Chancellor Angela Merkel has said that her government has never acted in a way that would encourage tax optimisation by companies operating in Germany.

At their final meeting of the year, EU leaders welcomed European Commission proposals for automatic exchange of so-called "tax rulings" in the EU.

The European Commission has widened its investigation into aggressive tax planning to all 28 member states – including many of the loudest critics of so-called tax optimisation on offer in Luxembourg and Ireland. "I am no judge or criminal investigator, I can only rule out that the federal government has ever made laws that insinuate that anything like that can be done," said Dr Merkel. "We make sure that as many as possible adhere to the law."

Germany’s federal finance ministry – responsible for drafting tax legislation – has welcomed the commission initiative. The 16 state capitals and hundreds of municipalities responsible for collecting taxes from companies have welcomed the proposal for tax authorities to exchange information on companies operating in multiple EU member states. But they say they require clarification from Brussels on what the commission means by “tax rulings”.

Level of tax

“Agreements between tax assessable parties and German finance authorities, in particular over the level of tax, are not permissible under German tax law,” said a spokeswoman for the finance ministry of North Rhine-Westphalia, the state currently heading the rotating chair of the

Bundesrat

upper house.

Taken together, tax officials say that companies operating in Germany can expect to pay, between commercial and corporate taxes, about a 30 per cent levy on their earnings.

The ostensibly restrictive system does not rule out tax competition between German cities and regions, with the most notorious example being the village of Norderfriedrichskoog on Schleswig-Holstein’s North Sea coast.

Its history of tax breaks stretches back to 1696, when a local duke asked villagers to finance a dyke by setting off the cost against their taxes. In more recent times Norderfriedrichskoog offered a raft of creative tax planning options, such as allowing companies to set their corporate tax bill against income tax contributions.

As a result the tiny village – 46 residents, two streets and no pavements – attracted at its peak subsidiaries of 514 companies, including Lufthansa and Deutsche Bank.

These companies profited from the flexible attitude to tax on display in Norderfriedrichskoog and guaranteed by local autonomy over taxes anchored in Germany’s post war constitution.

Unfair competition

But the village’s reputation as “

Monaco

of the north” ended a decade ago when a row over unfair competition went to Germany’s constitutional court.

In its ruling, Germany’s highest court retained the principle of local tax competence but set a minimum tax floor.

Under the German tax system, state authorities assess and send out company tax statements to cities and municipalities. It is then up to local authorities to decide then what “multiplier” they apply on commercial taxes.

The constitutional court set a minimum multiplier of 200 per cent – doubling the commercial tax indicated in the tax statement. Most regions around Germany levy a multiplier of about four. The local authorities reach their individual rates by a mixture of local authority peer pressure and a calculation of how much they can charge to cover costs without impinging on their attractiveness to companies.

Germany’s Chamber of Industry and Commerce says the system, though complicated, is more one-size-fits-all than in other countries and does not permit individual tax tailoring for individual companies.

A spokesman for Germany’s Städtetag, a union of German cities and municipalities, agrees. “The tax administration in Germany knows everything about the companies operating here,” he said.

Apart from its decentralised structure, German tax experts say the major difference between their tax system and that of Luxembourg or Ireland is the philosophy behind the rulebook.

"There is a big difference between what I make possible systematically – like Luxembourg-style tax rulings based on tax discussions with firms – and a system like ours which doesn't allow this," said Mr Thomas Eigenthaler, head of Germany's tax union, which represents about two-thirds of Germany's 110,000 tax officials.

He says he would have heard through his organisation’s grapevine of mass tax optimisation by companies, but hasn’t. He admits you cannot rule out black sheep companies fiddling their taxes but disputes the idea that tax optimisation is a mass phenomenon in companies operating here.

No overview

At the same time Mr Eigenthaler, tax head of Stuttgart for nine years, concedes that Germany’s size and decentralised tax system means no one authority has an overview of what is going on at local level, where commercial and corporate taxes are collected.

“We don’t know if a local municipality agrees to do without commercial taxes one year because a local firm says that paying it will close it down,” he said.

German federal states are no saints in tax matters, he adds, given how their public Landesbanks moved to Dublin partly to save on tax. “These banks represented the state,” he said, “yet invested in tax havens.”