All the signs indicate that key provisions of the current German Inheritance Tax Act that favor corporate assets will be held unconstitutional by the German Constitutional Court. According to unofficial reports new provisions are expected by next year at the latest, because if lawmakers are required to bring these rules in line with the Constitution, the Court is not likely to give them very long to do so. Therefore, it is likely that the tax burden on gifts and inheritances of corporate assets will increase.
Under the current tax exemptions for corporate assets, if the personal allowance of EUR 400,000 is used, a company with a value of up to EUR 2.66 million can be transferred to a child of the owner tax free, provided that the prerequisites for regular relief are met. If the stricter requirements for full relief are met, then no inheritance tax is incurred even on much higher company values. This preferential treatment of corporate assets will in all likelihood mean that the current rules will have to be amended to comply with the ruling of the German Constitutional Court, which will make the transfer of corporate assets significantly more expensive in the future. Even though the decision of the German Constitutional Court is not expected until the autumn of 2014, succession planning should start early so that there is plenty of time for it.
There are many aspects to consider—from bringing in the successor to providing income to the transferring owner after retirement. All the potential structures that can be used to accomplish these goals should be considered. This will require a great deal of care. Just as in corporate restructurings, the recognition of unrealized gains, which are subject to income tax, must be avoided. A split in operations that would be ended if only the operating partnership is transferred to the successor can turn out to be a pitfall in the case of partnerships. The result would be the recognition of hidden reserves in the economic assets held by the owning partnership (e.g. in the plants and administrative buildings leased to the operating partnership), and in the interest in the operating partnership that is part of the operating assets of the owning partnership when the business is split up. Similarly, capital gains could be immediately taxable if economic assets qualify as special operating assets, but only the interest in the partnership is transferred to the successor without the taxable special operating assets.
Instead of transferring the entire company to the successor with all rights and obligations, succession plans tailored to the individual situation are often requested. For example, if the owner is to continue to receive part or all of the company's annual income during retirement, a life interest can be agreed with the successor when the company is transferred. In this agreement, the life interest can be balanced such that the transferor's retirement is secured, but any income in excess of his retirement needs remains with the transferee and thus will not be subject to inheritance tax at a later point.
If the successor is to be brought into the company over the course of time, then only part of it could be transferred, with the transferor retaining certain voting rights.
In order to avoid an additional gift, or a gift that occurs later under worse conditions, a transfer to the owner's grandchildren could also be considered. This sort of "generation skipping" makes it possible to include the grandchildren in succession planning under the currently applicable inheritance tax relief. However, if the grandchildren are still minors, a generation-skipping plan should be considered very carefully due to the required participation of any special guardians and the family court.
Finally, it is possible (and frequently done in practice) to make the gift subject to revocation in order to avoid certain situations, such as where the donee predeceases the donor. If the company is transferred back to the owner because the owner reserved the right of revocation, the original gift will be unwound from a tax standpoint, and the gift tax incurred will be refunded. However, revocation clauses should be used carefully because overreaching revocation rights could jeopardize the tax recognition of the asset transfer.
The structuring possibilities described briefly here by way of example show that for optimal tax structuring and a legal, balanced arrangement of a corporate succession, not only tax expertise, but also comprehensive legal knowledge and experience is required. Sufficient time is also a deciding factor in successful succession planning.