Tax Advice

Residence abroad: A tax pitfall

As­sets ge­ne­ra­ted th­rough com­pa­nies do­mi­ci­led in Ger­many are sup­po­sed to be ta­xed in Ger­many - at least, that’s the ju­sti­fied prin­ci­ple the le­gis­la­ture in­ten­ded to uphold with tax law amend­ments that were spe­ci­fi­cally im­ple­men­ted by in­tro­du­cing and ex­pan­ding § 50i of the Ger­man Per­so­nal In­come Tax Act over the past two years. But - no doubt as an un­in­ten­ded side ef­fect - the new pro­vi­si­ons have un­leas­hed im­mense le­gal un­cer­tainty.

Just one ex­am­ple: The de­si­gna­ted suc­ces­sor to the ow­nership of a firm is gi­ven an equity in­te­rest in the cor­po­rate group early by being gran­ted a stake in the pa­rent com­pany - a “GmbH und Co. KG,” a form of li­mited part­nership in which the ge­ne­ral part­ner is a Ger­man li­mited lia­bi­lity com­pany, a GmbH. The pa­rent com­pany does not­hing but ma­nage the group’s as­sets. But what if the suc­ces­sor re­mains ab­road for an ex­ten­ded time - say, to study there or to gather early pro­fes­sio­nal ex­pe­ri­ence? Then re­struc­tu­ring mea­su­res that seem eco­no­mi­cally re­ason­able or even ne­cessary - such as contri­bu­ting the com­pany to ano­ther com­pany, or ma­king a gift, or le­ga­cies - may lead to heavy tax lia­bi­li­ties la­ter.

Residence abroad: A tax pitfall © Thinkstock

Spe­ci­fi­cally, the ca­ses con­cer­ned are those where as a first step, equity in­te­rests in a cor­po­ra­tion or other eco­no­mic goods that are in­clu­ded as ope­ra­ting as­sets are contri­bu­ted, with no net tax ef­fect, to a part­nership that does not ope­rate com­mer­ci­ally but still counts as com­mer­cial be­cause of its le­gal struc­ture. This is a clas­sic struc­ture for small to me­dium en­ter­pri­ses, in which, for in­stance, the pro­du­cing com­pany and the sa­les com­pany are ow­ned by a hol­ding com­pany in the form of a “GmbH & Co. KG” li­mited part­nership, which does not­hing but ad­mi­nis­ter its hol­dings. In the next step, an ow­ner mo­ves to a coun­try with which Ger­many has con­clu­ded a dou­ble ta­xa­tion agree­ment.

Un­der an amen­ded in­ter­pre­ta­tion by the tax courts, which the tax ad­mi­nis­tra­tion is now ap­ply­ing, the app­re­cia­tion of the contri­bu­ted equity in­te­rests or eco­no­mic goods must be ta­xed when a hol­der mo­ves away from Ger­many. Other­wise, the as­so­cia­ted tax base is lost. Pre­ven­ting this was the goal of § 50i of the Per­so­nal In­come Tax Act, whose ori­gi­nal form was pro­mul­ga­ted in Ger­many’s Fe­deral Ga­zette on June 29, 2013. Whe­re­ver equity in­te­rests or other eco­no­mic goods from ope­ra­ting as­sets were contri­bu­ted be­fore June 29, 2013, to a GmbH & Co. KG cha­rac­te­ri­zed as com­mer­cial - whe­ther the contri­bu­tion hap­pened only shortly be­fore the cu­toff date or even de­ca­des ear­lier - and the hol­der’s re­lo­ca­tion did not re­sult in ta­xa­tion un­der the ear­lier in­ter­pre­ta­tion, any fur­ther sale of the equity in­te­rests, eco­no­mic goods or a stake in the GmbH & Co. KG its­elf is sub­ject to ta­xa­tion in Ger­many. This is sup­po­sed to ap­ply whe­ther or not there is a pro­vi­sion to the con­trary in an ap­plica­ble dou­ble ta­xa­tion agree­ment.

But now, since the wording of the pro­vi­sion was sub­stan­ti­ally broa­de­ned in 2014, even an act like contri­bu­ting the GmbH & Co. KG to a cor­po­ra­tion or part­nership, or trans­fer­ring the contri­bu­ted equity in­te­rests or eco­no­mic goods gra­tis to ano­ther ope­ra­ting as­set, ne­ces­sa­rily re­sults in a dis­clo­sure of the app­re­cia­tion la­tent in the contri­bu­ted as­sets. Yet it’s not clear at pre­sent whe­ther ta­xa­tion ap­plies only in those ca­ses where the per­son li­ving ab­road is a part­ner in the GmbH & Co. KG or holds a stake in the equity in­te­rests or eco­no­mic goods. Still more, the ent­ire app­re­cia­tion might be ta­xable im­me­dia­tely. The re­sult is that tax must be paid on gains that have not been rea­li­zed yet. This can re­gu­larly re­pre­sent a pain­ful bur­den for a com­pany’s li­qui­dity and leave it in fi­nan­cial straits.

Ac­cor­ding to the broad wording of § 50i of the Per­so­nal In­come Tax Act, ta­xa­tion may be trig­ge­red even if the ow­ner has now come back to live in Ger­many. And it can’t be ru­led out yet that these tax con­se­quen­ces may even ap­ply to ca­ses that are ent­irely do­mestic, where none of the ow­ners re­si­des out­side Ger­many.

One thing is clear:

if (i) you have a cor­po­rate struc­ture in which the hol­ding com­pany has the le­gal form of a GmbH & Co. KG and ope­ra­tes pu­rely as an ad­mi­nis­tra­tor, and (ii) equity in­te­rests in cor­po­ra­ti­ons or eco­no­mic goods for­ming part of the ope­ra­ting as­sets were contri­bu­ted to that hol­ding com­pany be­fore June 29, 2013, with no net tax ef­fect, and (iii) one of the ow­ners re­si­des out­side Ger­many,

then be­fore you make any change in cor­po­rate struc­ture or any change in the ac­tivi­ties of the GmbH & Co. KG, you should check whe­ther the change will trig­ger ta­xa­tion. The tax ad­mi­nis­tra­tion is not pro­vi­ding any bin­ding in­for­ma­tion yet. But at least you could cla­rify in ad­vance whe­ther you can mi­ni­mize your tax risk by using some other struc­tu­ring op­tion.

In an age of glo­ba­liza­tion, when spen­ding se­veral years ab­road has be­come al­most a ba­sic pre­re­qui­site for fu­ture cor­po­rate lea­ders, these re­gu­la­ti­ons cause im­mense prac­tical pro­blems. And once again, one finds that re­qui­re­ments of law that are in­ten­ded to avert tax ar­ran­ge­ments iden­ti­fied as per­ni­cious must be gi­ven tho­rough con­side­ra­tion if they are not to ham­per the le­gi­ti­mate in­te­rests in busi­ness suc­cess of com­pa­nies that are ac­ting with no hid­den tax agenda wha­te­ver. Le­gis­la­tors would be well ad­vi­sed to re­view these pro­vi­si­ons once again. At the very least, the tax ad­mi­nis­tra­tion should make an ef­fort to is­sue an ad­mi­nis­tra­tive di­rec­tive or­de­ring the most re­stric­tive pos­si­ble ap­pli­ca­tion of § 50i of the Per­so­nal In­come Tax Act, and thus make at least a small contri­bu­tion to le­gal cer­tainty.

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