Triggering of shortfall assessments
Distress sales and insolvency
In view of the coronavirus crisis, a number of company successors have been forced to sell stakes in companies or essential business assets, or even to file for insolvency. Under existing law, violations of the 5-year or 7-year holding period – for whatever reason – would lead to the triggering of a shortfall assessment and to a pro rata tax payment on the transfer of business assets that was previously tax-privileged. Besides being severely affected by coronavirus, company successors will be additionally burdened by inheritance tax.
Risk of excess withdrawals during periods when there is a lack of profits
During periods when there is a lack of profits, withdrawals from reserves or advanced distributions of profits in order to protect private liquidity could easily result in excess withdrawals. Such excess withdrawals (defined as those withdrawals/dividends that, during the holding period, exceed the sum of the profits and capital contributions by more than € 150,000) would constitute a shortfall assessment trigger.
Recommendation: Since it is possible to rectify a situation where excess withdrawals have occurred by making a timely capital contribution before the end of the holding period, we would strongly recommend monitoring withdrawals, as this is the only way to ensure a response at the right time.
Sharp decline in aggregate wages
Compulsory staff cutbacks, lower wages and shorttime working due to the coronavirus crisis could result in non-compliance with the mandatory minimum aggregate wage level and you could, thus, reach a stage where a shortfall assessment is triggered.
Recommendation: Aggregate wage levels should be monitored on a regular basis and it will be necessary to check whether or not counter measures should be considered.
Liquidity through capital contributions – taxation of so-called recent funds
Family business owners, above all, are currently supporting their businesses with capital contributions from their private assets so that, despite the coronavirus crisis, their enterprises will be able to continue functioning and the wages can be paid. If the business owner were to die suddenly then these recent funds would be taxed as private assets without any kind of relief. Admittedly, under the so-called investment clause (Section 13b(5) of the German Inheritance Tax Act) there are tax privileges. These are however linked to tight preconditions that cannot readily be fulfilled and are not applicable to the coronavirus predicament (in particular, the testator’s previous specific investment plan, or liquidity outflows because of wages in the case of seasonal fluctuations).
Recommendation: In such a case, successors should be able to document that the funds were contributed in order to provide support to the distressed family enterprise.
Succession planning – tax relief for business assets (“90% test“) will be refused if there are falls in value
Financial projections (of enterprise values, the non-operating assets ratio and notional inheritance and gift tax charges) that were carried out even at the end of 2019 and which, under the circumstances at that time, would have resulted in full tax relief could now depict a completely different outcome due to the coronavirus crisis. Instead of theoretically being able to claim the full amount of tax relief that would have been applicable a few months ago, now, in view of the falls in value and, in individual cases, the sharp declines in prices, no tax exemptions whatsoever are possible any more because the ratio of non-operating assets to enterprise value is too high.
Recommendation: Any plans for accelerated inheritance should be carefully reviewed once again and – insofar as is reasonable – the gifting should potentially be postponed, or you should come to an agreement with the local tax office within the framework of an advance ruling.
Conclusion: The coronavirus crisis will have a serious impact on inheritance and gift tax that, under existing law, it will not be possible to avoid. Taxpayers will only be able to keep an eye on the risks during the holding periods through tighter monitoring of shortfall assessment triggers and by actively preparing for any equitable measures on the part of the local tax office by documenting the causality of the coronavirus crisis. That is why legislators should now be urged, because of the coronavirus crisis, to bring about mitigating measures into the inheritance and gift tax arena. In the meanwhile, until this happens, the fiscal authority is requested to enable proper outcomes within the framework of equitable measures.