cross-border german / us tax planning step webinar … webinar marc… · 26.375 % flat tax on...

CROSS-BORDER GERMAN / US TAX PLANNING

STEP Webinar March 13, 2019

Gerd Kostrzewa TEP, Heuking Kühn Lüer Wojtek, Düsseldorf, Germany

• Heuking Kühn Lüer Wojtek •

Presentation outline

1. The German tax system

2. Managing tax residence

3. Compliance

4. Inheritance/Estate law aspects

5. The German treatment of trusts

6. Case study

7. Summary

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The German tax system 1

Germany: Surely no tax haven !

German taxation is generally based on residence or habitual abode; citizenship is only relevant in certain

circumstances

German living place constitutes German tax residence; no day-count!

World-wide income taxation for German tax residents (tax treaty relief may apply)

Maximum income tax rate 47.475 %

German tax residents are subject to gift/inheritance tax on worldwide assets they transfer or receive by way of gift or

inheritance

Maximum Inheritance and gift tax rate from 7% to 30% for spouse (Yes, taxable!), children and grandchildren; from

30% to 50% for unrelated recipients

Corporation income tax rate approx. 30% (including trade tax); 15% for real estate companies

“Keine Extrawürste”: Strict constitutional equal treatment principle; e.g. no benefits for secondees/expatriates

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Believe it or not: We actually have some tax benefits

No wealth tax

26.375 % flat tax on capital income from interest, dividends, capital gains from sale of securities or

corporate shares (if less than 1 %)

No capital gains taxation on sale of art, antiques, gold, jewels, vintage cars etc., if held for more than 1

year or on personally held real estate, if held for more than 10 years

Total or substantial gift/inheritance tax exemption for business transfers – Very complicated rules !

Tax-neutral cross-border restructuring options within the EU (Effects of BREXIT?)

4



Tax treaties

Large income tax treaty network, usually OECD model treaties

Only 6 inheritance tax treaties (Denmark, France, Greece, Sweden , Switzerland, US)

Most German income tax treaties provide for an exemption of foreign source business or real estate

income from German taxation

Some treaties contain subject-to-tax or switch-over provisions

German national tax law contains several treaty-override rules

Foreign tax treaty residence is not acknowledged if lump-sum taxation applies in country of residence

(e.g. UK & Swiss Tax Treaty)

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We have many rules against tax havens, base erosion or profit shifting

Strict controlled foreign company rules; passive income of CFCs taxable at level of German resident

shareholder – no tax treaty exemption

Foreign holding companies: substance requirements for withholding tax reduction (anti-treaty-shopping

rules)

Extensive transfer pricing rules and documentation requirements for cross-border group companies

General anti-avoidance rules

Extensive information exchange; spontaneous exchange of information possible

Frequent tax audits

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We have an extensive exit tax regime

Exit tax applies to individuals who have been German tax residents under national German tax law for 10

years and hold at least 1 % of a German or foreign corporation

Exit tax applies if shareholder gives up German residence or (among other) if shares are transferred as a

gift or by way of inheritance to non-residents

Exit tax is charged on 60% of the built-in capital gain of the shares at regular progressive tax rate of up to

47.475% (fictitious sale of shares)

Potential double taxation: Exit tax and gift/inheritance tax?

Suspension of exit tax as long as the old/new shareholder stays in the EU/EEA and the old shareholder is

an EU/EEA citizen (Effects of BREXIT?)

Step-up in basis only granted if shares were subject to exit tax in former country of residence

7


Managing tax residence 1

German residence

A German residence is defined as an abode (house or apartment, owned or rented) which is used by the taxpayer under

circumstances that indicate an intended continued use as a living place.

Residence requires a place which is suitable as a permanent living place. This living place must be adequate in view of

the personal and economic circumstances of the taxpayer. A living place needs to be furnished in a way, that the taxpayer

is able to use it at any time. The German tax authorities may even regard simple vacation homes, hunting cabins or hotel

rooms which are continuously at the disposition of the taxpayer as suitable living places. The home of one spouse is

usually also regarded as the living place of the other spouse.

The assumption of a German residence does not require that the living place is used for a specific number of days during

the calendar year.

German citizens who have been German residents and who have given up their German residence less than 5 years ago

(10 years if they have moved to the US), will be regarded as German tax residents for inheritance/gift tax purposes.

