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Nexia Ebner Stolz

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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