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.
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.