8



Habitual abode in Germany

A habitual abode in Germany requires that the individual stays in Germany with certain regularity.

This regularity is always assumed if the stay continues for a period of more than six months.

The six-month period does not require completion within one calendar year. Short interruptions

(e.g. foreign travel) do not interrupt the six-month period.

Even stays of less than six months may constitute a habitual abode if the individual originally

intended to stay for more than six months.

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Taxation of non-residents (may be further limited by tax treaties)

Limited German income taxation on income from German sources, e.g.

German real estate (rental income, capital gains generated within 10 years of acquisition) German businesses

Interests in German business partnerships

Dividends from German corporations Capital gains from sale of shares in German corporations (minimum share of 1% required)

New: Also capital gains from the sale of shares in foreign corporations (minimum share of 1%

required) if these directly or indirectly hold more than 50% of their book value in German real estate Interest from loans secured by German mortgages

German employment

Limited Inheritance/gift taxation on transfer of German assets:

German real estate

German tangible business assets or partnership assets Shares of at least 10% held directly or indirectly in a German corporation

Copyrights etc. registered in Germany

Loan receivables secured by German mortgages Silent partnership in German businesses

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The tie-breaker-rule

(Art 4 US/German Income Tax Treaty)

The tie-breaker-rule allocates the tax treaty residence only to one country

If the taxpayer has permanent homes in both countries, the tax treaty

residence is primarily allocated to the country which is the center of his/her

vital interests

Center of vital interests is determined based on

Personal ties (e.g. spouse, family)

Economic ties (e.g. place of work, income sources, real estate)

Social ties (e.g. charitable activities, club memberships)

Other criteria (habitual abode, citizenship) will only become relevant if center

of vital interests cannot be identified

The US/German Inheritance Tax Treaty contains an equivalent tie-breaker rule

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Effects of US tax treaty residence on German income taxation

German taxation is basically only unlimited with respect to certain German source income, such as e.g.

Income from work performed in Germany

German business income

German rental income

No German withholding tax on interest income from German sources

Dividend income from German sources is subject to reduced German withholding tax (15% instead of 26.375%)

Capital gains from the sale of German assets will be exempted from German taxation, unless gains result from

Sale of German real estate (no tax if personally held for more than 10 years)

Sale of German business assets

Sale of shares in German real estate companies (real estate value > 50% of FMV of company)

German exit taxation will not apply

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Effects of US tax treaty residence on German inheritance/gift taxation

German inheritance/gift taxation would only apply to the transfer of the following assets between non-resident individuals:

Real estate located in Germany

German business assets

Partnership interests in German partnerships to the extent the partnership owns German real estate or German

business assets

Shares in German or foreign companies (corporations) or German bank accounts would consequently not be subject to

German inheritance/gift taxation

German tax treaty resident heirs or recipients of gifts will always be subject to German inheritance/gift taxation

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Compliance

Be careful: Non-compliance quickly leads to tax fraud prosecution

All German resident individuals are obliged to file annual income tax returns

Resident or non-resident donors and recipients of a taxable gift are obliged to notify the tax office of the

transfer within 3 months, the same obligation applies to heirs

The taxpayer is obliged to correct mistakes made in previous tax returns; failure to do so may be qualified

as criminal neglect

German tax law provides for a statutory voluntary disclosure option with relatively mild penalties

14


Inheritance/Estate law aspects

Clients moving to Germany need to adjust their wills

German inheritance law will in principle apply if the deceased had his/her center of vital interests in

Germany (EU Brussels IV Directive)

A US citizen having his/her center of vital interest in Germany can make a will under US law; Germany will

acknowledge this will

If German inheritance law applies, spouse and descendants (or even parents) are entitled to forced

heirship shares

German probate courts and the German tax authorities may have problems interpreting US wills from a

German perspective; the “universal succession” under German inheritance law requires the clear

identification of the heirs and their share of the inheritance

Adjustment of US will may also be advisable with respect to the transfer of German assets between non-

residents

15


The German treatment of trusts 1

German civil law and trusts

German Civil Law does not provide for trust-like distinction between legal title an equitable title

Not all Civil Law countries have signed the Hague Convention on Trusts; Germany for instance has not

Often complex interpretation or re-qualification of existing trust structures

Complex international private law rules with respect to trusts (e.g. EU-Directives Rome I and Brussels IV)

Qualification of trusts as presumed abusive structures under ordre public rules?

