Inheritance Tax Reform Significantly Raises Costs for Business Transfers

For a number of years, the Centre for European Economic Research (ZEW) has regularly calculated the inheritance tax burden applicable when a large mid-tier sample company, in the legal form of a limited liability company or a partnership, is transferred to a close family member (a spouse or child). Calculations are carried out for Germany and 17 other countries. The sample company used has an inheritance tax value of approximately EUR 103 million. The model calculations carried out by ZEW, which are based on three reform proposals made by the German federal government, suggest that the sample company's inheritance tax burden would grow considerably. If the latest cabinet draft was implemented, the post-reform tax burden would increase by approximately 142 per cent. In absolute numbers, this corresponds to an increase of EUR 10.9 million to a total of EUR 18.6 million.

Under current law, the inheritance tax burden for the transfer of the sample company amounts on average to EUR 7.7 million. This average constitutes the mean value of the tax burden when transferring the business to a spouse or child. Comparing the tax burdens across all 18 countries, Germany ranks 12^th, occupying a position in the lower mid-range. However, in its ruling of December 17, 2014, the Federal Constitutional Court declared the current legislation to be unconstitutional, thus obliging the legislator to adjust the legal framework by June 30, 2016. The Constitutional Court particularly criticised excessive tax exemptions for business assets.

In response to the verdict, the German federal government has already developed three alternative reform proposals. First, in February 2015, the Federal Ministry of Finance (BMF) submitted a benchmark paper that proposed limiting the existing tax exemptions for transferred business assets, which currently amount to 85 per cent, respectively 100 per cent, to a maximum inheritance volume of EUR 20 million. This ceiling is intended to serve as an exemption limit, i.e. provided that economic needs testing does not suggest that an exception should be made, transfers involving larger business assets will not qualify for preferential treatment. If this procedure is applied to the sample company, Germany falls from position 12 to position 17 in the international ranking of 18 countries. The average tax burden would increase almost five-fold, from EUR 7.7 million to EUR 34.6 million.

In June 2015, the BMF proposed further concrete reforms of inheritance tax by presenting draft legislation. In addition to the exemption limit of EUR 20 million, the draft also proposes a model that would enforce a gradually decreasing exemption for business assets in the region between EUR 20 million and EUR 110 million of value, as well as a standard deduction of 25 or 40 per cent for assets beyond the value of EUR 110 million. Specifically, the reduced tax exemption for our sample company would amount to 30 per cent. Despite the fact that the average tax burden decreases significantly from EUR 34.6 million to 25.2 million, Germany improves its position in the international ranking by just one place, moving up to rank 16.

The cabinet draft presented on July 6, 2015, includes further modifications. The exemption limit is to be raised from EUR 20 million to 26 million, respectively EUR 52 million, for family businesses. At the same time, however, deductions for transferred businesses will be reduced to 20 per cent or 35 per cent for assets with a value of EUR 114 million or more. For our sample company, raising the exemption limit merely creates a slightly increased exemption deduction of 34 per cent, respectively 51 per cent, for a family business. The average tax burden would thus total EUR 23.9 million or EUR 18.6 million (family business). Neither scenario would, however, result in an improvement in Germany's position in the international ranking.

In conclusion, if the cabinet draft is adopted in its current form, the tax burden associated with transferring our sample family business will increase from EUR 7.7 million to EUR 18.6 million. This corresponds to an increase of EUR 10.9 million, or approximately 142 per cent. In the international ranking of 18 countries, Germany would thus fall from rank 12 to rank 16. The inheritance tax would therefore constitute an immense fiscal disadvantage for Germany as a business location. This is all the more true as inheritance tax is fairly uncommon in neighbouring countries, particularly when it comes to high value business assets. "The question must therefore be asked as to why the legislator persistently refuses to introduce a fundamental inheritance tax reform that abolishes tax exemptions on the assessment base, but which would provide significantly lower tax rates instead?" says Professor Christoph Spengel, researcher at ZEW and at the University of Mannheim. "Such a reform would be revenue-neutral and would at the same time make Germany a much more attractive location for businesses. Blueprints for such restructuring have been on the table for a very long time."

For more information please contact

Professor Christoph Spengel, Phone +49(0)621/1235-142, E-mail spengel@zew.de

Maria Theresia Evers, Phone +49(0)621/1235-172, E-mail maria.evers@zew.de