Last year, the German Federal Fiscal Court [Bundesfinanzhof, BFH] ruled that when companies are transferred to the next generation, an application for so-called full exemption can be made for each individual transferred company (= economic unit). It thus rejected the previous view held by the tax authorities (ruling dated 26 July 2022 - II R 25/20). The decision whether standard or full exemption is better can therefore be reached in respect of each individual economic unit. It is not yet foreseeable whether the tax authorities will endorse this view. Caution is therefore required when transferring several economic units and making use of the full exemption.
In terms of tax policy, the transfer of companies to the next generation by way of gift or inheritance is privileged. This is intended to prevent the tax burden that would otherwise exist from having a negative impact on the transferred companies themselves, for example through the required capital deduction or restructuring measures. The prerequisite for tax privileges is therefore the very fact that this does not happen and that the company essentially remains intact in terms of its capital and personnel resources. Under the so-called standard exemption, up to 85% of the company's value can ideally be transferred tax-free. Upon application, as much as 100% can be transferred tax-free under stricter conditions (so-called full exemption).
The detailed requirements to be met have always been controversial and have already been the subject of numerous decisions by the courts and legislative amendments. This repeatedly concerns the handling of so-called administrative assets, which should only be tax-exempt within very narrow limits. In principle, administrative assets are assets that, despite being part of the operating assets, are not required for the company. They may include, for example, works of art, excessive cash holdings, leased real estate and securities. The legislator wishes to prevent assets that do not serve the company from being transferred tax-free under the guise of operational assets.
As part of the fulfilment of the particularly strict requirements for full exemption, it is required that the so-called assets eligible for privileged treatment may not comprise administrative assets to a degree of more than 20%. This becomes particularly controversial if it subsequently transpires that the 20% quota has been exceeded.
In the previous administrative opinion (cf. R E 13a.21 German Inheritance Tax Regulations [Erbschaftsteuer-Richtlinien, ErbStR]), in the basic case, i.e. the transfer of one economic unit, reversion to the standard exemption is possible. Thus, the only consequence of exceeding the quota is that, despite not being able to claim full exemption, standard exemption can at least be claimed.
When several economic units are transferred, however, according to the previous administrative opinion only one application for full exemption is possible for all economic units. If such application is made and the 20% quota is not met in an individual economic unit, neither full nor standard exemption comes into consideration for this economic unit. In this case, the transfer of this economic unit is fully taxable. Only when the quota is exceeded in each economic unit is a reversion to the standard exemption to at least be possible. In individual cases, it may therefore be extremely risky to apply for full exemption if it is not yet clear whether the 20% quota can be met with regard to individual economic units.
The BFH has now partially rejected the administrative opinion. The taxpayer is at liberty to file or refrain from filing an application for each individual economic unit. If there are concerns about exceeding the 20% quota with regard to individual economic units, these can be specifically excluded from the application for full exemption and thus at least benefit from the standard exemption.
However, it remains to be seen whether the tax authorities will adopt the ruling. To date, there is nothing to indicate that the tax authorities will change their administrative opinion.
If an application for full exemption is planned and concerns – in the administrative opinion - several economic units, one should therefore examine whether and to what extent there is the risk of exceeding the 20% quota. In this case, the better alternative might be to refrain from applying for full exemption.
Authors: Jan Mohrmann (partner, Tax Law) & Lydia Baumann (research assistant)