tax (Section 20 (9) EStG). This also leads to considerable allocation and delimitation problems and forces taxpayers to painstakingly filter out these costs and claim them annually in their tax return.
• Loss offsettingLosses from capital assets are currently "locked in" and may not be offset against other types of income (e.g. from non-self-employed work or letting and leasing). If positive income from interest-bearing securities is fully taxed in future, losses from such financial instruments must also be permitted to be offset against other types of income.
• Complex tax declarationThe main advantage of the current flat-rate withholding tax is the considerable simplification of the taxation procedure for taxpayers and the tax authorities. In many cases, tax can be levied conclusively at bank level; taxpayers no longer have to declare their investment income in their tax return. The planned partial abolition of the flat-rate withholding tax removes this simplification aspect. As a rule, investment income will once again have to be declared in full in the tax return; the above-mentioned questions of delimitation and loss offsetting will have to be clarified, which taxpayers will typically only be able to do with the help of a tax advisor. The tax authorities will also have to increase their capacities to cope with this increase in tax complexity.
• fund taxation again: The recently Reformed investment fund taxationwhich from 1 January 2018 taxes all distributions from investment funds for private investors indiscriminately at the flat-rate withholding tax, would have to be revised again. The legislative aim of the InvStG 2018 was also to simplify the taxation procedure by eliminating the need for a time-consuming calculation of income on the fund input side for the purposes of investor taxation. This will be necessary again in future, as distributions from a fund cannot be taxed at the 26.375% flat-rate withholding tax rate in future if the distributions consist of interest at fund level. A significant simplification effect of the recently reformed fund taxation would be abolished again.
• Low tax revenueThe increase in tax revenue from the abolition of the flat-rate withholding tax on interest income is likely to be low. This is of course initially due to the current low level of interest rates. If one also takes into account the above-mentioned possibilities for offsetting expenses and losses and the rising administrative costs on the part of the tax authorities, the net effect of this tax increase is unlikely to be positive.

As a result, it is to be hoped that this plan will be reconsidered in the upcoming coalition negotiations and that the coalition partners will decide against a complex schedular taxation of capital income.

Dr Thomas Elser is a tax consultant at TAXGATE, a tax law firm specialising in transactions, investments and tax compliance.