Fiscal Court facilitates transfer of operating assets by relaxing “90% test”

Tax advantage for operating assets

The German Inheritance and Gift Tax Act (Erb- und Schenkungssteuergesetz – “Inheritance Tax Act”) provides for various tax advantages for those acquiring business assets as a gift or inheritance. The basic prerequisite for claiming them is successful completion of the “90% test” that the German legislator introduced in its inheritance tax reform of 2016 based on the requirements set by the German Federal Constitutional Court (Bundesverfassungsgericht) in its decision dated 17 December 2014, 1 BvL 21/12.

The German Federal Fiscal Authority (Finanzverwaltung) conducts the 90% test on a gross basis Certain types of deemed passive assets (e.g. cash on hand, bank balances, receivables, securities, real property leased to an external party or precious metals) must constitute less than 90% of the company’s total value (business related debt is not set off against the value of the deemed passive assets). If these “gross passive assets” constitute 90% or more of the company’s total value, the tax advantages are lost for all of the transferred company assets (“guillotine effect”).

Some strong criticism against the Fiscal Authority’s opinion has been voiced in expert literature because, at least ultimately, it also undisputedly places operating companies with a lower tangible asset value and/or a higher ratio of current assets to total assets (Umlaufintensität) and a larger percentage of borrowed capital at a disadvantage solely due to their business model. For example, there are known cases on the market in which companies with a large amount of receivables and cash on hand and a high amount of debt were denied all tax advantages due to the impermissibility of setting off debt, even though, if the debt had been set off, such a low amount of passive assets would have fulfilled even the higher statutory prerequisites for “complete exemption” (Vollverschonung) from inheritance and gift tax. Furthermore, the inheritance and gift tax is an “effective-date tax” (Stichtagssteuer), and the passive assets existing on the effective date either can only be projected with remaining uncertainties or – in the case of inheritance – are impossible to plan. Due to the Fiscal Authority’s procedural practice, (unexpected) business events (such as receiving down payments or loan amounts being credited to an account) that occur before the effective date can cause serious tax disadvantages for the parties involved, making it necessary to monitor occurrences such as payments received on a daily basis.

Fiscal Court decision

In its judgment dated 13 September 2023 (II R 49/21), which has now been published, the German Federal Fiscal Court (Bundesfinanzhof) contradicted the opinion of the Fiscal Authority and permitted the deduction of operationally prompted debt, at least for an originally commercially active trading company, even in the context of the 90% test. The court explained that, although the wording of the law (section 13b(2) second sentence of the Inheritance Tax Act) stated that debts were not to be set off, this wording was not free of contradictions. The court also stated that, taking into account the law’s systematics, intention and evolution, setting off debt was to be permitted, at least for companies that pursue as their main purpose original commercial operations and that have given no reason to believe that their claim to the tax advantages is illegitimate.

Practical consequences

The Fiscal Court’s decision is welcome. Particularly for companies with comparatively few tangible assets and/or a higher ratio of current assets to total assets (e.g. service providers) and a high ratio of borrowed capital, it creates options for planning an eventual succession.

It remains to be seen whether the Fiscal Authority applies the Fiscal Court’s judgment other than on a case-by-case basis. Nevertheless, ongoing monitoring of a company’s passive asset ratio retains its solid position in planning for company succession.