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Tax Advice

Inheritance Tax Reform - Initial Practical Experience

The political showdown over the reform of inheritance tax was second to none. Now there is legal certainty for business owners. But how practical is the reform?

Eve­r­y­t­hing remains the same?

On October 14, 2016, the tough struggle to adapt inhe­ri­tance and gift tax law to the judg­ments of the Federal Con­sti­tu­tio­nal Court came to an end. At first glance, the chan­ges brought about by the reform do not sound all that dra­matic. Busi­ness assets that are eli­gi­ble for pri­vi­le­ges under inhe­ri­tance tax law will remain as they are. Law­ma­kers are also sti­cking with a – slightly modi­fied – list of admi­ni­s­t­ra­tive assets.

Inheritance Tax Reform – Initial Practical Experience © Thinkstock

Chan­ges in the rules for admi­ni­s­t­ra­tive assets

Howe­ver, a more detai­led exa­mi­na­tion reveals that the chan­ges are actually more exten­sive and affect small and large enter­pri­ses in equal mea­sure. Why is this? Law­ma­kers mana­ged to change the rules for admi­ni­s­t­ra­tive assets. Whe­reas in the past admi­ni­s­t­ra­tive assets were inclu­ded in the tax bene­fits under inhe­ri­tance tax law as long as their value did not exceed 50% of the value of the busi­ness assets, they are now sub­ject to full inhe­ri­tance/gift tax – aside from a one-time “conta­mi­na­tion surch­arge” of 10%.

This results in a hig­her inhe­ri­tance tax bur­den for all com­pany suc­ces­si­ons affec­ted. It has eli­mi­na­ted the lee­way that was pos­si­ble under the exis­ting rules. The most important goals now are to create tax-pri­vi­le­ged assets and avoid admi­ni­s­t­ra­tive assets. In group struc­tu­res, moni­to­ring this and also kee­ping an eye on it during the year on a con­so­li­da­ted basis will be a huge chal­lenge.

Further­more, a 90% cap for admi­ni­s­t­ra­tive assets has been intro­du­ced for the first time as an addi­tio­nal pre­re­qui­site for uti­liza­tion of any tax relief rules in the case of gra­tui­tous busi­ness trans­fers. In practice, this rep­res­ents a furt­her obst­a­cle to obtai­ning relief. If an enter­prise does not pass the 90% test, all of the eli­gi­ble assets will be exclu­ded from the relief. In spe­ci­fic cases, it may be expe­di­ent to reclas­sify non-tax-pri­vi­le­ged admi­ni­s­t­ra­tive assets as per­so­nal pro­perty to be able to apply the relief rules for tax-pri­vi­le­ged assets. Enter­pri­ses with sig­ni­fi­cant finan­cial resour­ces and debts may also be affec­ted by these rules because there are no pro­vi­si­ons for off­set­ting. Con­se­qu­ently, a com­pany may quickly exceed the 90% limit. In this respect, the legis­la­tor attemp­ted in an incon­sis­tent and con­sti­tu­tio­nally ques­tionable man­ner to pre­vent abuse of law. Howe­ver, in the pro­cess, it unfort­u­na­tely enlar­ged the group of affec­ted com­pa­nies unduly.

In the case of inhe­ri­tance, though not gifts, admi­ni­s­t­ra­tive assets can be retro­s­pec­ti­vely reclas­si­fied as tax-pri­vi­le­ged assets if, and only if, the cri­te­ria in the “in­vest­ment clause” are met. For this, the admi­ni­s­t­ra­tive assets must be inves­ted in items of pro­perty wit­hin the eli­gi­ble assets acqui­red by the testa­tor wit­hin two years of the tax beco­ming char­geable in accor­dance with a plan pre­viously drawn up by the testa­tor. The pro­b­lem here is that the exis­tence of this invest­ment clause will fail in many cases owing to legal and de facto obst­a­c­les because in practice it will be dif­fi­cult to fur­nish evi­dence that the pro­perty was acqui­red in line with a plan that had been drawn up in advance by the testa­tor.

Tax relief resul­ting from adjust­ments to valua­tion

Even though the new tax rules for admi­ni­s­t­ra­tive assets are likely to cause a hig­her tax bur­den in the main, some tax relief is expec­ted to be pro­vi­ded through adjust­ments to the valua­tion of the enter­prise. This already app­lies with retroac­tive effect from January 1, 2016. If this is achie­ved using the sim­p­li­fied income approach, the now sta­tutory capi­ta­liza­tion fac­tor tends to pro­duce lower average values to be used for the taxa­tion.  

