Tax-Free Successions

Taxing Time for German Family Firms

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Handing over the keys from one generation to the next isn't quite that easy in Germany.
  • Why it matters

    Why it matters

    Family firms are soon going to have to comply with a more complicated and pricier inheritance tax code, but lawmakers still need to sort out the specifics.

  • Facts

    Facts

    • Chancellor Angela Merkel’s coalition government is tasked with implementing changes to federal inheritance tax law following a Constitutional Court ruling last year.
    • The judges ruled that Germany’s complicated tax code under charges family-owned companies, compared with other forms of capital inheritance.
    • The Bundestag will debate this week dueling legislative proposals for how to address the upheaval, with some favoring tests for inheritance-tax exemption for any company worth more than €26 million and others wanting a uniform, lower flat tax on all inheritances.
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    Audio

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There is still a glimmer of hope for Raimund Wilhelmi. The 66-year old head of the healthcare firm Fastenklinik Buchinger, which runs therapeutic fasting clinics in Baden-Württemburg and Marbella, Spain, is still hesitating whether to go ahead and hand over his company to his two sons. He intends to carefully follow the debates on inheritance law which begin this Friday in the Bundestag, the lower house of the German parliament.

“I really hope that economic common-sense prevails. If not, I don’t have much time left,” he said. He’s in a tight spot – his sons both want to work for the company, but not for another few years.

Business owners like Mr. Wilhelmi want to decide for themselves when to hand over the reins to their children. But German lawmakers may soon put limits on their freedom of action.

Parliamentarians are responding to a decision last year by the Bundesverfassungsgericht, the German Constitutional Court, which will usher in changes as soon as December and as late as next summer on how inheritance tax is handled.

One thing is clear – for large family-owned German companies, inheritance is about to get a whole lot trickier. And in many cases, much more expensive, too.

The constitutional court ruling has set off a last-minute rush among family businesses. “It is important for us that the equity stays in the family. Before the end of the year, we’ll arrange things so it does,” said one businessman, who preferred to remain anonymous.

For a country priding itself on orderly civic arrangements, there are some notably murky corners of the German tax collection system.

Inheritance tax has been a touchy topic since at least 2012, when the German Federal Finance Court passed the issue on to the Constitutional Court for a ruling. Since then, many holdings have been discreetly transferred to heirs.

“Questions of inheritance – including taxes – are handled quite proactively in medium- to large-sized family firms,” Wernen Bahlsen, the president of the influential CDU economic advisory group and head of cookiemaker Bahlsen, told Handelsblatt. “And that goes for Bahlsen too.”

The Constitutional Court decision centered on the relative “privilege” of family firms in inheritance law. According to the judges, inheritance of family companies is under-taxed, compared with other forms of capital inheritance. In many cases, bequests of family businesses are hardly taxed at all as long as the company stays in the family and there are no employee layoffs.

Not fair, said the justices, insisting that family firms must begin paying some inheritance tax. To start with, the court said, larger companies should face an “economic needs test” to check if estate taxation would actually harm the business.

It is the job of Chancellor Angela Merkel’s coalition government – comprising conservative Christian Democrats and left-of-center Social Democrats – to implement specific changes in federal tax law.

The chancellor herself made this explicit this summer, in an address to the Congress of German Family Businesses. “Things cannot remain as they are, there won’t be any return to the status quo,” she said, while also hinting that the court’s mandate may not have been to her liking. “It wasn’t politicians who came up with this idea of an ‘economic needs test’,” Ms. Merkel said.

Concrete legislative proposals are now on the table. They propose that any company worth more than €26 million ($29.4 million) must be tested by tax inspectors to see if it merits tax-exempt inheritance. Officials will check whether a tax bill would genuinely damage the company or threaten jobs. In firms where heirs have more limited rights over capital, this limit rises to €52 million.

Worryingly for family firms, the “economic needs test” can also take half of a family’s private wealth into account.

But the proposals do offer some work-arounds. Above all, there is the so-called “melt-away model,” a colorful German phrase referring to the gradual tax-free distribution of an estate while the owners are still alive. Nonetheless, lobbyists have responded to the proposals with indignation.

One thing is clear: German inheritance law, already gruesomely complicated, is about to get considerably more byzantine.

But some say it doesn’t have to be like that. A quite different school of thought on German estate taxes argues for radical simplification.

They favor a uniform, lower flat tax on all inheritances, with no exceptions and no get-out clauses. All heirs would be equal before the tax office. The Federal Finance Court – one step down from the Constitutional Court in Germany’s complex jurisprudential system – has been demanding precisely this for years.

The proposal has also found support from economists, like Stefan Bach of the German Institute for Economic Research (DIW). Mr. Bach’s studies have shown that half of all estates over €5 million pay not a cent in tax. For estates over €20 million, the proportion of non-payers rises to a startling 90 percent. This is because family firms make up Germany’s largest inheritances.

