Germany Christian Birkholz Baker

Germany

Christian Birkholz

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Using Trusts in Family Wealth Planning

Wednesday March 21, 2007


©2007 Baker & McKenzie 2

Overview

• Basic legal considerations

• Testamentary trust

• Intervivos trust

• The trust in German Income Tax Law

• The trust in German Inheritance/Gift Tax Law

• Income versus inheritance/gift tax effects

• Summary



“The Trust, the unknown being”



Basic legal considerations

• A trust is an unknown being in Germany– German civil law does not acknowledge the trust as a legal tool

– As a result a trust is an “unknown being” in the day-to-day practice




• Comparable structures (“translation” into German legal structure)– Fiduciary relationship versus trust

• Fiduciary relationship is restricted to the escrow holder (Treuhänder) as a person

• In contrast, the trust is, as a basic principle, not restricted to the trustee

• Basically, the fiduciary relationship allows instructions etc. to a large extent

• Fiduciary relationship is neglected for tax purposes, as the grantor (Treugeber) is the economic owner of the assets for tax purposes




– Trust versus Foundation • Both legal forms establish a specific kind of separated assets

• The foundation itself is the holder of the assets

• In contrast the trust itself is not the holder of assets, but the trustee

• Trust itself has no legal capacity, but the foundation

– Other German related legal forms

• Preliminary heritage (Vor- und Nacherbschaft)

• Usufruct (Nießbrauch)

• Execution/administration of a will (Testamentsvollstreckung)

• Last will with specific conditions (Testamentsauflage)



Testamentary trust

• A German citizen is not entitled to set up a testamentary trust via testament nor may he/she dispose by last will such a formation



Testamentary trust

• Why is that?– A trust lacks legal capacity according to German law

– Germany did not sign the Hague Convention of July 1, 1985

– Basic German provision for succession law requires law of the state, the decedent is a citizen of

• Therefore a German citizen may only use acknowledged legal instruments for his/her testament planning

• Result a testamentary trust of a German citizen is invalid (!)

– Exemption • Real estate situated in common law countries

• German international private law allows a split of legal status regarding real estate



Testamentary trust

• Summary – A German citizen may not set up a testamentary trust regarding

e.g. securities, shares in corporations, cash etc., as such a testamentary trust would be invalid

– Real estate situated outside of Germany may be subject to a testamentary trust



Intervivos trust

• The foundation of an invervivos trust is possible according to German civil law– Foundation of an intervivos trust is not subject to law of

succession, but subject to law of obligations (Schuldrecht)

• German civil law differs between the law of obligations and the law of property (Sachenrecht). The transfer of legal title of assets usually requires effectiveness of both sides.

The foundation of an intervivos trust is possible according to German law of obligations



Intervivos trust

• What about law of property?– According to law of property the transfer of legal title is based

on the law where the assets are located

– As German civil law does not acknowledge the trust as a legal entity, the transfer of e.g. legal title to a trust is invalid, as far as assets are concerned, which are situated in Germany



Intervivos trust

• Further issue: the transfer of assets (situated in Germany) which are subject to registration – Can a trust be the legal owner of a real estate in Germany (legal

ownership requires registration in the real estate register)?

– Can a trust hold a participation in a limited partnership (limited partner is required to be registered in the trade register)?



Intervivos trust

• Summary – A German citizen may set up an intervivos trust regarding

assets which are situated in Germany

– A German citizen may not set up an intervivos trust regarding assets which are situated outside of Germany

– Both, a testamentary and an intervivos trust only work regarding

assets situated outside of Germany



Intervivos trust

• Example– Mr. Müller is a German citizen and wants to set up a trust in order to

avoid forced heirship rules. For this purpose he sets up a trust and transfers his entire German situated real estate to the trust. Was he successful in avoiding the forced heirship rules?

• The actual transfer of title in the real estate is legally valid only to the extent German law of property (Sachenrecht) has been followed

• Furthermore German law of property requires the registration of the acquirer of the real estate who should be registered as legal owner of the real estate in the real estate register?



Intervivos trust

– The transfer of German real estate to the trust is invalid. Mr. Müller was not successful in avoiding forced heirship rules.



The trust in German Income Tax Law

• What kind of income may trigger German income tax effects?– Income from investment activities, such as interest income,

dividends, capital gains etc.

– Rental income etc.

– only income from assets which are situated outside of Germany (due to the legal restrictions)




• Who is the tax entity, the trust, the settlor or the beneficiaries?– If German legal law does not recognize the trust as a legal instrument,

German tax law could follow and deny the effectiveness of the transfer of assets to a trust

– German tax law differs between legal law ownership and economic ownership in the underlying assets

• It depends on the individual trust structure if the transfer of assets to a trust is acknowledged by tax law

• Economic ownership of settlor can be assumed in case of fully revocable trust




• As a general rule, a trust is acknowledged as a specific legal estate and qualifies as an entity for tax purposes




• What is required to acknowledge a trust as “own” legal estate– The assets which have been transferred to the trust must have left

economic ownership of the settlor

– Trust as a separate legal estate requires a specific economic independence of the trust