Trans­fer of busi­ness assets below the thres­hold for large eli­gi­ble assets

Gene­rally spea­king, busi­ness assets will con­ti­nue to bene­fit from the gran­ting of basic relief of 85% (regu­lar relief) and the deduc­ti­ble amo­unt of EUR 150,000 or optio­nal relief of 100%, i.e. com­p­lete exemp­tion from taxes. In each case, the tax­payer is requi­red to com­ply with the reten­tion periods and mini­mum pay­roll regu­la­ti­ons. The pre­vious excep­tion to the mini­mum pay­roll for micro­en­ter­pri­ses has been modi­fied and now app­lies only to busi­nes­ses with fewer than five emp­loyees. Lower mini­mum pay­roll limits apply inc­re­men­tally to busi­nes­ses with up to 15 emp­loyees.

Howe­ver, neit­her regu­lar nor optio­nal relief is app­lica­ble if the assets are what are known as ‘large eli­gi­ble assets’. This con­cerns acqui­si­ti­ons of tax-pri­vi­le­ged assets with a value of more than EUR 26 mil­lion. The goal must the­re­fore be to make use of this acqui­si­tion thres­hold on mul­tiple occa­si­ons and for mul­tiple people. For this it is use­ful – as in the case of pro­perty asset suc­ces­sion – to think in ten-year periods. As the acqui­si­tion thres­hold is app­lica­ble per per­son, it is advisa­ble to divide the acqui­si­tion among several people. The enter­prise can, for example, be trans­fer­red not just to one child but to several child­ren if this makes sense from a busi­ness per­spec­tive. The gene­ra­tion leap can be taken alter­na­ti­vely or cumu­la­ti­vely. It is also important to con­s­i­der this in parti­cu­lar when dra­wing up the last will and tes­ta­ment for the busi­ness owner’s remai­ning equity invest­ment due to the risk of agg­re­ga­tion wit­hin a ten-year period with acqui­si­ti­ons prior to July 1, 2016. Other trans­fe­rees that could be con­s­i­de­red include a family foun­da­tion or a non-pro­fit foun­da­tion; relief for the lat­ter is not cap­ped at EUR 26 mil­lion.

More­o­ver, in view of the amo­unt of the acqui­si­tion thres­hold, the com­pany valua­tion will also play a more important role than in the past. It is advisa­ble to make use of times of eco­no­mic cri­sis for trans­fers by gift because the enter­prise value is then lower; in other words, a lar­ger per­cen­tage of the enter­prise or the equity invest­ment can be trans­fer­red before the EUR 26 mil­lion acqui­si­tion thres­hold is rea­ched.  

Com­pa­nies and enter­pri­ses for which the acqui­si­tion thres­hold is not excee­ded because the equity invest­ments are spread among a large num­ber of share­hol­ders or suc­ces­sors the­re­fore only need to adapt their suc­ces­sion con­cepts to the new legal situa­tion selec­ti­vely.

Relief for family-owned busi­nes­ses

Family-owned busi­nes­ses will be gran­ted furt­her relief through an advance deduc­tion of up to 30% of the equity invest­ment’s fair mar­ket value. This advance deduc­tion redu­ces the value of the tax-pri­vi­le­ged assets prior to app­li­ca­tion of the regu­lar relief of 85%. If the tax­payer choo­ses optio­nal relief, the advance deduc­tion beco­mes irre­le­vant. Nevert­he­less, the advance deduc­tion may be inte­res­ting if the value of the tax-pri­vi­le­ged busi­ness assets is close to the EUR 26 mil­lion acqui­si­tion thres­hold for large acqui­si­tion assets and can be redu­ced to below this thres­hold as a result.

Howe­ver, the advance deduc­tion can only be app­lied if the com­pany’s con­ti­nued exis­tence can be ensu­red through the pro­vi­sion of limi­ta­ti­ons in the share­hol­der agree­ment on with­dra­wals, sever­ance pay­ments, and dis­po­sal. The limi­ta­ti­ons on dis­po­sal must exist two years before and 20 years after the acqui­si­tion. These dis­pro­por­tio­na­tely strin­gent requi­re­ments are likely to be dif­fi­cult to meet in practice. Whe­ther the relief is practica­ble remains to be seen. What is more, criti­cism is already being voiced that the advance deduc­tion is not con­sti­tu­tio­nal.

