What is the issue? The version of the Inheritance Tax Act that has been in effect since 1 January 2009 provides for comprehensive tax relief for the transfer of business assets, but this relief can only be claimed when strict conditions are met. Thus 85% or 100% of the value of business assets, agricultural and forest assets and shares of corporations with a minimum interest of over 25% is not taxed. Additional discounts, such as the general application of a more favorable tax bracket, are also provided. By establishing this rule the legislators particularly intended to protect companies in which the decedent or the heirs are particularly involved in the company, as is typical of a family-owned business. The productive assets of these companies should enjoy favorable tax treatment so that tax-related liquidity problems will not jeopardize the existence of the company and the jobs it creates.
The Federal Constitutional Court has granted legislators some leeway in making their decision on how to grant favorable tax treatment for this type of company, in order to secure their existence and maintain the jobs they create, but the Court has criticized the following details:
- The far-reaching or complete tax exemption of business assets is considered unreasonable to the extent that such exemption extends beyond small and mid-sized companies without providing for a needs test. In this connection the Court has instructed legislators to establish precise, easy-to-apply criteria to determine which companies are no longer eligible for tax benefits of this kind without a needs test.
- The exemption of companies with not more than 20 employees from the aggregate wage regulation, with the goal of preserving jobs, is unconstitutional. This exception must be limited to companies with only a very few employees.
- The comprehensive inclusion of administrative assets – up to 50% in the case of the exclusion provided for by the rule – is unconstitutional.
- The current rules can be avoided by structuring transactions in a certain way. For example, there are structures using the 50% rule in group structures (this is known as the "cascade effect") that make possible a tax-free transfer of a considerable amount of assets qualified as non-operative with a harmful effect from an inheritance standpoint. In addition, until 7 June 2013, cash companies were possible, but they are no longer regarded as favored business assets.
Even though they have been held unconstitutional, the provisions will remain in effect until 30 June 2016. The legislature is required to establish new rules by that date. However, according to a press release, the fact that the unconstitutional rules remain in effect does not provide protection against new rules that could be retroactive to the time of the ruling of unconstitutionality and "prohibit an excessive exploitation of the provisions that violate equality." Accordingly, the current law will probably continue to apply until the legislature issues new rules, at least in cases of inheritance and transfers of business assets whose favorable treatment was not deemed unconstitutional in the judgment. However, to be on the safe side, gifts should be protected by including a right of revocation in agreements to make a gift lest taxation be triggered unintentionally.
If the legislature decides to make the new rules retroactive, then they can probably be expected to be implemented quickly, in order to keep legal uncertainties to a minimum. On the other hand, if it takes the legislature the entire period established by the court in order to establish new rules, then the legislature would be well advised not to make them retroactive.
Rumors suggest that the Federal Government is keen on maintaining the tax benefits for business assets. So it is not very likely that a fully new tax benefit system will be implemented. However, it will likely be difficult in the future for companies that exceed the limits of small and mid-sized companies to transfer assets tax-free or mostly tax-free. The needs test required by the Federal Constitutional Court could force these companies to demonstrate a need for liquidity, which would likely be difficult to do in practice. It is to be hoped that the legislature will demonstrate sound judgment in this case. It is also conceivable that different exemptions or different prerequisites for exemption could be established for small and mid-sized businesses than for large companies, in order to take into account the concerns of the Federal Constitutional Court.