Stückmann Podcast Episode 38: Inheritance and gift tax under scrutiny at the Federal Constitutional Court: what does this mean for business succession?

Why inheritance tax is currently a topic of discussion

The political debate and the pending decisions of the Federal Constitutional Court are causing uncertainty amongst many companies. Niels Doege warns against jumping to conclusions: it is not possible to deduce how the Federal Constitutional Court will rule from the questions it asked during the oral hearing.

Nevertheless, the two days of hearings have revealed which constitutional issues are of particular importance to the Court.

Regional autonomy: Bavaria versus the rest

On the first day of the hearing, the Federal Constitutional Court considered a constitutional review brought by the Free State of Bavaria, which aims to secure greater regional autonomy in relation to inheritance and gift tax. Bavaria seeks to regionalise the valuation rules, tax-free allowances and tax rates.

Differing valuation rules, tax-free allowances and tax rates across the individual federal states could complicate the application of the law and increase its complexity – for example, where the taxpayer’s place of residence and the transferred property assets are located in different federal states. Possible tax-motivated changes of residence (such as retirement homes in Bavaria) were also discussed.

Business assets: Equal treatment and a high tax burden

On the second day of the hearing, the focus was on the tax advantages granted to business assets. However, before the Federal Constitutional Court can examine the substantive issues, it must first rule on the admissibility of the constitutional complaint. The issue at stake is whether, and to what extent, the inheritance tax exemption rules favour acquirers of business assets over acquirers of private assets in a manner that is not justified under constitutional law (breach of the principle of equality under Article 3(1)).

On the morning of the second day of the hearing, the economic implications of the current regulations and of a possible abolition of tax relief on business assets were discussed. The focus was on revenue from inheritance and gift tax, the distribution of assets, the level of tax rates and the valuation of business assets using the income approach. It was noted that the valuation is based on future expected returns which have not yet been generated as at the valuation date.

There was broad agreement amongst the experts regarding the insufficient data available, as well as the considerable tax burden and the associated outflow of liquidity in the event of immediate payment. Opinions differed, however, on whether a deferral of inheritance and gift tax could provide adequate compensation. It was argued against a mere deferral that it merely postpones the burden and does not permanently prevent the outflow of assets and liquidity.

What is the basis for the assessment of the need for relief?

A key focus of the proceedings was the assessment of the need for relief, particularly in cases of abusive arrangements. Under certain conditions, this allows for extensive tax relief if a beneficiary is unable to pay inheritance tax from their disposable assets. The discussion centred on when arrangements might be considered abusive and what role, for example, transfers to minors or trusts play. Niels Doege makes it clear that the exemption needs test is not a simple tool for avoiding inheritance tax. The tax relief is subject to strict conditions. These include, in particular, compliance with the requirements for eligible assets, retention periods and wage bill requirements; furthermore, a portion (50 per cent) of the available, non-exempt assets (private assets), as well as any additional private assets received free of charge over the next 10 years, must be used to settle the tax liability. The complex assessment and the long-term requirements that must be met call for careful tax planning and support.

What does the future hold for inheritance tax law?

The negotiations have once again highlighted the complexity of the legal provisions governing tax relief on business assets. At the same time, the question arises as to how specifically the Federal Constitutional Court should formulate the constitutional requirements for new legislation. Overly detailed guidelines could further complicate inheritance and gift tax law and significantly restrict the legislature’s political discretion. A ruling by the Federal Constitutional Court is expected within approximately three to six months of the oral hearing. Niels Doege considers it likely that, in the event of an objection, the court will order the existing regulations to remain in force for a transitional period until the legislature has adopted new legislation. However, this is merely an assessment; the outcome of the proceedings remains to be seen.

What does this mean for business succession?

Anyone planning business succession or where a transfer appears feasible should take the current debate – particularly in the case of larger business assets, where an assessment of the need for tax relief may be relevant – as an opportunity to carefully review, prepare and, where appropriate, implement the intended transfer. Particularly in the case of larger companies, it is important to clarify which assets meet the criteria for tax relief. Niels Doege, however, advises against carrying out a transfer solely on the basis of tax considerations. The economic, family and business context remains the decisive factor.

Conclusion: Plan for succession, keep track of developments

The proceedings before the Federal Constitutional Court concern key issues relating to inheritance and gift tax law – ranging from the legislative powers of the federal states to the constitutional justification for the preferential treatment of business assets. Companies with specific succession plans should review their asset structure and the tax requirements at an early stage, and carefully prepare any planned transfers.