To keep all opti­ons open none­t­he­less, the requi­re­ments for the advance deduc­tion should pre­fe­r­a­bly be met. At a later point in time, the tax­payer can always opt out of this addi­tio­nal relief to be app­lied wit­hout requ­est by deli­be­ra­tely vio­la­ting the limi­ta­ti­ons on with­dra­wals or dis­tri­bu­ti­ons. This may be the case, for example, once the enter­prise value has been finally and abso­lu­tely ascer­tai­ned and the tax risk can the­re­fore be deter­mi­ned, but the enter­prise does not wish to be bound to the sub­se­qu­ent 20-year period.  

In light of this situa­tion, on acco­unt of the two-year wai­ting period, family-run enter­pri­ses should review their share­hol­der agree­ments or arti­c­les of asso­cia­tion promptly and make any necessary modi­fi­ca­ti­ons in line with the new law. It is also advisa­ble to make a refe­rence to the advance deduc­tion in the share­hol­der agree­ment, for example in the sec­tion on the terms for amen­ding the share­hol­der agree­ment. Other­wise, there is a risk that nobody will remem­ber this spe­cial relief dis­co­unt at a later date, lea­ding to the advance deduc­tion being unin­ten­tio­nally drop­ped with retroac­tive effect.  

Sig­ni­fi­cant tigh­te­ning-up of large eli­gi­ble assets

When tax-pri­vi­le­ged assets with a value in excess of EUR 26 mil­lion are acqui­red, app­li­ca­tion of an abla­tion model can be requ­es­ted. In this model, the hig­her the acqui­si­tion, the lower the amo­unt of relief gran­ted. There is no lon­ger any reduc­tion for tax-pri­vi­le­ged assets at around EUR 90 mil­lion. Like the nor­mal basic relief, this redu­ced basic relief also requi­res the tax­payer to com­ply with the rele­vant mini­mum pay­roll and main­tenance regu­la­ti­ons.

Alter­na­ti­vely, acqui­rers of large busi­ness assets can apply for means tes­ting. In this case, the acqui­rer will be exemp­ted from paying all or a por­tion of the inhe­ri­tance tax if the tax to be paid on the acqui­si­tion exceeds half of the acqui­rer’s non-tax-pri­vi­le­ged assets, i.e., inclu­ding the acqui­rer’s per­so­nal pro­perty. And if that was not enough, assets that will not be tax-pri­vi­le­ged in the future which are trans­fer­red to the acqui­rer by death or by gift wit­hin the fol­lo­wing ten years must also be fac­to­red into the cal­cu­la­tion of available assets. Here, too, the stric­ter requi­re­ments rela­ting to the main­tenance period and the mini­mum pay­roll for optio­nal relief must be com­p­lied with. This impo­ses a sig­ni­fi­cant addi­tio­nal bur­den on both the tax aut­ho­ri­ties and the acqui­rer, com­bi­ned with pos­si­ble back taxa­tion of the ori­gi­nal acqui­si­tion.

As a result, the tax bur­den on the admi­ni­s­t­ra­tive assets or per­so­nal pro­perty may be 80% or more, depen­ding on which tax bra­cket the tax­payer is in. It should also be remem­be­red that where the tax­payer only acqui­res a cer­tain quota of the assets, the tax-pri­vi­le­ged assets can be clas­si­fied repea­tedly as available assets. Owing to this ext­re­mely high tax bur­den, each large busi­ness owner should imp­le­ment inhe­ri­tance tax plan­ning to make pro­vi­sion for their demise.

The objec­tive at a com­pany level must be to create aba­te­ment requi­re­ments that are as com­pre­hen­sive as pos­si­ble, i.e., to gene­rate tax-pri­vi­le­ged assets (admi­ni­s­t­ra­tive assets: maxi­mum of 10%). Ideally, this has the advan­tage that the tax aba­te­ment can reach the maxi­mum allo­wance, no admi­ni­s­t­ra­tive assets need to be used to pay taxes, and the opti­mi­zed overall pac­kage can be trans­fer­red to the desi­red suc­ces­sor, in other words it does not need to be trans­fer­red to dif­fe­rent acqui­rers. Further­more, more weight should be given to the tax-pri­vi­le­ged assets and less to per­so­nal pro­perty. Ano­ther option is to have the available per­so­nal pro­perty trans­fer­red to ano­ther indi­vi­dual in the event of death. The ideal trans­fe­ree is the spouse or civil part­ner if this per­son is entit­led to a spe­cial tax allo­wance in the amo­unt of the actual or notio­nal claim to divi­sion of com­munity pro­perty. The aim of this is for the very valuable com­pany stake that exclu­si­vely com­pri­ses tax-pri­vi­le­ged assets to be trans­fer­red to an acqui­rer. This acqui­rer has no (more) available assets, having trans­fer­red their own assets to their child­ren, for example, prior to the acqui­si­tion. In cer­tain cir­cum­stan­ces, ano­ther ideal acqui­rer for inhe­ri­tance tax pur­po­ses could be a family foun­da­tion set up for the pur­pose of incor­po­ra­ting the com­pany stake. In an ideal sce­na­rio, this foun­da­tion can apply for the full tax aba­te­ment in connec­tion with the means tes­ting for the relief as it has no other assets.

