Federal Constitutional Court Overturns Favorable Inheritance Tax Treatment of Business Assets

What is the is­sue? The ver­sion of the In­heri­tance Tax Act that has been in ef­fect since 1 Ja­nu­ary 2009 pro­vi­des for com­pre­hen­sive tax re­lief for the trans­fer of busi­ness as­sets, but this re­lief can only be clai­med when strict con­di­ti­ons are met. Thus 85% or 100% of the va­lue of busi­ness as­sets, agri­cul­tu­ral and fo­rest as­sets and sha­res of cor­po­ra­ti­ons with a mi­ni­mum in­te­rest of over 25% is not ta­xed. Ad­di­tio­nal dis­counts, such as the ge­ne­ral ap­pli­ca­tion of a more fa­vor­able tax bra­cket, are also pro­vi­ded. By es­ta­blis­hing this rule the le­gis­la­tors par­ti­cu­larly in­ten­ded to pro­tect com­pa­nies in which the de­ce­dent or the heirs are par­ti­cu­larly in­vol­ved in the com­pany, as is ty­pi­cal of a fa­mily-ow­ned busi­ness. The pro­duc­tive as­sets of these com­pa­nies should enjoy fa­vor­able tax tre­at­ment so that tax-re­la­ted li­qui­dity pro­blems will not jeo­par­dize the exis­tence of the com­pany and the jobs it crea­tes.

The Fe­deral Con­sti­tu­tio­nal Court has gran­ted le­gis­la­tors some lee­way in ma­king their de­ci­sion on how to grant fa­vor­able tax tre­at­ment for this type of com­pany, in or­der to se­cure their exis­tence and main­tain the jobs they create, but the Court has cri­ti­ci­zed the fol­lo­wing de­tails:

• The far-re­aching or com­plete tax ex­emp­tion of busi­ness as­sets is con­side­red un­re­ason­able to the ex­tent that such ex­emp­tion ex­tends beyond small and mid-si­zed com­pa­nies wi­thout pro­vi­ding for a needs test. In this con­nec­tion the Court has in­struc­ted le­gis­la­tors to es­ta­blish pre­cise, easy-to-ap­ply cri­te­ria to de­ter­mine which com­pa­nies are no lon­ger eli­gi­ble for tax be­ne­fits of this kind wi­thout a needs test. 
• The ex­emp­tion of com­pa­nies with not more than 20 em­ployees from the ag­gre­gate wage re­gu­la­tion, with the goal of pre­ser­ving jobs, is un­con­sti­tu­tio­nal. This ex­cep­tion must be li­mited to com­pa­nies with only a very few em­ployees.
• The com­pre­hen­sive in­clu­sion of ad­mi­nis­tra­tive as­sets – up to 50% in the case of the ex­clu­sion pro­vi­ded for by the rule – is un­con­sti­tu­tio­nal. 
• The cur­rent ru­les can be avo­ided by struc­tu­ring tran­sac­tions in a cer­tain way. For ex­am­ple, there are struc­tures using the 50% rule in group struc­tures (this is known as the "cascade ef­fect") that make pos­si­ble a tax-free trans­fer of a con­side­ra­ble amount of as­sets qua­li­fied as non-ope­ra­tive with a harm­ful ef­fect from an in­heri­tance stand­point. In ad­di­tion, un­til 7 June 2013, cash com­pa­nies were pos­si­ble, but they are no lon­ger re­gar­ded as fa­vored busi­ness as­sets.

Even though they have been held un­con­sti­tu­tio­nal, the pro­vi­si­ons will re­main in ef­fect un­til 30 June 2016. The le­gis­la­ture is re­qui­red to es­ta­blish new ru­les by that date. Howe­ver, ac­cor­ding to a press re­lease, the fact that the un­con­sti­tu­tio­nal ru­les re­main in ef­fect does not pro­vide pro­tec­tion against new ru­les that could be re­troac­tive to the time of the ru­ling of un­con­sti­tu­tio­na­lity and "pro­hi­bit an ex­ces­sive ex­ploi­ta­tion of the pro­vi­si­ons that vio­late equa­lity." Ac­cor­din­gly, the cur­rent law will pro­bably con­ti­nue to ap­ply un­til the le­gis­la­ture is­sues new ru­les, at least in ca­ses of in­heri­tance and trans­fers of busi­ness as­sets whose fa­vor­able tre­at­ment was not deemed un­con­sti­tu­tio­nal in the judg­ment. Howe­ver, to be on the safe side, gifts should be pro­tec­ted by in­clu­ding a right of re­vo­ca­tion in agree­ments to make a gift lest ta­xa­tion be trig­ge­red un­in­ten­tio­nally.

If the le­gis­la­ture de­ci­des to make the new ru­les re­troac­tive, then they can pro­bably be ex­pec­ted to be im­ple­men­ted quickly, in or­der to keep le­gal un­cer­tain­ties to a mi­ni­mum. On the other hand, if it ta­kes the le­gis­la­ture the ent­ire pe­riod es­ta­blis­hed by the court in or­der to es­ta­blish new ru­les, then the le­gis­la­ture would be well ad­vi­sed not to make them re­troac­tive.

Ru­mors sug­gest that the Fe­deral Go­vern­ment is keen on main­tai­ning the tax be­ne­fits for busi­ness as­sets. So it is not very li­kely that a fully new tax be­ne­fit sys­tem will be im­ple­men­ted. Howe­ver, it will li­kely be dif­fi­cult in the fu­ture for com­pa­nies that ex­ceed the li­mits of small and mid-si­zed com­pa­nies to trans­fer as­sets tax-free or mostly tax-free. The needs test re­qui­red by the Fe­deral Con­sti­tu­tio­nal Court could force these com­pa­nies to de­mons­trate a need for li­qui­dity, which would li­kely be dif­fi­cult to do in prac­tice. It is to be ho­ped that the le­gis­la­ture will de­mons­trate sound judg­ment in this case. It is also con­ceivable that dif­fe­rent ex­emp­ti­ons or dif­fe­rent pre­re­qui­si­tes for ex­emp­tion could be es­ta­blis­hed for small and mid-si­zed busi­nes­ses than for large com­pa­nies, in or­der to take into ac­count the con­cerns of the Fe­deral Con­sti­tu­tio­nal Court.