Are German businesses ready for reforms?

Despite its international appeal, three in every four of the visitors to Hanover are German. And their industry is in for a shock

The Hanover fair takes place this year against a backdrop of sweeping reforms which are about to be introduced to the German corporate tax system, writes David Fowler. These are expected to transform Germany’s capital market.

‘Generally both the German capital and labour markets are quite heavily regulated,’ says Commerzbank Securities debt and equity strategy analyst Rolf Elgeti. ‘The capital market will be brutally changed from next year onwards.’ The sweeping nature of the reforms is all the more unexpected because they are being introduced by a social democratic government.

The key changes are a reduction in corporation tax from 40% or 30% to 25%, the abolition of capital gains tax on stakes in firms held for more than a year, and a reduction in depreciation allowances from 30% to 20%.

The reforms could briing on a wave of mergers, and reduce capital spending. The Mittelstand, the highly successful but mainly family-owned small and medium sized sector, is expected to face a difficult transition.

The abolition of capital gains tax is expected to act as a catalyst for the restructuring of the corporate sector. German companies have extensive cross-shareholdings in other firms, amounting to 40% of the equity market. This includes long-term shareholdings by banks. These appear on balance sheets at their purchase price, though they may have risen in value since they were bought. Now that they can be sold without attracting tax, a vast hidden reserve of capital is expected to be freed.

Commerzbank estimates as much as 600bn euro’s could change hands over the next couple of years as companies sell off their stakes. The freed cash will lead to an upsurge in mergers and acquisitions as companies bid to become niche or mass market leaders.

But the reduction in depreciation allowances means ‘it will not be so advantageous to invest in tangible assets, resulting in a long-term shift in favour of the service economy’, says Elgeti

At least 1,000 non-incorporated businesses in the Mittelstand are expected to turn into corporations.