A new era is the­re­fore begin­ning for inhe­ri­tance tax plan­ning at large enter­pri­ses. This must start simul­ta­neously with the testa­tor/donor, at enter­prise level, and with the acqui­rer. The grace periods must also be moni­to­red clo­sely to achieve the best pos­si­ble tax result. Here, the Federal Mini­s­try of Finance appears to hold the view that not only the acqui­si­ti­ons from July 1, 2016, but also acqui­si­ti­ons under the old inhe­ri­tance tax law must be tal­lied up for che­cking whe­ther the EUR 26 mil­lion acqui­si­tion thres­hold has been rea­ched. As a result, there is a risk that trans­ferors will also get caught up in the highly com­plex relief regime for large acqui­si­ti­ons – some­t­hing they didn’t expect given the anti­ci­pa­ted com­pany suc­ces­sion imp­le­men­ted in the past.

In practice, parti­cu­lar atten­tion will have to be paid to whe­ther the means test or the abla­tion model is cho­sen for a large acqui­si­tion. App­li­ca­ti­ons must be made for both of these forms of tax relief. Howe­ver, a requ­est to apply the abla­tion model is irre­voca­ble and rules out an app­li­ca­tion for means tes­ting for the same acqui­si­tion. Pro­b­lems arise in the inter­play of both app­li­ca­ti­ons if a furt­her acqui­si­tion, be it by gift or by inhe­ri­tance, is made wit­hin the ten-year period. Then, the agg­re­ga­tion can lead to the ori­gi­nally expec­ted basic relief being lower and pro­ving to be eco­no­mi­cally disad­van­ta­geous in hind­sight.

Defer­ral of pay­ment now only per­mis­si­ble to a les­ser extent

If, in the event of an acqui­si­tion on acco­unt of death, inhe­ri­tance tax is requi­red to be paid out of the per­so­nal pro­perty, there is an option to defer pay­ment. Howe­ver, this has been res­tric­ted under the reform and is now limi­ted to just seven years. The defer­ral is inte­rest- and repay­ment-free for the first year. Star­ting in the second year, inte­rest of 6% is char­ged and annual repay­ments of one-sixth of the amo­unt must be made each year. The option of defer­ral ends when the heir trans­fers sta­kes in the enter­prise to third par­ties.


While the inhe­ri­tance tax reform appears at first glance to be the “mi­ni­mal inter­ven­tion” in exis­ting law that was ini­tially pro­pa­ga­ted, a clo­ser look reveals a large num­ber of tax pit­falls that must be taken into acco­unt when plan­ning a com­pany suc­ces­sion. In any case, any tax bur­den on an enter­prise to be trans­fer­red after the reform of inhe­ri­tance tax must be recal­cu­la­ted. Other­wise, the change in the taxa­tion of admi­ni­s­t­ra­tive assets in parti­cu­lar may lead to nasty sur­pri­ses for many.

In the final ana­ly­sis, each busi­ness owner needs an inhe­ri­tance tax plan that is tai­lo­red to their spe­ci­fic situa­tion. Thin­king in long-term trans­fer cyc­les and incor­po­ra­ting the per­so­nal pro­perty of all par­ties and dis­tri­bu­ting this among the family mem­bers up to inte­g­ra­ting family foun­da­ti­ons and the next gene­ra­tion of heirs but one are new chal­len­ges ari­sing from the reform of the law. Where pos­si­ble, tax-pri­vi­le­ged and non-tax-pri­vi­le­ged assets should be sepa­ra­ted in the long term, both legally and com­mer­cially, and trans­fer­red sepa­ra­tely. On acco­unt of the caps impo­sed, large assets should be trans­fer­red by gift early on. Brin­ging gifts for­ward to an early age for donors and donees neces­si­ta­tes ret­hin­king the arran­ge­ment of the family’s assets and the rules of the game (family gover­nance). Legal inde­pen­dence in the form of foun­da­ti­ons is also likely to become an inc­rea­sin­gly via­ble plan­ning option. In addi­tion, income tax con­s­i­de­ra­ti­ons must be incor­po­ra­ted into the orga­niza­tion of dona­tion and trans­fer pro­ces­ses. 

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