In December 2019 the Federal Ministry of Finance published a draft bill for a law implementing the Anti-Tax Avoidance Directive (ATAD-Umsetzungsgesetz).
This draft bill by the Federal Ministry of Finance contains among other topics the implementation of Art.9 and 9b of the Directive with respect to hybrid structures, a reform of the German CFC rules (Section 7ff German Foreign Tax Code), new rules about transfer pricing and, the subject of that Newsletter a drastic reform of the German exit tax (Section 6 of German Foreign Tax Code).
In summary, under the current concept of German exit tax a German resident taxpayer who is subject to tax on his worldwide income in Germany and who moves to another country is deemed to sell his shares in a corporation upon departure and is subject to exit tax. However, in case the taxpayer moves to another EU/EEA country he receives under the current law an unlimited, interest free and unsecured deferral of the exit tax payable, as long as he continued to hold the shares. In case of a departure to another non EU/EEA country the exit tax becomes due immediately.
According to the proposed draft by the German Federal Ministry of Finance there will be no longer any deferment possible but the calculated exit tax has to be paid in annual equal installments over 7 years without any differentiation whether the taxpayer moves to a EU/EEA state or to a non EU/EEA country.
- General concept of German Exit Tax
A shareholder of a domestic or foreign corporation with a shareholding of at least 1 % in the respective corporation is subject to taxation of the hidden reserves in this investment if he departs from Germany. At the time of his departure there is a deemed sale of his investments. The reason for this exit tax is based on the provision of most double tax treaties, according to which the resident state has the right of taxation on the capital gain from the sale of privately held shares in a corporation (see: Art 13 para 5 of the OECD Model Double Tax Treaty). In order not to lose its right of taxation on the accumulated reserves, when the taxpayer moves abroad, the German Foreign Tax Code (hereinafter G-FTC) contains in Section 6 of the law a so called “exit tax”. The shares held in a German or foreign corporation with at least 1 % shareholding are deemed to be sold at fair market value at the time of departure. Furthermore, the transfer of the shares by way of gift or by reason of death will be treated the same as a departure and therefore also trigger an exit tax.
- Current German Exit Tax
According to the current law (Section 6 G-FTC) a German taxpayer individual who has been subject to unlimited tax liability in Germany for at least 10 years – in the course of his entire life up to the exit – is subject to the exit tax. In case this taxpayer is moving to another member state of the EU or EEA the current law is granting an automatically unlimited interest-free and unsecured deferral of the exit tax triggered with the departure, as long as the taxpayer holds the shares (Section 6 para 5 G-FTC). With respect to a departure in other than EU/EEA countries the exit tax is due immediately. Only in hardship cases and upon application by the taxpayer, the exit tax due can be paid in five, equal, annual, interest-bearing installments. These installment payments will only be granted if the taxpayer provides collateral security for the exit tax to be paid. (Section 6 para 4 G-FTC).
In case the taxpayer is only temporarily absent and reestablishes unlimited tax liability in Germany the exit tax will be omitted completely retroactively in case the taxpayer has departed originally to a EU/EEA country. In cases where the taxpayer originally moved to a non-EU/EEA country the exit tax will be cancelled only if he reestablishes unlimited tax liability in Germany within 5 years after departure. This 5 year period can be extended to 10 years, if the taxpayer demonstrates that his temporary absence from Germany has professional reasons and his intention to return has not changed (Section 6 para 3 G-FTC).
- Proposed German Exit Tax according to the draft bill of the Federal Ministry of Finance
According to the draft bill, the general concept of the German exit tax remains unchanged. It is expressly stated, that only gains not losses will be taken into account. Exit tax is primarily applicable if the taxpayer’s German unlimited tax liability is terminated. According to the draft bill, the taxpayer must have been subject to unlimited tax liability for 7 years out of the last 12 years before his departure. This is a reduction of the required period of unlimited tax liability compared to the current law. Thus, a taxpayer who moved originally from abroad to Germany will be liable for exit tax 3 years earlier than under the current law. On the other hand, only the last twelve years are looked at and not like under the current law the entire life of the taxpayer.
A substantial difference to the current law is that the draft law provides that the exit is immediately due and therefore abolishes any permanent deferment under the current law. Upon request by the taxpayer (according to the explanation to the draft the administration has zero discretion) the exit tax due will be payable in 7 equal annual interest-free installments. As a general rule, the installment route will only be possible if the taxpayer provides for collateral security (Section 6 para 4 German Foreign Tax Code- Draft – G-FTC-D). A positive development is that the draft provision – in contrast to the current law – does not make any differentiations, whether the taxpayer is moving within or outside the EU or EEA.
In case the taxpayer reestablishes unlimited German tax liability within 7 years of departure, the exit tax will be omitted retroactively. An extension by an additional 5 years up to 12 years will be possible, whereby the taxpayer has to demonstrate a continued intention to return. With this provision, the taxpayer has the possibility to return to Germany with the exit tax due to be cancelled within 12 years after departure. This offers a taxpayer a relative sufficient flexibility and mobility. If the taxpayer can demonstrate an intention to return, the installment payments will be omitted upon request by the taxpayer (see Section 6 para 3 sentence 7 G-FTC-Draft). Also with respect to a temporary absence and the possibility to reestablish unlimited German tax liability within 12 years, the proposal does not distinguish between departure to EU/EEA countries or not.
However, in contrast to the current law, the draft provides stricter rules with respect to the elimination of the omission of the tax claim by reason of a possible return. Any “transfer” (sale, gift, or transfer to a foundation, or a German or foreign corporation) that is not made by reason of death is detrimental and causes the exit tax to become due even though the taxpayer intended to return to Germany. That means that even the gift of the shares to a German resident taxpayer will be detrimental and exit tax will become due upon this transfer. In addition, the draft provides that the exit tax will be due immediately if there is a dividend distribution by the corporation in the amount of at least 25 % of the value of the taxpayer’s share (see Section 6 para 3 No. 2 German Foreign Tax Act-Draft). This provision intends to prevent that the exit tax rules are used by the taxpayer to depart from Germany and then to receive substantial dividend distributions which are not fully taxable in Germany (see explanation to the draft). Thus, substantial dividend distributions will eliminate the deferment of the exit tax, which should be definitely be taken into account before a shareholder is planning to move.
Conclusion
For departures to non EU/EEA countries the draft bill shows a positive development and allows the exit tax to be paid in 7 equal annual non-interest bearing installments. However, the requirement for collateral security could become an impossible obstacle for many taxpayers, especially if the taxpayer has no other valuable German real estate or federal treasury bonds at his disposal other than the shares in the corporation subject to the exit tax. If the taxpayer cannot provide collateral security, the exit tax will become due immediately.
In addition, the regulations proposed in the draft bill, especially the conditions for deferment and the circumstances for its revocation are excessively restrictive. In this context it is yet not clear whether these restrictive rules are in line with the free movement of capital and the freedom of establishment within the EU and the EEA. The legislator might improve the draft bill in this respect. According to the draft bill, the new exit rules should take effect retroactively as of January 1, 2020. Therefore, especially family enterprises should examine carefully what protective tax measures should be taken so that the international mobility of the shareholders does not result in an unintended tax trap.