Inheritance and gift tax reform

The wrestling for agreement lasted almost two years. Only after the Federal Council had called a mediation committee on 8 July 2016, representatives of the Federal Parliament and the Federal Council finally agreed to a consensus on 21 September 2016 and passed the amended Inheritance and Gift Tax Act on 14 October 2016. After its publishing in the Federal Law Gazette on 9 November 2016 the amended Inheritance and Gift Tax Act has become legally valid. Now that all obstacles have been removed, it is once again possible to plan for corporate succession with reasonable assurance.

The principle of tax exemption for business assets essentially remains the same. Also in the future the familiar tax relief models shall apply if the retention periods are adhered to. On the whole, the present system of eliminating non-operating business assets from tax relief has been retained. In the future the value of business assets to be transferred shall, however, be decisive for determining how high tax relief may be. For business asset transfers of up to €26 million, tax relief shall, to the greatest extent, remain unchanged. For business assets between €26 million and €90 million, tax relief is increasingly reduced the higher the value of a company. For business asset transfers of over €90 million, only a tax waiver may be granted after having undergone a review of eligibility. The new Inheritance and Gift Tax Act is retroactively to go into effect as of 1 July 2016.

The finer points of the new inheritance and gift tax act are

• Tax relief rules remain:
  It will also be possible in the future to obtain a tax exemption of 85% or 100% (regular or optional tax relief) if the business successor continues operating the company for five, respectively seven years and maintains the same level of employment. This applies to medium-sized companies when transferring business assets of up to €26 million.

• For large companies – a melt-away model …:
  The higher the value of the business assets to be transferred in excess of €26 million, increasingly tax relief of 85% or 100% melts away to zero euros. It falls away completely if the value of a company amounts to €90 million or more. As in the past, the business must be continued during the retention period, and minimum wage thresholds are to be maintained.

• … or an inheritance and gift tax waiver:
  If the acquirer of a large company can provide evidence that he/she cannot afford to pay the inheritance or gift tax from 50% of his/her personal assets and/or from the nonoperating business assets, then it is possible to apply for a waiver of the inheritance and gift tax due instead of applying for the melt-away model. The business successor is obligated to completely disclose all assets including personal assets to the tax authorities when a review for an inheritance and gift tax waiver is conducted. Here it also applies that the company needs to be continued while maintaining a minimum wage threshold.

• Assets eligible for tax relief and non-operating business assets:
  The system for delineating non-operating business assets shall also continue to apply in the future. However, what is new is that non-operating business assets are no longer fully included for tax relief. Only non-operating business assets having the value of 10% of the company may be eligible.

• Non-operating business asset ratio:
  It is not possible to apply tax relief rules on business assets if the non-operating business asset ratio exceeds 90% in order to avoid a misuse of tax planning models. A prerequisite for applying for optional tax relief is a maximum non-operating business asset ratio of 20%.

• Investment clause in an inheritance case:
  Inherited funds can be treated as assets eligible for tax relief from inheritance tax if these funds are, according to the will of the deceased, to be invested in the business within two years after receiving the inheritance. The same applies to non-operating business assets.

• New thresholds for wage rules:
  In the future, businesses with up to five employees will be excluded from adhering to wage threshold rules. For businesses with over five employees, a progressive minimum wage threshold is required in accordance with the application of either regular or optional tax relief.

• Company valuation adjustment:
  In valuing companies by using the simplified discounted cash flow method as defined in the Valuation Act, a uniform capitalisation factor of 13.75 may be applied in the future. This factor is to be applied to transfers as of 1 January 2016; however, considerable doubt of its constitutionality has been raised. The Federal Ministry of Finance is empowered to adjust the capitalisation factor along the lines of how interest rates develop.

• Special deduction for family-owned businesses:
  A special deduction from the value of a company applies to family-owned businesses that have typical commitment clauses for family members in their Articles of Association. These restrictions must be adhered to within a period of two years prior to and 20 years after the transfer. One of these restrictions is that withdrawals or profit distributions are limited to a maximum of 37.5% of earnings after taxes. Withdrawals made for paying taxes are thereby not to be taken into consideration. Another typical clause concerns the right of disposition only applying to family members. A deduction from the value of family-owned businesses is based on reducing severance pay for family members agreed upon in the statutes and the Articles of Association in comparison to its fair market value and is limited to a maximum of 30%.

• Deferment rules in an inheritance case:
  Inheritance tax on business assets eligible for tax relief can be deferred for a maximum of seven years. No interest is assessed in the first year of the deferment, but subsequently the deferred amount is subject to 6% interest per annum. Once again the requirement is that the business is continued while abiding by the wage threshold rules.

Further changes have resulted in the area of non-operating business assets:

• Consolidated determination of non-operating business assets:
  In the future, net assets will be determined for the tax base by allocating liabilities proportionately to those business assets eligible or not eligible for tax relief. Moreover, net assets will be determined in a consolidated manner (group view) for multi-level company structures such as corporate groups.

• Liquidity test amended:
  Liquidity up to 15% of the value of a company may be considered as operating business assets if the operating business assets eligible for tax relief of the company or its subsidiaries and affiliated companies are mainly used for commercial, freelance, agricultural or forestry activities. This regulation is to serve the purpose of addressing the demand of the Federal Council to prevent new types of ‘Cash GmbHs’ (‘cash limited liability companies’).

• New version of the exception for non-operating business assets:
  The exception for non-operating business assets has been expanded with regard to property made available for use by third parties: in the future, such property is no longer to be classified as being non-operating business assets if they primarily serve to sell own goods and products in conjunction with supply contracts.

• Old-age pension obligations:
  The portion of assets eligible for tax relief, which solely and continuously serve to fulfil paying old-age pension obligations and are not accessible to any creditors not directly entitled to old-age pension promises, do not belong to non-operating business assets up to the amount of the fair market value of the old-age pension obligations classified in pension provisions.

• Expanding the definition of art objects serving as non-operating business assets:
  Stamp collections, vintage cars, yachts, gliders as well as other objects typically serving personal lifestyles are now also allowed to be classified as non-operating business assets. An exception may be made when the commercial trading of such objects, whose manufacture, processing or use is charged to third parties is the main purpose of the company.