– Extensive rights of settlor to give instructions to the trust may result in economic ownership of settlor

– Same is true if the administration of assets by the trust is predominantly in the interest of settlor (in such a case fiduciary relationship according to German law)

– Lack of legal capacity is of no further relevance for the acknowledgement of a trust for German tax purposes (Federal Tax Court, Decision of June 23, 1992 and February 2, 1994)




• § 15 Foreign Tax Act (AStG)– § 15 AStG deals predominantly with the taxation of so called “family foundations” – § 15 AStG is an anti-avoidance provision which provides a deemed income

allocation to the founder/settlor and/or the beneficiaries – § 15 AStG also applies to trusts – Any income of a trust will be allocated to the founders/beneficiaries, even if there

is no actual “distribution” of income to those persons– § 15 AStG is subject to supervision by the European Commission, European

Commission opened a breach of contract procedure against Germany because § 15 AStG seems to discriminate foreign foundations/trusts

– A suspension of this provision by Germany within Europe would not necessarily comprise trusts located in countries outside the EU such as in the US




• Example: Mr. Berger, who is a German citizen but who has been living for more than five years in the US sets up a US trust. Beneficiaries are his family members B, C and D. B will acquire the entire assets in case of dissolution of the trust. C and D are entitled to ongoing benefits.

Alternative a): C and D are not family members of Mr. Berger

Alternative b): B is not a family member of Mr. Berger

Alternative c): B and C are not family members of Mr. Berger




• In the basic alternative B is entitled to receive the entire assets. The trust is a family trust. Any income of the trust is allocated to B, C and D.

• According to alternative a) again only B is entitled to receive the entire assets. The trust qualifies again as a family trust.

• According to alternative b) the entitlement of C and D is decisive for the qualification of the trust as a family trust.

• According to alternative c) the trust does not qualify as a family trust.




• According to § 15 AStG any income of a family foundation with place of management/registered office outside of Germany is allocated to the individuals as far as they are subject to unlimited tax liability

• Family foundation is described as a foundation where the founder, his relatives and/or their descendants are entitled to more than half of the benefits of the foundation/trust




• Legal consequence of § 15 AStG– Deemed income allocation liquidity of taxpayer required !!!

– Shielding effect does not occur

– Foreign taxes are creditable in Germany




• “Regular” German income tax effects– If the beneficiaries are entitled to regular payouts by the trust,

they may also be liable to regular German income tax (as far as they are domiciled in Germany)

• § 15 AStG is the prevailing provision towards the “regular” income tax provisions



The trust in German Inheritance/Gift Tax Law• Legal status prior to March 4, 1999

– The transfer of assets to a trust is not subject to inheritance/gift tax

– Neither the trust nor the beneficiaries inherit any assets

– Only upon actual distribution of funds to the beneficiaries inheritance/gift tax is due

• Considerable deferral effects could have been achieved



The trust in German Inheritance/Gift Tax Law• Current legal status

– Foundation of a trust• The transfer of assets to a trust is subject to inheritance/gift tax

• All subsequent transfers of assets are subject to inheritance/gift tax

• The trust itself and the settlor (if settlor is resident in Germany) are liable for taxes

• Tax class III. applies the most detrimental tax class – Tax class III. varies between 17 % and 50 %

– Tax class I. varies between 7 % and 30 %



The trust in German Inheritance/Gift Tax LawValue of assets including

EURTax class

I

Tax class

III

512,000 15 % 29 %

5,113,000 19 % 35 %

12,783,000 23 % 41 %

25,565,000 27 % 47 %

more than

25,565,000

30 % 50 %




– Distributions of a trust• The distributions of a trust to a beneficiary are subject to

inheritance/gift tax

• Taxation only upon actual distribution (no deemed allocation of distributions for inheritance/gift tax purposes)

• Tax class goes by the relationship between settlor and beneficiary




– Dissolution of a trust • Dissolution of a trust and subsequent distribution of funds is again

subject to inheritance/gift tax

• Same tax class applies as in case of distribution, that is to say relation between settlor and beneficiary is decisive



Income tax versus inheritance/gift tax effects• § 15 AStG deemed income allocation and tax liability

• Actual distributions are subject to inheritance/gift tax

• Double taxation with income tax and inheritance/gift tax

• No tax credit between these to types of taxation !!!



Summary

• Foundation of a trust is subject to strong civil law restrictions

• Trust is subject to a rather detrimental tax treatment– Deemed income allocation according to § 15 AStG

– Detrimental tax class applies in case of setting up a trust (up to 50 %)

– Double taxation based on income tax and inheritance/gift tax liability

Trusts are not a preferred planning tool for German tax purposes



Contact

Christian BirkholzRechtsanwalt/SteuerberaterBaker & McKenziePartnerschaft von Rechtsanwälten,Wirtschaftsprüfern, Steuerberatern und SolicitorsFriedrichstraße 79-8010117 BerlinTel.: +49 (0) 30 – 203 87-720Fax: +49 (0) 30 – 203 87-699E-Mail: [email protected]

Germany Christian Birkholz Baker

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