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Trust or foundation as owner of German companies or real estate?

German property law does not acknowledge trust as direct shareholder of German companies or direct

owner of German real estate; however, a trust could indirectly hold such assets via a holding company

Foundations can directly hold shares in German companies or German real estate

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Not funny at all: The German taxation of trusts

Contributions to non-charitable trust/foundation by German-resident settlor or in form of German situs assets are

subject to German inheritance/gift tax

Any distribution from a trust and all non-obligatory distributions from a foundation to German-resident recipients are

subject to gift tax, unclear whether obligatory foundation distributions (fixed interest) are also subject to gift tax

Undistributed income of Non-EU trusts or foundations is subject to German income tax at level of German-resident

settlor or beneficiary (according to his/her “interest”) at a rate of 26.375 % – no tax treaty exemption

Actual trust/foundation distributions are taxable at the level of German-resident recipients; income tax rate 26.375 %;

prior tax payments on undistributed trust/foundation income can be credited

Statutory law does not explicitly exclude a double taxation of trust or foundation distributions with gift and income tax

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Case Study: The Father and his Heirs

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Father:

- US citizen, divorced, Girlfriend in US- Large mansion in the US- Luxury apartment in Germany- German resident for 15 years- Family business in the US- Holds 20% of shares in US company- Holds 20% shares in German company- CEO of US and German companies- Frequent traveler- Less than 100 days p.a. in Germany- Substantial US security accounts- Small German security account

Daughter:

- US citizen, single- Lives and works in Germany- Apartment in Germany- No home in the US

Son:

- US citizen, married- Lives and works in the US- Apartment in the US- No home in Germany


Case Study: The Problem

The Father wants to transfer as many assets as possible to a trust, but …

A trust could not directly own the German apartment or the shares in the German company

A transfer of the German apartment or the shares in the German company to a new owner structure

could be subject to German capital gains tax

A transfer to a trust or foundation could also be subject to German gift tax

Undistributed income of a Non-EU trusts would be subject to German income tax at level of the Father,

and – after his death – partially at the level of his German-resident Daughter

A transfer of the shares in the German and the US companies to his Son by way of gift or inheritance

could also lead to German exit tax (capital gain tax)

20


Case Study Solutions: Defend the Father’s US tax treaty residence

The German tax authorities need to be convinced that the Father’s tax treaty residence is the US

(center of vital interests)

US/German Income Tax Treaty: Exemption from German capital gains tax or exit tax if Father transfers shares in

the German or the US company to another entity/structure (holding company, trust, foundation)

A transfer of the German apartment to a new owner structure would in principle be subject to German capital

gains tax, unless the Father has held the apartment for more than 10 years

US/German Inheritance Tax Treaty: Exemption from German gift/inheritance tax if Father transfers shares in

German or US companies to trust/foundation

Any gift/inheritance received by German-resident daughter is always subject to German gift/inheritance tax

German gift/inheritance tax on transfer of German apartment

21


Case Study Solutions: Use LLC as “adapter plug” to connect German assets to trust

A trust could hold German real estate or shares in German companies through an LLC

Father could transfer shares in German GmbH to LLC free of German capital gains tax (if tax treaty resident in

the US); no capital gains tax on transfer of German apartment if held for more than 10 years

LLC structure must meet certain criteria to be qualified as corporation under German law:

- Centralized management and representation- Limited liability- Free transfer of shares- Profit distribution based on shareholders’ resolution- Capital contributions- Unlimited lifetime of the company- Profit distribution based on share quota

Transfer of shares in LLC with sufficient substance would not be regarded as transfer of German situs assets: no

German gift/inheritance tax (no treaty benefits needed), unless transferor or transferee is resident in Germany;

no adverse effect of “check-the-box” election

22


Case Study Solutions: Foundation as “adapter plug” to connect German beneficiaries to trust

EU foundation could serve as blocker from taxation of undistributed trust income at the level of Germanbeneficiaries

Father could transfer shares in LLC to trust free of German gift tax

Instead of the German-resident Father or Daughter, an EU/EEA foundation (e.g. in Austria, Liechtenstein) could be

appointed as beneficiary of the trust; undistributed trust or foundation income would not be subject to German income tax

at level of Father or Daughter

Actual trust/foundation distributions are taxable at the level of German-resident recipients; income tax rate 26.375 %; gift

tax handling of distributions is under judicial review – most probably no double taxation

