The German law on inheritance and gift tax (ErbStRG) introduces new regulations for the treatment of business assets

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With the law to amend the inheritance and gift tax in line with the legal ruling of the German constitutional court, after a long legislative procedure including a conciliation procedure the lower and upper houses of the German parliament have voted to introduce new regulations to govern the treatment of business assets in connection with inheritance and gift with effect from July 1, 2016. We have listed the essential principles of the new law for you.

 

 
 

 

Differentiation with the succession planning

A differentiation is made because the scope of the individual inheritance in future defines the exemption concept. Small and medium-sized companies and companies where the company shares are distributed between numerous shareholders and/or successors will have to selectively adapt their succession concept to the new legal situation. Large family-owned companies will only benefit from tax relief under very strict conditions and will have to come to terms with an additional burden in terms of inheritance tax. They should undertake a general revision of their succession planning. In this respect an approach towards long-term transfer cycles and the inclusion of the private assets of all those involved and distribution within the family up to the consideration of family foundations and the second generation of inheritors represent totally new requirements.

 

Different exemption concepts

Inherited amounts up to 26 million euros (inspection threshold)

The previous exemption concept remains in place, i.e. a regular exemption (tax relief for 85 percent of the taxable value) and optional exemption (100 percent tax relief), respectively with the known retention periods and payroll requirements. In future companies will feel an additional burden to the extent that harmful administrative assets will surely be subject to tax.

 

Inherited amounts to the value of more than 26 million euros

A choice has to be made between the melt-away model and the exemption model where the need for exemption is examined. With the melt-away model the previous tax relief is reduced as the inherited amount grows in value until there is full tax liability for inherited amounts above 90 million euros. In the exemption model the inheritor must disclose his private assets and make up to 50 percent of the assets available for the payment of tax on the company assets and is then exempt from any further tax. For inherited amounts within 10 years, the exceeding of the examination threshold, the meltdown and the need for exemption are calculated together.

 
The examination to establish the exemption requirement can in future lead to the fact that future gifts or inherited assets to already prosperous inheritors could be hindered which is a highly debatable incentive effect which gives rise to completely new approaches in the succession planning.

 

Payroll total requirement

For a certain time after the transfer (regular exemption: 5 years; optional exemption and exemption model: 7 years), when the tax privileges are used there must be a certain amount of payroll total which is constantly maintained. Companies with up to 5 employees (by head) or with a reference salary amount of 0 do not have to fulfil this criterion. Up to now the limit was with 20 employees. A new point is that the amount of the realised salary depends on the number of employees. This is shown in the following table:  

 

Minimum payroll ​ 6 to 10 employees 11 to 15 employees​ More than 15 employees​
Regular exemption​250% in 5 years300% in 5 years​400% in 5 years
Optional exemption500% in 7 years565 % in 7 years700 % in 7 years​

 
Administrative assets subject to tax

In contrast to the past, administrative assets in principle no longer quality for exemption. This means inheritance tax must always be paid on so-called harmful administrative assets. However, a pro rata debt deduction with administrative assets is permitted (net administrative assets). For multi-tier company structures, in future the administrative assets have to be determined with a combined asset listing at the company group level.
 
Administrative assets are defined in the listing of § 13b par. 4 of the German law on inheritance and gifts (ErbStG). A new element is the regulation to prevent misuse which means that administrative assets now include classic cars, yachts, precious metals and other objects which are typically associated with private lives. A financial test applies for money and monetary receivables (so-called financial assets), whereby up to 15 percent of the market value of the company counts as assets eligible for tax relief and the rest counts as harmful administrative assets. The exception is companies where the financial assets do not serve an original company purpose and for these companies the complete financial assets are harmful. Assets which serve to settle debts arising from pension obligations are eligible for tax relief under strict conditions. Administrative assets of up to 10 percent of the assets eligible for tax relief are not harmful and are also eligible for tax relief.
 
The investment clause is a new clause, whereby to the reference date an existing amount of harmful administrative assets can be invested within a time period of 2 years after the death of the benefactor by the inheritor (not with a gift) for certain assets eligible for tax relief. The conditions, however, are much too strict in practice.
 
If the company assets consist by at least 90 percent of administrative assets, the tax relief is removed for the whole of the assets. In trading companies, for example, which have a high amount of receivables, this can lead to a complete failure of the tax relief.
 
The condition for the granting of the tax relief in case of optional exemption (of 100 percent) is similar to the existing law with an administrative assets test, whereby the assets eligible for tax relief are permitted to be up to a maximum of 20 percent of the administrative assets.

 

What changes are there with the valuation?

The capitalisation factor with the simplified German income approach for the valuation is defined to be retroactively effective from January 1, 2016 at 13.75. In contrast to the previous overvaluation with a factor of 17.85, this represents a movement towards realistic market values for small and medium-sized companies which cannot afford a company valuation. This initially sounds positive, but for transfers in the first half of 2016, a retroactive application of the lower capitalisation factor can also have a negative effect on the proportion of administrative assets.

 

Valuation discount for family-owned companies

If there are certain provisions in the articles of association, a valuation reduction of max. 30 percent is granted on the assets eligible for tax relief. The conditions for this are:
  • The withdrawal/distribution must be limited to a max. 37.5 percent of the profit after tax, whereby withdrawals for the purpose of paying income tax are not taken into account.
  • The possession of a shareholding of the partnership or shareholding in a corporation is limited to relatives, a family foundation or also co-shareholders.
  • If a shareholder leaves the company, a settlement is agreed which is below the market value of the shareholding. The amount of the reduction defines the amount of the valuation discount which, however, is capped at 30 percent.

 

The conditions must be accumulatively in place and maintained for 2 years before and 20 years after the transfer. The stipulations should be taken into account in the design of the articles of association.

 

Extended deferment of payment regulation

If, despite exemption regulations, melt-away models or a decree accepting exemption, inheritance tax is applied to assets eligible for tax relief, the taxpayer can apply for deferment of payment when the inheritance is due to a death. This is possible for up to 7 years, but is only not subject to interest in the first year. The condition for the granting of the deferment is compliance with the payroll total regulation and the retention period.

 

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