Putting a good succession plan in place is no walk in the park. Many business owners have only a rough idea of whether—and to what extent—taxes will be incurred during a business transfer. The constantly changing legal landscape makes it even more difficult to stay on top of things.
According to estimates by the Institute for Small and Medium-Sized Business Research (IfM) in Bonn, the number of companies awaiting a transfer is rising steadily. Between 2014 and 2018, approximately 135,000 family-owned businesses are expected to be affected. Generally, the transfer of an owner- or family-run business takes place through two processes: either via sale, or without consideration—or with partial consideration—through a gift or inheritance.
When the business is sold, the profit is subject to tax under the Income Tax Act. The senior entrepreneur may claim a tax exemption of 45,000 euros, provided they are at least 55 years old or permanently unable to work. In addition, the profit may be taxed at half the standard tax rate.
Exemption for Business Assets
Nevertheless, the profits to be distributed and the corresponding taxes are substantial, as hidden reserves are realized and paid out. A gift does not result in any gains from the sale. Consequently, the senior entrepreneur does not receive any income subject to the Income Tax Act. However, gift tax may apply with this form of transfer. In this regard, the Inheritance Tax Act has established exemption provisions for business assets, such as a business exemption of 150,000 euros.
Changes to Inheritance Tax
The Federal Constitutional Court (BVerfG) in Karlsruhe ruled at the end of December last year that the inheritance tax in its current form is unconstitutional. A new regulation is set to take effect in July 2016. The BVerfG requires a needs assessment for the future tax exemption of large family-owned businesses. However, it remains unclear at what size threshold companies must undergo this assessment and what criteria will apply. Smaller and medium-sized family-owned businesses could continue to benefit from extensive or even complete tax exemptions on business assets. Given the broad discretion granted to the legislature, it is important to closely monitor further developments.
Until new regulations are enacted, business owners can continue to take advantage of the tax exemption provisions and allowances under the current terms. However, transfers should definitely include a revocation clause to prevent potential subsequent intervention by the legislature.
Proper Succession Planning
Companies should address succession planning and the associated tax-related aspects early on. To avoid potential tax burdens and long-term disadvantages, it is advisable to seek support from external advisors. After all, what is at stake is the senior owner’s retirement security, the successor’s success in their new role, and the company’s financial viability.