Transfer of position as beneficiary of the foundation from Father to Daughter and Son (or others) would not be subject to

German inheritance tax

23


Case Study Solutions: Holding company (LLC) with sufficient substance

Requirements for the assumption of sufficient substance

No abusive, economically ineffective or artificial structure; no implementation for mere tax-saving purposes

Legal, political or religious reasons may constitute a genuine business purpose (non-tax purpose)

A genuine business activity requires an activity that exceeds mere asset management

A genuine business activity cannot be assumed if the relevant business activities are outsourced to external service providers

A genuine business activity requires that the foreign company performs its essential business activities with its own resources and

makes its own business decisions

A participation in general commerce is also given if the company provides services to related companies, as long as these services

are charged at arm’s-length prices (i.e. with profit)

The foreign Holding company must have an adequate and “tangible” business infrastructure sufficient for its purposes, i.e. qualified

management and subordinate staff, office facilities, communication technology

If the activity of the foreign holding company is limited to the mere holding of shares in its subsidiaries, a genuine business activity

requires that the holding company is engaged in an active management of its shareholdings. The holding company needs to

perform not only shareholder functions (“passive shareholder management”), but also actual management functions relating to its

subsidiaries (“active shareholder management”). If the holding company has no other business activities, it is not sufficient if the

holding company is engaged in the management of only one subsidiary. “Active shareholder management” requires a written

documentation of repeated and substantial management decisions with a sustained impact on the subsidiary

.

.

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Summary

I am happy if you remember the following rules:

If possible: Keep your client away from becoming a German tax resident – There is no day-count !

If a German tax residence cannot be avoided, your client should maintain his/her foreign residence as

center of vital interests under a tax treaty

Your client should consider holding German assets indirectly through a non-German holding company

Beware of German trust taxation. Your client may have to restructure his/her trusts before moving to

Germany as settlor or beneficiary

Your client may have to adjust his/her will before coming to Germany

Above all: If you think something is tax-free in Germany, you are most probably wrong !

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Gerd Kostrzewa

Partner

Certified Tax Lawyer

Location: Düsseldorf

Phone: +41 44 200 71-00

Fax. +41 44 200 71-01

Email: [email protected]

Vita Admitted to the Bar since 1996

Born 1964 in Donaueschingen, Germany

Education and former activities Ernst & Young AG, Düsseldorf (1995-1999)

University of Konstanz (Legal Trainee/Referendar 1993; Assessor 1995)

German University for Administrative Sciences, Speyer (1994)

Affiliations International Bar Association (IBA), Officer of the Individual Tax and

Private Clients Committee 2008-2015, Committee Chair 2014-2015

STEP (TEP)

German Association for Inheritance Law and Property Successions (DVEV)

German-Israeli Lawyers Association (DIJV)

German-Swiss Lawyer Association (DSJV)

Contact

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Our Locations

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Berlin

Unter den Linden 10

10117 Berlin/Germany

T +49 30 88 00 97-0

F +49 30 88 00 97-99

Chemnitz

Weststrasse 16

09112 Chemnitz/Germany

T +49 371 38 203-0

F +49 371 38 203-100

Düsseldorf

Georg-Glock-Straße 4

40474 Düsseldorf/Germany

T +49 211 600 55-00

F +49 211 600 55-050

Frankfurt

Goetheplatz 5-7

60313 Frankfurt a. M./Germany

T +49 69 975 61-0

F +49 69 975 61-200

Hamburg

Neuer Wall 63

20354 Hamburg/Germany

T +49 40 35 52 80-0

F +49 40 35 52 80-80

Cologne

Magnusstrasse 13

50672 Cologne/Germany

T +49 221 20 52-0

F +49 221 20 52-1

Munich

Prinzregentenstrasse 48

80538 Munich/Germany

T +49 89 540 31-0

F +49 89 540 31-540

Stuttgart

Augustenstrasse 1

70178 Stuttgart/Germany

T +49 711 22 04 579-0

F +49 711 22 04 579-44

Brussels

Rue Froissart 95

1040 Brussels/Belgium

T +32 2 646 20-00

F +32 2 646 20-40

Zurich

Bahnhofstrasse 3

8001 Zurich/Switzerland

T +41 44 200 71-00

F +41 44 200 71-01

www.heuking.de

08.03.2019 Overview of our Law Firm 28

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