Inheritance Tax and Gift Tax Act (ErbStG)

Basics and importance

The Inheritance Tax and Gift Tax Act regulates the taxation of gratuitous transfers of assets both upon death and inter vivos in Germany. The constitutional dimension of the law was shaped by several fundamental decisions of the Federal Constitutional Court, which particularly affected the equality of taxation and the exemption of business assets. The reform of the Inheritance Tax Act in 2016 led to a reorganization of the exemption regulations for business assets, with a focus on compatibility with the principle of equality in the German Basic Law. The socio-political significance of the law is reflected in the discussion about the fair taxation of large assets and ensuring business continuity during generational changes. The tax revenue from inheritance and gift tax flows to the federal states and represents an important source of income, although the amount depends heavily on large transfers. The international dimension is gaining in importance due to the increasing mobility of assets and individuals, which raises complex questions of international tax law. The structuring practice in inheritance and gift tax law requires long-term planning, taking into account the various exemption regulations and allowances. The valuation of assets follows complex rules that regularly lead to disputes with the tax authorities. The importance of anticipated succession is continuously increasing due to demographic trends and the early transfer of assets to the next generation. Digitalization is leading to new challenges in the recording and valuation of digital assets. The complexity of the law requires intensive tax advice for succession planning.

Taxable transactions and tax liability

The German Inheritance Tax Act (ErbStG) covers taxable transactions in addition to the classic acquisition upon death as well as gifts inter vivos and gifts for a specific purpose, whereby the focus is on the transfer of assets without corresponding consideration. The unlimited tax liability is linked to either the residence of the testator/donor or the acquirer in Germany, while the limited tax liability covers assets located in Germany. In the case of inheritance, the tax arises upon the death of the testator, whereby subsequent changes due to the renunciation or division of the estate can be taken into account. In the case of inter vivos gifts, the date of the gift is decisive, which requires careful planning in the case of staggered transfers. The tax classes of the Inheritance Tax Act differentiate according to the relationship between the testator/donor and the transferee, whereby the closest family members are privileged through higher allowances and lower tax rates. The personal allowances can be used again every ten years, which opens up the possibility of tax-optimizing structuring through staggered transfers. The aggregation of several acquisitions within ten years prevents the circumvention of progression by splitting gifts. The recording of indirect gifts and hidden transfers of assets requires a precise analysis of the economic transactions. The international dimension of tax liability is regulated by double taxation agreements and unilateral imputation rules. The obligations to provide evidence for tax-exempt transfers are extensive and require careful documentation. The parties’ obligations to cooperate in determining the taxable acquisition are far-reaching and can lead to tax surcharges if breached. The increasing complexity of international asset structures places particular demands on the determination of tax liability.

Valuation of assets

The transferring assets are valued in accordance with the provisions of the Valuation Act, with the common value (market value) serving as the basic valuation standard. Since the 2016 reform, the valuation of real estate has been based on a simplified capitalized earnings value method or the asset value method, with the choice of method depending on the type of property and its use. The valuation of companies poses particular challenges, especially when determining the capitalized earnings value of medium-sized companies, whereby simplified methods such as the standardized capitalized earnings value method can be used. The valuation of investments in unlisted corporations often requires expert opinions and regularly leads to disputes with the tax authorities. The consideration of liabilities and encumbrances reduces the taxable acquisition, whereby the economic burden must be proven. The valuation of usufructuary rights and other rights of use is carried out according to standardized procedures, taking into account statistical life expectancy. The determination of the value of foreign assets follows special regulations and often requires foreign expert opinions to be obtained. The valuation of digital assets and cryptocurrencies poses new challenges in practice, as there are no established valuation procedures. The documentation of the valuation must meet the strict requirements of the tax authorities and be comprehensible. Timely valuation is particularly important for volatile assets and can have a significant impact on the tax burden. Case law is continuously developing the valuation principles and specifying the legal requirements. The increasing complexity of valuation procedures often requires the involvement of specialized experts.

