Inheritances and gifts with a foreign element

 

Inheritance tax law and gift tax law are inconsistent within the individual countries of the European Union and also outside of the European Union. The legal systems refer to different criteria in the areas of civil law and tax law. This often leads to a collision of the applicable inheritance law and to a double taxation of the same process in different countries. The EU succession regulation represents a first step towards the harmonisation of inheritance law and procedural law within the EU. The succession regulation applies to inheritance cases from August 17, 2015.
 

New opportunities for a higher non-taxable threshold for persons with limited tax liability

Example 2:

A woman who resides in Switzerland passes on a piece of real estate in Germany to her husband who also resides in Switzerland. The ECJ also ruled here that in the case of limited tax liability for those involved living in a country outside of the EU the higher non-taxable threshold is applicable. In the specific case this means a non-taxable threshold of 500,000 euros (tax exempt amount for spouse) is applicable.

Optional rights

The German legislator reacted to the first ruling of the ECJ in 2010 and added an optional right in the inheritance tax law for gifts and inheritance cases with effect from December 13, 2011 for persons with limited tax liability. Accordingly, unlimited tax liability can be applied for when the bequeather, person giving or recipient at the time the tax is levied has his place of residence in a member state of the EU or the European economic area. An application for the optional right can also be made for inheritances which took place prior to December 13, 2011. For taxpayers who live in a country outside of the EU, the optional right is currently not available.
 
If an application is made for unlimited tax liability, the increased personal non-taxable threshold is applied, but at the same time the complete world assets are also subject to inheritance tax. In addition, with regard to the option and the determination of the inheritance tax, all inheritances which occur ten years before and ten years after the case will be subject to unlimited taxation. If use is made of the optional right, a calculation must first be made as to whether the option will lead to a lower inheritance tax burden. This is because despite application of the higher non-taxable threshold the option can lead to a higher inheritance tax burden due to the taxation of the world assets.
 

 

A considerable inheritance tax burden may result when, for example, a bequeather living in Germany passes on substantial capital assets which are invested abroad. In such a case the inheritance is subject to unlimited tax liability. If the capital assets are at financial institutes, e.g. in Spain, the Spanish state can under certain conditions additionally make the inheritance subject to Spanish inheritance tax. The result is an inheritance tax burden in Germany as well as in Spain. There is no double taxation agreement with Spain in the area of inheritance tax. An offsetting of the inheritance tax incurred in Spain against the German inheritance tax is according to current legislation not an option because the capital claims against financial institutes acc. to § 121 BewG are not defined as foreign assets. The German Federal Court of Finance (BFH) in its ruling of June 19, 2013, AZ II R 10/12 confirmed this result and does not see a conflict with European law. In the absence of a European harmonisation of the term for foreign assets this situation indeed leads to a double taxation, but neither the constitution nor the European Convention on Human Rights require that the foreign inheritance tax is to be offset against German inheritance tax. Accordingly, the BFH is in line with the ECJ (ECJ ruling of February 12, 2009, C-67/08, Margarete Block). The BFH, however, has noted that the excessive confiscatory tax burden may require an equitable measure.
 
Taxpayers should therefore in each individual case have the chances of success of an equitable measure examined. The best, however, is to avoid double taxation right from the beginning, for example, by the timely reallocation of capital assets into assets which fall under the offsetting regulations, or the taking of financial investment in countries with which there is a double taxation agreement in the area of inheritance tax.
 

The well-known Finca in Spain can present inheritors with an unpleasant surprise when it comes to inheritance tax. If the Spanish real estate is passed on to an inheritor living in Germany, the acquisition is subject to unlimited German inheritance tax liability and also limited Spanish inheritance tax liability. Although the Spanish inheritance tax under certain conditions can be offset against the German inheritance tax, an offsetting is, however, only to the extent that the Spanish inheritance tax does not exceed the German inheritance tax. This means that the taxpayer in the end has to accept the higher tax level. Apart from a few examples the non-taxable thresholds in Spain are low and the tax rates in comparison to German rates are high which means for the total tax burden in such cases the Spanish level is decisive.
 
In the past German citizens often acquired Spanish real estate indirectly through a Spanish corporation in order to bypass the limited inheritance tax obligation in Spain. In the meantime within Europe such real estate companies are commonly subject to limited inheritance tax liability in the respective countries.
 
Apart from that the holding of a piece of holiday real estate via a foreign corporation can lead to a concealed profit distribution which is subject to tax. In the case of the use without charges of a piece of holiday real estate by the shareholder of the foreign corporation a prevention of an increase in assets is triggered at the company level. This is because a proper and conscientious managing director would not have allowed a third party to use the real estate free of charge. Such a concealed profit distribution to a domestic shareholder constitutes income from capital assets (§ 20 par. 1 no. 1 of the German Income Tax act, EStG). The right of taxation of dividends and concealed profit distribution is usually in the country where the shareholder is resident. The amount of the concealed profit distribution can be calculated from the rental value.
 
In addition, a later relocation abroad of the bequeather previously subject to unlimited tax liability in Germany to his foreign holiday real estate may have further consequences in terms of income tax. This is because with the relocation abroad under certain circumstances a disposal of shares in the corporation (§ 6 Abs. 1 AStG) is simulated. The market value less acquisition costs are taken to be the profits from the disposal. The tax amount can be deferred free of interest in the case of a relocation abroad to the EU or EU economic area. This deferral, however, will be revoked by the German tax authorities when all parts have been disposed of, or, for example, in the course of the succession or when a gift is passed on to a legal successor (e.g. descendants in Switzerland) who does not have a place of residence in the EU or EU economic area.
 
The purchaser of Spanish real estate should observe the consequences in terms of inheritance tax and also the not inconsiderable effects on income tax. This is particularly applicable when as experience in the past has shown the real estate is held by a Spanish corporation.