This was preceded by a protracted legislative process in which the Bundestag and the Bundesrat had reached a last-minute agreement on the content in the Mediation Committee, after the deadline set by the Federal Constitutional Court for June 30, 2016, to revise the inheritance tax—which had been deemed unconstitutional—had already passed. The result is not the fundamental reform that some had called for, but rather a revised version that specifically addresses the provisions challenged by the Federal Constitutional Court.
Continued Extensive Exemptions
Accordingly, there will continue to be far-reaching exemptions for business assets from inheritance and gift taxes, with exemption rates of 85% (so-called standard exemption) and 100% (so-called “optional exemption”), as well as—for the first time—an independent advance deduction of 30% for certain companies (family-owned businesses).
However, in order to meet the Federal Constitutional Court’s requirements for a constitutionally valid inheritance tax law, these exemptions will be subject to more restrictive conditions.
Definition of Eligible Assets
As before, the following are eligible for inheritance tax relief: the transfer of business assets in the form of sole proprietorships, interests in commercial partnerships (so-called co-ownership partnerships), agricultural and forestry operations, and shares in corporations in which the decedent or donor holds more than a 25% stake.
However, the exemption is not granted to the extent that the eligible assets consist of non-productive or non-business-necessary assets (so-called administrative assets). Unlike in the past, administrative assets are no longer eligible for preferential treatment up to a 50% share of business assets and are therefore subject to inheritance tax; in the future, only administrative assets up to a 10% share will be reclassified as eligible assets. Which assets qualify as administrative assets continues to be governed by an exhaustive list, with only minor additions.
Assessment of the Need for Exemption
Since the absolute preferential treatment reaches particularly high levels for large corporations, the Federal Constitutional Court has further required an assessment of the need for exemption. Against this backdrop, the acquirer-based assessment threshold will be EUR 26 million in the future (for asset acquisitions that do not exceed this threshold, the need for relief is presumed).
If the value of the acquisition exceeds the threshold of EUR 26 million (so-called “large acquisitions”), the exemption amount therefore decreases progressively (so-called “phasing-out model”) and is denied entirely for acquisitions exceeding EUR 90 million. Alternatively, the acquirer may apply for an inheritance tax waiver (the so-called “waiver model”), provided they can demonstrate that they cannot pay the tax from half of their assets not eligible for inheritance tax benefits, i.e., existing and co-acquired administrative and private assets (so-called “available assets”).
It should be noted that multiple acquisitions by the same person within a ten-year period are aggregated, so that subsequent acquisitions may retroactively cause the threshold to be exceeded and/or trigger an inheritance tax liability. In addition, a tax waiver that has already been granted is revoked if, subsequently, available assets are acquired free of charge from any party. In that case, although a new application for the waiver may be filed, the newly acquired disposable income must also be used to pay off the inheritance or gift tax.
Continuation of the Business
As has been the case up to now, maintaining the exemption requires that the acquired business be continued, which must be ensured through five- (standard exemption) or seven-year (optional exemption) retention periods and compliance with certain wage bill and withdrawal restrictions.
A new development is that the payroll threshold requirement will now apply to businesses with more than five employees—the Federal Constitutional Court had objected to the previous threshold of more than 20 employees because, under that threshold, more than 90% of business transfers would not be subject to the payroll threshold requirement.
Conclusion
The new inheritance tax law ties inheritance and gift tax exemptions to significantly more restrictive conditions, which further increase the complexity of the Inheritance Tax Act. Nevertheless, there will still be planning options in the future to take advantage of and maintain the still very extensive exemptions of 85% or 100%, whether through successive acquisitions in compliance with the ten-year period, the targeted distribution of assets among multiple recipients, or the incorporation of foundation solutions, etc.
Prudent and long-term succession planning will become even more important in the future, particularly in light of the newly introduced ten-year assessment period, which must be taken into account in addition to the business-related retention and payroll thresholds. Otherwise, the inheritance tax burden can quickly amount to as much as 30% or even 50% of the value of the transferred assets.
Whether the new Inheritance Tax Act is constitutional remains to be seen should it be brought before the Federal Constitutional Court again.