This is not the only anomaly – to put it mildly – in the German inheritance tax set-up. For a country priding itself on orderly civic arrangements, there are some notably murky corners of the German tax collection system.

And none murkier than inheritance tax, as recent studies have confirmed. In most states, it turns out, declarations of inherited wealth are comparatively rarely audited.

Inheriting in German-01

 

The results of this slackness are predictable enough: when the state of North Rhine-Westphalia recently checked a sample of 1,209 inheritance declarations – the majority running into millions of Euros – it found almost half of them had serious discrepancies.

A simplified flat-tax inheritance system would save most companies a lot of bureaucratic hassle. The obvious downside: wiggling out of estate tax would be a great deal more difficult.

But both parties in the governing Berlin coalition have clearly rejected this flat-tax model. The political consensus appears to support the idea that the system should look favorably on people who inherit actual working companies, rather than those, for example, who receive a windfall portfolio of shares.

Thus the government breathed a sigh of relief when the Constitutional Court did not force through the simplified inheritance tax, merely demanding a reform of relative privilege in the current system. The powerful lobby for family firms was relieved too.

So now the dispute is all about the detail: just how much to cut long-standing privileges given to family-owned companies. The CDU economic advisory group, in a position paper obtained by Handelsblatt, comes down on the side of the firms. It wants higher thresholds before the “economic needs test” would kick in. It also insists that a firewall should protect private wealth from taxes on inherited company capital, saying any blurring of that line would be unconstitutional.

The CDU’s sister party, the Christian Social Union, sees things more or less the same way. But some CDU parliamentary deputies have echoed fears voiced by Wolfgang Schäuble, the CDU Federal Finance Minister. Mr. Schäuble recently reminded his colleagues that inadequate reforms could end up being overturned by the Constitutional Court justices.

For their part, the center-left SPD thinks the proposals are already too friendly to the family business lobby. “The ‘melt-away model’ already lets large fortunes reduce tax liabilities from 30 to 18 percent. We in the SPD are saying no to that,” said Cansel Kiziltepe, a fiscal policy expert in the SPD parliamentary group.

In the Bundesrat, the parliament’s upper house, representatives of states ruled by the SPD and the Green Party vowed last week to vote down further concessions to business heirs. This increases the possibility that the current legislative proposals – which split the difference between SPD and CDU positions – will pass through unaltered, other than a few technical details.

These details include gnarly re-definitions of “business-essential” versus “business-inessential” capital. But even this small-print stuff can have real-world consequences: new definitions would mean breweries, for example, could include pub furnishing in their company assets. On the other hand, changes might make life harder for companies needing a lot of liquidity.

No wonder then, that company owners who can are passing on their holdings to their children. Martin Schoeller, head of a long-established property investment group, and a vocal critic of reforms, has already done just that.

This means that there may be comparatively few cases of inheritance and equity transfer immediately after the law is passed. Nonetheless, fears remain.

Patrick Adenauer, President of FBN, a networking organization for family firms, voiced worries that the whole landscape of company ownership could “dramatically change” in the coming decade, if passing on a company to heirs is more risky than selling it. “How is it good for the country,” he asked, “if a badly thought-out tax reform means a lot of companies end up in the hands of speculators?”

There is no shortage of bleak forecasts. “Catastrophic horse-trading with German family firms,” is what Lutz Goebel, president of one small business group, called it. “An assault on job-creating businesses,” said Christian Rödl, a prominent tax advisor.

But German lawmakers are taking forecasts of doom with a pinch of salt. “As soon as we start talking about inheritance tax, the lobbyists tell us the sky is falling down. Or worse!” said SPD finance expert Lothar Binding. Parliamentarians on left and right emphasized that the changes were moderate, merely bringing the law into line with the court’s ruling.

Nonetheless, as reform approaches, there is real anxiety among business owners. Many are unwilling to go on the record: “We’ll get the transfers done before the end of the year, but it’ll be done discreetly,” said one.

In fact, many already took the necessary steps over the last few years, ever since the issue began moving through courts and parliament. The logistics companies Schnellecke, of Wolfsburg, and Hoyer of Hamburg for example, have already transferred ownership.

Intergenerational gifts of capital tripled between 2010 and 2013, to reach a total of 20.1 billion Euros. “There’s going to be a last minute rush of companies who were late in making a decision, and also some completing the final transfers of remaining capital,” said Kay Klopping, specialist for family firms with auditors KPMG.

It’s hard to find business owners who are happy with the new rules, but not everyone thinks it’s a complete disaster.

“Business owners will just squander goodwill if we moan about this too much,” Daniel Terberger, chief executive of the fashion services company Katag, told Handelsblatt. “A lot of people just don’t seem to understand why politicians have a different perspective on this.”

 

Anja Müller writes about family and small- and mediumsized firms, which form the backbone of Germany’s economy. Donata Riedel covers economic policy for Handelsblatt. To contact the authors: riedel@handelsblatt.com; mueller@handelsblatt.com

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