It was time for another meeting with my wine-making client, Mr Collins, who was planning the export of his English Huxelrebe to Germany.'My studies show that after year one, we should be breaking even at the very least, so given what you've told me about the rates of tax, I'm inclined to go straight for the German subsidiary,' commented Mr Collins.

'So can we take it that I should have a subsidiary and go from there?''That's fine,' I replied, 'in which case we need to discuss how to fund the subsidiary.

For the sake of completeness, the written notes I shall be sending you will contain the tax implications of converting a branch into a subsidiary, both in the UK and in Germany.

I should still suggest you consider the branch structure first, but we can set that aside for the purposes of this afternoon.'Incidentally,' I added, 'since I wrote to you after our last meeting, the tax reductions I mentioned were in the pipeline have in fact been confirmed, at slightly different rates.'The result is that from 1 January this year, the effective rate of tax on a branch will be 42%, compared to 33.5% for a subsidiary, making the advantage of a subsidiary from this point of view alone even greater.

However, it's a case of two steps forward and one step back.

From 1 January 1995, Germany is imposing a 7.5% surcharge on corporate and personal income tax, to pay for reconstruction in the east.

This is the position for a subsidiary distributing all its profit to the UK parent in 1994 and 1995, respectively,' I said, giving him a note of the information, 'with the provision that there is also local business tax on profits, the net effect of which is to increase the tax burden by about 10%.''I see.

And, if I remember correctly, the 5% withholding tax is coming off the following year - 1996?''Yes.

Under EC rules, Germany must eliminate its withholding tax by 1 July 1996.

Of course, a subsidiary is unlikely to distribute all its profit in the way I have suggested, which leads me on to the question of financing.'The subsidiary will need working capital.

The choice is between equity and loans.

Essentially, as in this country, dividends are not deductible against tax in Germany, whereas interest on the loan capital is.

So, in theory, apart from the statutory minimum capital for a GmbH, a German limited liability company, which is DM50,000, you could provide the rest of the finance by way of loan capital.'The loan can be in any currency and, provided the interest rate is not excessive, the interest would be deductible against German corporation tax.

It would be taxable in the UK, of course, but at 33% rather than at the 45% German rate on retained profits.

What is more, interest payments between Germany and the UK are already free of withholding tax, and loans can be freely repaid, without tax consequences, whereas share capital has to be sold, or repaid within strict limits.''You're going to tell me,' said Mr Collins, 'that there are snags.''The snag is called the "thin capitalisation rules".

Tax authorities aren't usually very fond of this kind of arrangement, as you can imagine.

After years of rebuffs to the German revenue in the courts, Germany now has a thin capitalisation law.'This means a foreign shareholder can only finance a German company with a certain proportion of debt.

Once that proportion is exceeded, the rest of the interest is treated as if it were a dividend.

The proportion we're talking about in this case is three parts debt to one part equity.

That is to say, if the total funding from the UK for the subsidiary were, say, DM 500,000, the loan capital should not be more than DM 375,000.'There may be ways round this.

The loan could, for example, be made by a financing company, which would not be a shareholder in the subsidiary.

My German colleague, Dr Gratz, could advise us on this.

But we'll take it as a given for now.''What about borrowing in Germany? Would that make any difference?' asked Mr Collins.

'Isn't it true that German banks are keen to take an equity stake when making a major loan?''That had been my impression as well, but Dr Gratz tells me this is the exception rather than the rule.

They se em to go rather for extensive guarantees.''Sounds like home,' Mr Collins observed.

'And how about interest rates?''Well, for the first time in many years, interest rates are lower here than in Germany,' I replied.

'Which leads me on to different means of profit extraction.'We've already looked at dividends and interest.

But there are various other methods that could be considered.

Sooner or later, the German subsidiary will indeed have to borrow locally on some scale.

In such a case, it is highly likely as we have seen, especially for a new company, that the German banks will require guarantees from the parent company back in the UK.

The UK company should charge guarantee fees to the subsidiary.

These ought to be tax deductible in Germany.

Then again, if you were so minded, you could also sell the subsidiary's debts to a factor, or lease assets to it and charge rentals.'The UK company would almost certainly supply management services to the GmbH, at least initially, in return for the payment of management charges.

Royalties for trade marks is another possibility.

All these - rentals, management charges, royalties - should be deductible against corporation tax in Germany, and there would be no German withholding tax.'In practice, some or all of these will be appropriate at one time or another.

As the company grows and prospers, you'll begin to think about taking over rivals, or establishing other subsidiaries, and tapping into markets elsewhere in continental Europe.