Planned Revision of Inheritance Tax Largely Dispels Criticisms from the Federal Constitutional Court

June 30, 2016, saw the expiry of the deadline imposed by the Federal Constitutional Court on the German Bundestag for the creation of a new statutory basis for the inheritance tax. Following a series of intermediate proposals, it seemed that a compromise had been reached. However, the future of this proposal is yet again under question, as it threatens to be refused by the German Bundesrat. And indeed, even if the Bundesrat agrees to the proposed revisions, the question remains as to whether the current proposal will hold up in the Federal Constitutional Court. This question has been the focus of an analysis carried out by the Mannheim Centre for European Economic Research (ZEW).

Having used uniform criteria to evaluate the various proposals made since the Court's decision, ZEW has come to the conclusion that in comparison to previous proposals, the latest proposal made by the coalition partners in several respects implies a reduction in the tax burden for businesses. The new proposal is, however, somewhat unfavourable for very large businesses. Nevertheless, according to ZEW researchers, the criticism of earlier proposals made by the Federal Constitutional Court has now largely been addressed.

The Court's criticisms focused on three primary issues: the extensive exemption limit for business assets (usually 85 per cent; optionally 100 per cent) irrespective of a company's size or of individual requirements; the wage regulation clause, which so far only applied to businesses with more than 20 employees, as well as the disproportionately high tax limit of up to 50 per cent for administrative assets. Following analysis of the new proposal drafted by the coalition, ZEW has concluded that the Bundestag has taken the Federal Constitutional Court's criticisms into account and has presented a draft bill that is consistent with the constitution and addresses at least two of these three core issues.

The applicability of the wage regulation clause has been reduced from 20 to five employees. In the future, businesses exceeding this limit will be required to prove that wage costs have remained relatively stable if they are to benefit from the same level of inheritance tax exemption. The new proposal also foresees a reduction in the share of administrative assets from 50 to ten per cent. Regulations pertaining to tax exemptions for business assets have thus been made significantly tougher. The choice to maintain the current approach used to determine the value of administrative assets in the latest proposal is considered to be particularly positive. Suggestions made in earlier proposals to introduce differentiated approaches according to business' principal activity would have led to significant demarcation problems and increased administrative processing.

The ZEW analysis gave particular consideration to the development, in the various proposals made, of tax exemption regulations for very large businesses. The planned change to the capitalisation factor, considered necessary in view of continued low interest rates, constitutes an implicit increase in the exemption limit of 26 billion euros included in the current proposal. Businesses with a current worth of around 37.14 billion euros would also be able to benefit from full exemption from inheritance tax. In addition, family-run businesses are now eligible for tax relief of up to 30 per cent, thereby effectively further increasing their tax exemption limit.

Earlier proposals included uniform, one-off tax relief of 40 or 35 per cent for very large businesses. The current proposal does not include a similar ruling. The only option remaining for heirs of businesses with a current total worth of 128.57 billion euros (family-run business: 183.7 billion euros) is to make use of extended deferment regulations or the possibility of a (partial) remission.

The extent to which the approach now taken to the taxation of large business assets reflects the requirements of the Federal Constitutional Court yet remains to be seen. The Court's decision did, however, give the Bundestag significant leeway in terms of introducing differentiated tax regulations for large business assets, citing, for example, the size classifications used by the European Commission.

For more information please contact

Professor Christoph Spengel, Phone +49(0)621/181-1704, E-mail spengel@uni-mannheim.de

Rainer Bräutigam, Phone +49(0)621/1235-163, E-mail rainer.braeutigam@zew.de

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