Drastic Tightening of Exit Tax as of 1 January 2022
On 21 May 2021, the German Bundestag (Federal Parliament) has approved the Bill on the Implementation of the European Anti-Tax Avoidance Directive (ATADUmsG). Beyond the scope of the named Directive, which only concerns business assets, the German legislator has also revised the exit taxation for privately held company shares (see our client information of 15 January 2020). In particular, the interest-free, indefinite deferral in the case of a relocation of EU/EEA citizens within the EU/EEA area is abolished and replaced by the possibility of a seven-year instalment payment. The Bundesrat (Federal Council) is scheduled to approve the law on 25 June 2021.
The new regulation will be effective for all relocations from 1 January 2022 (sec. 21 para. 1 AStG-new). International entrepreneurial families and family businesses in particular may be affected by the tightening. Shareholders planning a relocation under the current rules with its generous deferral rules for relocations within the EU should act swiftly.
The German exit taxation (sec. 6 AStG) will be revised as of 2022. In particular, the interest-free, unlimited deferral will be abolished for relocations of EU/EEA citizens within the EU/EEA area. In addition, the personal scope of application and the so-called returnee regulation will be revised.
1. General Information on German Exit Tax
When a shareholder moves abroad, Germany subjects the value increase of a shareholding of at least 1% (in individual cases even less than 1%) of a corporation’s capital to income tax, deeming a sale of such shares (sec. 6 Foreign Tax Act, Außensteuergesetz – AStG and sec. 17 Income Tax Act, Einkommensteuergesetz – EStG). Thus, Germany secures the right to tax the hidden reserves in privately held shares generated in corporations until the taxpayer’s relocation from Germany at the moment he moves abroad. Since under most double taxation treaties (DTT), the state of residence has the right of taxation on the capital gain from the sale of privately held shares in a corporation (Art. 13 para. 5 OECD model tax convention), Germany loses the taxation right on relocation of German taxpayers. However, already today, the provisions of sec. 6 AStG go beyond the purpose of a final taxation of all hidden reserves generated in Germany and accordingly display in several respects an excessive taxation tendency.
2. Personal Applicability of the Exit Tax
According to the current law, the taxpayer must have been subject to unlimited tax liability in Germany for at least ten years – in the course of his entire life up to his exit – in order to be subject to the exit tax at all.
Future System according to the ATADUmsG
The new law provides for a reduction of the period of unlimited tax liability required before the exit from ten to seven years. This means that taxpayers moving to Germany will be subject to exit tax three years earlier. However, in future, in the case of relocation, the duration of the unlimited tax liability will no longer be determined on the basis of the entire lifetime, but only on the basis of the last twelve (time-) years.
3. Abolition of unlimited Deferment when moving to another EU/EEA Country
Under current law, if a taxpayer moves to another member state of the EU or EEA, the tax owed must be deferred unlimited, interest-free and without security, as long as the taxpayer is an EU/EEA citizen and continues to hold its shares.
Future System according to the ATADUmsG
The draft bill no longer provides for a permanent deferral of exit taxes. The law will no longer distinguish between relocations of EU/EEA citizens to other EU/EEA countries on the one hand and relocations of third-country nationals and relocations to third countries on the other hand. In future, the tax will generally be due immediately in all cases. Upon request, it is possible to pay the tax in seven equal annual installments if the taxpayer provides a collateral security to the tax office for this purpose. No interest will have to be paid on the installments.
Thus, the legislator substantially tightens the taxation of relocations of EU/EEA citizens to other EU/EEA countries, since permanent deferral will be no longer possible and relocating citizens will generally have to provide security even in purely EU/EEA cases. In contrast, for relocations to third countries, the possibility of extending the payment to seven equal, non-interest-bearing annual installments will be introduced for the first time.
