Change in the definition of a group within the meaning of the German Inheritance and Gift Tax Act?

The definition and significance of horizontal groups

In view of demographic changes, the issue of business succession planning is becoming increasingly important in the Mittelstand. According to the latest estimates, by the end of 2028 alone, around 100,000 companies may be affected by this. The organisational structures that are normally found in small and medium-sized companies - beneath a parent company - consist of, besides an operating company, another company that assumes the management of the company’s own (business) assets (including properties) and makes these available to the operating company. Previously, such groups of companies typically formed a so-called horizontal group. This generally facilitated - especially in cases where there is no direct splitting of operations - the use of tax concessions for the transfer of business assets within the framework of (accelerated) inheritance. 

The horizontal group - like the vertical group (Unterordnungskonzern) - was included in the original definition of an (interest barrier-)group in the Income Tax Act (Einkommenssteuergesetz, EStG). In the case of a horizontal group, the managing company and the operating company exist independently of each other and are merely under common management. In contrast to this, a vertical group consists of at least one controlling parent company and one dependent subsidiary company.

Change in the definition of a group under the EStG

The EStG was however amended in this respect with effect from 15.12.2023. The “definition of a group” for income tax purposes under Section 4h EStG, among other things, was impacted by this. As a result of the amendment, the rules on horizontal groups will no longer apply and the vertical group provision has been modified; while previously, the theoretical possibility of preparing consolidated financial statements was sufficient, now the (new) legal requirements can only be satisfied if consolidated financial statements are actually prepared.

Significance for inheritance and gift taxes

In Section 13b(4) no. 1 sentence 2(c) of the Inheritance and Gift Tax Act (Erbschaft- und Schenkungsteuergesetz, ErbStG) reference is made to Section 4h EStG; the question that arises is: to what extent do the changes in the EStG likewise affect the definition of a group for inheritance and gift tax purposes?

In the case of (accelerated) inheritance, under the ErbStG specific business assets are tax-privileged. The so-called non-operating assets are however not eligible for inheritance and gift tax concessions. A portion of these non-operating assets are notably properties that are made available to third parties for use. The ErbStG makes an exception to this principle solely if the properties are made available between two companies and both of these companies are members of one group within the meaning of Section 4h EStG. 

Since the change in the definition of a group in the income tax legislation there has been legal uncertainty, because of the reference in the ErbStG, as regards the tax concessions in the case of business succession planning. There is a lack of clarity about whether the reference to inheritance and gift taxes incorporates the definition of the interest-barrier group in accordance with Section 4h EStG (old version) or in accordance with Section 4h EStG (as amended).

Outlook

The legal interpretation of the reference to the definition of a group for income tax purposes under Section 4h EStG is still open. In the course of the legislative procedure for the 2024 Annual Tax Act, the Bundesrat [upper house of German parliament] did admittedly address this issue and recommended a separate definition of a group for the ErbStG. This was however ultimately not included in the published 2024 Annual Tax Act.

Since the implications for the ErbStG arising from the amendment of the EStG were presumably not intended and indeed conflict with the actual purpose of the preferential tax treatment of business assets under the ErbStG, it still remains to be seen what position the fiscal administration or German lawmakers will adopt in respect of this issue. Should the fiscal administration accept the reference to the revised definition of a group under Section 4h EStG (as amended) then this would have direct consequences for the treatment of business succession planning for inheritance and gift tax purposes.