Impending discontinuation of tax deferrals in the event of relocations in old cases

As part of the Federal Government’s draft bill to implement the EU Directive on global minimum taxation (BT printed matter 20/8668 dated October 6, 2023), the legislator has also introduced an amendment to exit taxation (Art. 6 AStG (German Foreign Transaction Tax Act)) for relocations to EU/EEA countries that took place before January 1, 2022. Previously, an indefinite interest-free deferral was granted in these exit cases (Art. 6 (5) AStG old version). The legislator has now considerably restricted this extensive deferral regulation with the introduction of Art. 21 (3) sentence 2 no. 2 AStG, as amended, in the 2nd and 3rd readings on November 10, 2023.

System change as of January 1, 2022 for new relocations

The legislator had already tightened the exit tax regime with the ATAD Implementation Act to the effect that exit tax (i.e., notional sale of shares held in a corporation amounting to at least 1%) can no longer be deferred permanently and interest-free in the event of an exit from Germany after December 31, 2021 (in particular due to the termination of the German unlimited income tax liability) to an EU/EEA state. In this respect, the only remaining option is an interest-free payment in installments spread over seven years.

Under the (old) law applicable to relocations before January 1, 2022, the exit tax incurred when moving to another EU/EEA country was deferred without interest. The tightening of the exit tax from January 1, 2022, on the other hand, has so far had no effect on deferred relocations that have already taken place in the past.

Law on global minimum taxation – tightening now surprisingly also for old cases

According to the now revised draft bill of the Federal Government dated October 6, 2023, the deferral granted for all old cases will be revoked by amending the transitional provision of Art. 21 (3) sentence 2 no. 2 of the draft AStG if profit distributions or capital contribution refunds from the investment subject to exit tax exceed 25 percent of the shares’ fair market value (market value at the time of exit).

A comparable provision was introduced for the first time with the system change for relocations from January 1, 2022, in Art. 6 (3) sentence 1 no. 2 and (4) sentence 5 no. 5 AStG (as amended) and is intended to lead to a (pro rata) exclusion of the exit tax’s reversal in the event of a return to Germany (Sec. 3) or to a lapse of the interest-free installment payment granted (Sec. 4) for new relocations alone. With the proposed legislation that has now been passed, the legislator intends to apply this revocation regulation to all old relocations with permanent deferral.

The legislator justified the tightening for new relocations after December 31, 2021 with the prevention of avoidance schemes: Relocations should not be used to allow the taxpayer to “empty out” the corporation in the respective country of destination, possibly under a special tax regime, which would lead to a significant tax advantage or sometimes even tax exemption. In order to create alignment with the new law, this regulation should now also apply to relocations before January 1, 2022 (BT printed matter 20/8668, p. 239).

In temporal terms, the examination of whether the 25 percent limit has been exceeded will take into account for the first time those profit distributions and returns of capital contributions by the corporation that are made after the cabinet decision (August 16, 2023) for the now envisaged tightening of the law.

Example: “A” moved to Spain in 2019 by giving up his place of residence. At the relevant time, he held a 50 % stake in a Spanish corporation (Sociedad Limitada). The fair market value of the shares held amounted to EUR 25 million, i.e., with acquisition costs of EUR 1 million, this resulted in a notional capital gain of EUR 24 million subject to exit tax and thus an income tax burden of EUR 6.48 million in 2019 (simplified calculation: 60 % partial income method and top tax rate of 45 %). This exit tax was deferred indefinitely and without interest. After the relocation, annual distributions of one million euros each are made to “A” from the investment, which are subject to normal income taxation in Spain.

With the tightening, the 25 percent limit, i.e., 25 percent of the then market value of the company subject to exit tax, of EUR 6.25 million (25 percent of EUR 25 million) must now be complied with. Therefore, if this limit is exceeded by EUR 750,000 from the seventh year onwards, the deferral granted will be revoked for the first time on a pro rata basis in this amount. Accordingly, this amount must mandatorily be reported to the German tax authorities and then paid after the tax assessment notice has been amended.

It is to be feared that foreign taxes – which are regularly paid with the distribution in the individual countries – can probably not be taken into account, at least according to the current version of the draft. After all, the distribution is only the trigger for the deferral revocation and is therefore not itself subject to German taxation. Accordingly, the total gross amount of the further distributions in subsequent years would have to be used in order to pay the exit tax as a result of the now pro rata temporis revoked deferral.

Furthermore, it is irrelevant for the deferral revocation at what point in time the 25 percent limit is exceeded. In contrast to the new relocation cases, the regulation now applying to old cases does not specify any observation period. Within the scope of the permanently granted deferral, it is therefore generally only a question of time when the threshold is exceeded. It is questionable whether the limit now introduced will also have to be observed by the relocated person’s legal successor.

Recommended action

The tightening for old relocations is probably the next challenge for international entrepreneurs and their families, especially for business heirs.

Affected parties must examine how to react to the impending payment burden as part of their distribution and liquidation planning. A possible relocation back to Germany might also be considered. This is due to the fact that, under the old provisions of Art. 6 (3) sentences 1 and 4 AStG (old version), which continue to apply, in the event of a relocation back to Germany and the associated (re-)establishment of unlimited income tax liability, the already assessed and deferred exit tax would no longer apply.

However, it should be noted that the foreign country of destination may levy its own exit tax. In this respect, a relocation back to Germany would cancel the German exit tax, but would result in a foreign exit tax.