Bryan Cave’s Tax law expert Stefan Skulesch: “Last minute solution with flaws will continue to impede company successions in Germany”
On 14 October 2016 the Bundesrat (the upper house of the German parliament) has approved the reform of the German Inheritance Tax law, completing the parliamentary procedure of the legislation. The reform will affect all transfers by death or by gift from 1 July 2016 onwards. German Inheritance Tax is triggered where either the decedent/donor or the heir/donee has got his domicile or habitual abode in Germany. In addition, German Inheritance Tax can also be triggered insofar as the transfer comprises German eligible assets, i.e. business assets or shares in German corporations.
It may have been the legislator’s intention to arrange the inheritance tax law in compliance with the German Constitution. “Obviously, the legislator did not aim to make the law more comprehensible and user-friendly” comments Stefan Skulesch, Tax law expert and counsel at Bryan Cave in Frankfurt. “Tax advisors might profit much more from the reform than taxpayers or tax authorities. The still existing privileges of the eligible assets for family owned businesses will certainly be again re-examined by the German Supreme Constitutional Court. In the end, the reform might again - then for the 4th time - be judged as not in compliance with the German Constitution. The retroactive application of the law might also be challenged. Bearing in mind that the Inheritance Tax only contributes less than 1% to the aggregate German tax revenue, it is questionable whether all the related administrative and legislative efforts are actually worth it.”
International investors seeking to acquire German Mittelstand companies or shares in firms that recently had a company succession should carefully study the new legal framework. “Selling assets or shares of the firm might directly lead to a high tax burden for the owners. This could lead to higher prices in transactions in Germany”, says Skulesch.
The basic principles of the modified German Inheritance and Gift Tax Act are as follows:
- The basic concept of tax reliefs applying to eligible assets remains intact. A basic relief of 85% (regular relief) or 100% (optional relief) can be chosen by the taxpayer (heir or donee). The requirements for the regular relief or optional relief are still tied to the preservation of jobs (aggregate wage regulation) and the continuation of the business (retention period of five years for regular relief and seven years for optional relief). Now the reform introduces a gradual increase of the aggregate wages to be observed, depending on the number of employees. The aggregate wage regulation applies now to businesses with more than 5 employees (instead of 20 employees), with the aggregate wage requirement increasing for businesses with 6 to 10, 11 to 15 and more than 15 employees.
- The distinction between productive business assets and administrative assets is still necessary. However, the portion of the administrative assets is no longer relevant for the application of the regular relief. Administrative assets will now be in principle subject to tax insofar as their value exceeds 10% of the enterprise value less net administrative asset value. If the business assets consist of at least 90% administrative assets no relief shall be possible for the remaining productive business assets. The application of the optional relief requires that the business assets do not contain more than 20% of administrative assets.
- The key changes of the Inheritance Tax law relate to “large eligible assets”, the value of which is determined at EUR 26m. by the legislator. If that threshold is exceeded the taxpayer may choose between (a) a decreasing basic relief or (b) a tax exemption if the acquirer passes an appropriate means test. (a) leads to a reduction of the relief by 1% for each EUR 750,000-step exceeding the EUR 26m.-threshold. The application of (b) upon the taxpayer’s request requires that the taxpayer demonstrates that he is not able to settle the inheritance tax debt by using his own estate or the transferred assets. The tax exemption shall be granted to the extent that 50% of the owns estate and the transferred assets are not sufficient to settle the tax obligation.
- The determination of the enterprise value still requires the application of the so-called simplified capitalized earning method. What is new is that the applicable capitalization factor is set at 13.75 (instead of currently 17.86). The reasoning of the legislator was to take into account low-interest phases, for which the previous rules lead to excessive values.
- In relation to family enterprises a special relief is granted if the articles of association contain distribution restrictions, transfer restrictions and compensation reductions. The special relief may not exceed 30%.
- In relation to transfers of eligible assets by way of inheritance, the taxpayer may apply for a deferment in the future. The deferment may take up to 7 years, but is subject to a 6%-interest per year.
“The last minute solution of the German government to avoid an imposed regulation by the Constitutional Court has a lot of flaw and introduces an even higher level of bureaucracy. This will continue to impede company successions in Germany”, concludes Skulesch.