In a judgement released on December 17, 2014 (1 BvL 21/12), the Federal Constitutional Court (Bundesverfassungsgericht – “BVerfG”) declared the applicable Inheritance and Gift Tax law partly (especially the exemption regulations for business assets) unconstitutional.
The main subject of the lawsuit was whether the legislator breaches his constitutional duty of equal treatment of taxpayers if he allows that business assets can be exempted from Inheritance or Gift Tax in difference to assets from other sources which do not enjoy such a tax privilege. The BVerfG ruling turned out to be less strict than it was widely expected as the court did in principle allow the legislator to privilege business assets in order to avoid that the imposition with Inheritance or Gift Tax can cause a financial crisis to an operation which ownership is transferred from one generation to the next. However, the BVerfG required the legislator to change the current legal practice fundamentally.
The current rules may continue to apply until June 30, 2016. Until then, the legislator must adopt new regulations which presents a new challenge for the legislator, companies, and tax consultants for the next years. It has to be noted that the upcoming reform of the Inheritance and Gift Tax will then be the third attempt to establish an Inheritance and Gift Tax regime which does not violate fundamental principles of constitutional law.
It is the view of the BVerfG that the current structure of the exemption regulations for business assets violates the principle of equality (Art. 3 Section 1 German Constitution, Grundgesetz – “GG”), as
- the privileges of business assets are disproportionate that go beyond the range of small- and medium-sized companies without an economic needs test;
- the exemption of companies with up to 20 employees from withholding the minimum of total wages and salaries is disproportionate;
- the exemption of business assets containing up to 50 % operative assets for tax purposes is disproportionate;
- Sections 13a and 13b Inheritance and Gift Tax Act (Erbschaftsteuer- und Schenkungsteuergesetz – “ErbStG”) are insofar unconstitutional as they permit structuring leading to an unjustifiable unequal treatment (e.g., corporate restructurings to avoid the assessment of aggregated wages and salaries).
As the current ErbStG may be valid until June 30, 2016, the privileges of business assets pursuant to Sections 13a and 13b ErbStG are in general also applicable to cases of Inheritance and Gift Taxes that have not yet been assessed. An exception to this is the excessive utilization of Sections 13a and 13b ErbStG that violates the principle of equality. According to the BVerfG, for these cases there is no protection of legitimate expectations. Further, the continued validity of the unconstitutional provisions does not mean that there is a protection of legitimate expectations with regard to new regulations that apply retroactively for the time since this judgement was delivered, and which do not recognize an excessive utilization of Sections 13a and 13b ErbStG. Thus, it is the legislator’s decision whether to take a retroactive effect into consideration or not.
However, the decision of the BVerfG has no effects on Inheritance and Gift Tax statements that were previously issued, even if they contain a notice of provisional status pursuant to Section 165 German Fiscal Code (Abgabenordnung – “AO”). According to a press release of the Federal Ministry of Finance (Bundesministerium der Finanzen – “BMF”), the affected Inheritance and Gift Tax statements are issued on a provisional basis until new legal regulations come into force.
Possible Scope of the New Law
In summary, it is now task of the legislator to modify the exemption regulations according to the guidelines of the BVerfG and to legally eliminate the structuring criticized by the BVerfG. The legislator must pay attention to the requirements laid down by the Federal Constitutional Court to finally implement an Inheritance and Gift Tax Act that will be accepted in front of the court.
The legislator has discretion to award preferential treatment to small- and medium-sized companies. However, it is disproportionate to favor business assets that go beyond the range of small- and medium-sized companies without an economic needs test. Hence, an exemption of 100 % is possible – even in cases of the transition of large company assets –, but goes too far if the necessity to exempt is not specifically determined. While the aggregated wage regulation is in principle compatible with Art. 3 Section 1 GG, this does not apply to the exemption of companies with less than 20 employees. Finally, the period of 5 or 7 years for which to hold a company is in general compatible with the principle of equality.
Taxpayers who intend to transfer assets in the future must consider carefully whether transactions within the scope of the current or within the law that continues to apply after June 30, 2016 are more favorable. It is likely that the exemption of business assets as it exists today will no longer exist after June 30, 2016. Nevertheless, it can be assumed that the exemption regulations for business assets will generally continue to apply.