Exemption regulations for business assets

The exemption of business assets is a central aspect of the Inheritance Tax Act and is intended to ensure the continuation of companies during generational changes. The option model provides for a standard exemption of 85 percent or a full exemption of 100 percent of the tax-privileged assets, whereby different holding periods and payroll regulations must be observed. The payroll regulation requires compliance with certain minimum payroll amounts over a period of five to seven years in order to secure jobs in the transferred company. Administrative assets may not exceed certain limits, whereby the definition of the beneficiary assets is based on complex regulations and regularly leads to questions of delimitation. The assessment of the need for tax relief for large acquisitions of more than 26 million euros requires comprehensive disclosure of the acquirer’s private assets. The reduction tariff for acquisitions between EUR 26 million and EUR 90 million leads to a gradual reduction in the exemption. The reinvestment clause enables the tax-neutral reallocation of non-favored assets to favored assets within certain periods. Subsequent taxation in the event of a breach of the retention rules can lead to considerable tax burdens and requires careful monitoring. The 100% option exemption is subject to stricter conditions, particularly with regard to the ratio of administrative assets and the retention periods. The inclusion of group structures in the exemption rules is subject to special regulations and requires a group-wide approach. The structuring practice must carefully weigh up the various exemption models and take into account the long-term consequences. The documentation requirements for claiming the exemption are extensive and must be fulfilled over the entire retention period.

Tax brackets and tax rates

The amount of inheritance and gift tax is largely determined by the allocation to one of the three tax classes, which are based on the personal relationship between the testator/donor and the transferee. Tax class I includes the closest family members such as spouses, children and grandchildren and grants the highest personal allowances as well as the most favorable tax rates of between 7 and 30 percent. Tax bracket II applies to more distant relatives such as siblings, nieces and nephews with significantly lower allowances and tax rates of between 15 and 43 percent. Tax class III covers all other acquirers, in particular unrelated persons, with the lowest personal allowance and tax rates of between 30 and 50 percent. The personal allowances can be claimed every ten years, which enables long-term transfer planning. The special pension allowance for spouses and children supplements the general allowances and takes into account the pension nature of certain gifts. The progression of the tax rates is based on the value of the taxable acquisition after deduction of the allowances and increases as the amount of the acquisition increases. The aggregation of several acquisitions within ten years prevents the circumvention of progression through staggered transfers. The tax reduction for acquisitions already taxed abroad is intended to avoid double taxation and follows complex credit rules. The deferral of tax is possible under certain conditions and can avoid liquidity bottlenecks, particularly in the case of business transfers. Interest on deferred tax amounts follows the general provisions of the German Fiscal Code. The practical significance of the tax brackets is particularly evident when structuring transfers within the family.

Procedural law and structuring options

The tax structuring of asset transfers requires long-term planning, taking into account the various allowances and exemption regulations. The notification obligations for inheritances and gifts are comprehensive and must be fulfilled within certain deadlines, whereby notaries, courts and banks are also obliged to provide notification. The tax declaration obligations include detailed information on the transferred assets and their valuation, whereby non-compliance can lead to late surcharges and estimates. The structure of anticipated succession offers considerable tax advantages through the use of the ten-year period and the targeted utilization of allowances. The combination of different transfer methods such as gifting, reservation of usufruct and mixed gifting enables an optimized transfer of assets. Involving family companies and foundations in succession planning opens up additional structuring options. Tax optimization must take into account the consequences of the transfer under civil law, in particular compulsory portion claims and pension interests. The use of valuation leeway requires careful documentation and must stand up to later review. International succession planning must take into account the different tax systems and double taxation agreements. The involvement of executors and asset managers can safeguard the implementation of succession planning. Regular review and adjustment of the arrangements is necessary due to changing legal and economic conditions. The importance of digital succession planning is constantly growing due to the increasing digitalization of assets.

Future prospects and reform discussion

The future of inheritance and gift tax law is the focus of intense political and social debate, which particularly concerns the issue of fair taxation of large asset transfers. Despite the 2016 reform, the constitutional dimension of the exemption rules for business assets remains controversial and could lead to further adjustments. Demographic trends and the imminent generational change in many family businesses are increasing the pressure for succession regulations to be designed in a practical manner. The increasing internationalization of asset structures requires better coordination of national tax systems and more effective mechanisms to avoid double taxation. The digitalization of assets places new demands on the valuation and recording of digital assets, cryptocurrencies and other innovative forms of investment. The importance of anticipated succession will continue to increase due to rising life expectancy and the early transfer of assets. The complexity of the exemption rules is leading to calls for simplification and better administration of tax law. European integration could lead to a harmonization of inheritance and gift tax in the medium term. The role of foundations and alternative asset structures in succession planning will continue to gain in importance. The development of new financing instruments and forms of company requires an adjustment of tax regulations. The socio-political debate on wealth distribution and social justice will influence the further development of inheritance tax law. Technological developments are enabling new approaches to the valuation and management of assets.