German inheritance and gift tax (Part 4)

Germany has an inheritance and gift tax that addresses inheritances and gifts in respect of taxation in a national and international context. This includes the transfer of assets from tax residents and non-residents. This is part 4 of a series of articles.

International aspects of German inheritance tax

Cross-border situations are subject to German inheritance tax if there is a connecting factor in Germany. At the personal level, this is the case if either the testator or the recipient (heir, legatee, beneficiary of a compulsory portion) is resident in Germany. The connecting factor is that the assets are located in Germany.

Domestic assets in Germany

The concept of domestic assets is of key importance in the context of limited tax liability. Limited tax liability exists if neither the testator nor the acquirer is resident in Germany, but domestic assets are bequeathed or gifted. The following assets constitute domestic assets:

Domestic assets include:

1. Domestic agricultural and forestry assets.
2. Domestic real estate.
3. Domestic business assets. Domestic business assets are assets that serve a domestic business if a permanent establishment is maintained in Germany or a permanent representative is appointed for this purpose.
4. Shares in a corporation if
   a.    it has its registered office or management in Germany and
   b.    the shareholder, either alone or together with related parties, holds at least 10% of the company's share capital or nominal capital, either directly or indirectly.
5. Inventions, utility models and topographies that are entered in a domestic book or register.
6. Transfer (renting and leasing) of assets to a domestic commercial enterprise.
7. Mortgages, land charges, annuity debts and other claims or rights if they are directly or indirectly secured by domestic real property, by domestic rights equivalent to real property or by ships entered in a domestic shipping register.
8. Claims arising from participation in a commercial enterprise as a silent partner and from profit-participating loans if the debtor has his domicile or habitual residence, registered office or management in Germany.
9. Rights of use to one of the aforementioned assets.

If assets located in Germany are not included in the above list, they are not subject to limited tax liability. This applies, for example, to cash accounts or securities held with German banks, works of art and household effects.

Notes:

If no inheritance tax is levied abroad or the tax burden is lower than in Germany, it may make sense to avoid or minimize the limited tax liability in Germany. This applies, for example, to Swiss or US citizens who own real estate in Germany. This applies to the Swiss nationals because most cantons levy no or only a very low inheritance tax when assets are inherited within the family circle. This applies to US citizens because a very high tax-free allowance is currently granted for estates of US citizens.

The following situations may also arise:

(1)    The person invests in assets that are not subject to limited tax liability in Germany. These can be, for example, bank deposits or shares or stock.

(2)    Assets located in Germany, in particular domestic real estate, which are not held directly but through a foreign corporation. This shields the German property from tax in the event of inheritance.

(3)    If investments in Germany are to be debt-financed, the debt can be deducted by deliberately establishing a connection between the investment (in particular the acquisition of a German property) and the borrowing. The borrowing must be economically related to the acquisition, improvement or maintenance of the property.

It should be taken into consideration that all situations also have income tax implications, which may be disadvantageous.

Tax credit

If persons are subject to unlimited tax liability in Germany and have assets abroad, a comparable foreign tax can be credited against German inheritance tax under certain circumstances. If the foreign assets are located in several countries, the tax-free amount must be calculated separately for each country.

However, the regulation governing the crediting of foreign taxes contains special features that prevent the full crediting of foreign taxes:

(1)    The foreign tax must be comparable to German inheritance tax. However, many countries do not levy inheritance tax, but tax a "fictitious" sale as part of income tax in the event of inheritance. This applies to Canada and Sweden, for example. In a Canadian case, the Federal Fiscal Court ruled that the Canadian capital gains tax could not be offset against German inheritance tax due to a lack of comparability.

Some countries - such as Portugal or Italy - levy registration fees. Whether these are creditable has not yet been conclusively clarified.

(2)    Foreign inheritance tax is only creditable if it is levied on foreign assets. Foreign assets are the mirror image of what is classified as domestic assets in the reverse case. This means, for example, that foreign inheritance tax on bank balances or securities held in free float at foreign banks cannot be offset against German inheritance tax of German nationals.

In the Block case (judgment of February 12, 2009 - C-67/08), the European Court of Justice ruled that double taxation in a German-Spanish inheritance case does not violate European freedoms.

(3)    Further problems arise if the time of taxation in Germany and abroad diverge. If taxation does not take place more than five years apart, a credit is possible in Germany, provided the other requirements are met.

Double taxation agreements

Double taxation agreements (DTAs) generally lead to double taxation being avoided or at least mitigated. The German network of inheritance tax DTAs is very limited. DTAs exist with the USA, Switzerland, France, Sweden, Denmark and a very old agreement with Greece. The agreement with Sweden will be repealed in the next revision, which is understandable due to the lack of inheritance tax in Sweden. With regard to the agreement with Switzerland, it should be noted that this only applies to inheritances and not to gifts.

Trust

Trusts are legal entities that are not part of German law. There are special features for them in both income and inheritance tax law. For details see here.

Authors:

Peter Scheller, Tax adviser, Master of International Taxation, Certified expert on customs and excise taxes

Rainer Scheller, Chartered Accountant, Tax adviser

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