4. Temporary Abscence (“Returnee Provision”)
Under current law, the exit tax lapses with retroactive effect if the taxpayer is only temporarily absent (with well documented intention to return at the time of relocation!) and re-establishes unlimited tax liability in Germany within five years after the exit. An extension of this period to a total of ten years is possible if the taxpayer can plausibly demonstrate that his absence is due to professional reasons and he still has the intention to return. In the case of relocations of EU/EEA citizens within the EU/EEA area, the possibility of return has so far been unlimited in time.
Future System according to the ATADUmsG
The rules regarding the return of taxpayers will in principle still apply, but the regular period will be extended from five to seven years. An extension by additional five years up to a total of twelve years will also be possible, whereby only the continued intention to return is required; the existence of professional reasons will no longer be necessary. Upon application of the returnee, annual installments will not be levied. On the other hand, the hitherto unlimited return regulation for relocating EU/EEA citizens is to be abolished.
According to the explanatory statement to the law, it will not be necessary in the future to substantiate the intention to return. However, considering the unchanged wording of the provision and the partly contradictory explanatory statement, it seems possible that the tax authorities could continue to demand for the intention to return to be existent at the time of departure. Therefore, it is strongly recommended that in case of an exit, the taxpayer still carefully documents such an intention in the future in order to benefit from the retrospective omission of the exit tax in case of a later return to Germany.
If a deferral is applied for under the usage of the returnee provisions, no installments are due for the entire deferral period until the taxpayer returns to Germany. This combination is therefore recommended. According to the intention of the legislator, this way shall in future be the only possibility for a shareholder of a corporation of more than 1% to be able to terminate the tax liability in Germany without incurring an immediate exit tax burden.
5. Revocation of Payment in Installments
In future, any transfer that is not made upon death is to be detrimental to the deferment, regardless of whether the recipient is resident in Germany or abroad.
Another planned tightening is a regulation according to which in future profit distributions or deposit repayments from the corporation with a volume of at least 25% of the value of the taxpayer’s shares will trigger an immediate due date of the tax. This can lead to a (partial) “lock-up” of assets in the company, which should definitely be taken into account when planning to relocate.
6. Collateral Security
According to current law, collateral security for the deferred exit tax only has to be pro-vided to the tax office by a taxpayer who is moving to a country outside the EU/EEA.
Future System according to the ATADUmsG
Due to the legislator’s intention to put EU/EEA cases on an equal footing with third-country cases, there will be no longer a distinction between relocations to third countries and EU/EEA countries – to the detriment of taxpayers who wish to move within the EU/EEA. In the future, in general, collateral security for the exit tax has to be provided for all relocations. This will be an impossible obstacle for many taxpayers even if applying for the seven-year installment payment. This is because, according to the tax authorities of at least some federal states, the shares of the corporation subject to the exit tax themselves cannot be accepted as collateral security. If the taxpayer does not have valuable German real estate, federal treasury bonds or similar assets with sufficient value at his disposal, the exit tax could become due immediately, even in the case of relocations of EU/EEA citizens within the EU/EEA.
However, there are good reasons to take the view that tax authorities will have to exercise their discretion in demanding a collateral security (“as a general rule”) in accordance with the freedom of capital movement and freedom of establishment in a way that no such security can be demanded within the EU/EEA. This is because the EU Recovery Directive applies in this respect, therefore there should be no risk for the German tax revenue. Nevertheless, in the majority of future cases, this may assumingly only be enforceable with assistance by the Tax Courts.
7. Assessment and Outlook
The Federal Ministry of Finance (Bundesfinanzministerium – BMF) had been planning the tightening of the exit tax for some time; the first draft bill was published on 10 December 2019. The second draft bill appeared on 24 March 2020 and was adopted by the Federal Government exactly one year later, on 24 March 2021. Despite criticism in the parliamentary expert’s hearings, the government’s draft was passed unchanged by the Bundestag.
From our perspective, it is doubtful whether the new regulations can withstand European law. After all, in its judgment in the Wächtler case (of 26 February 2019, C-581/17), the European Court of Justice (ECJ) emphasised the requirement of equal treatment of domestic relocations with cross-border relocations within the EU/EEA area (as well as Switzerland in the specific case). The explanatory memorandum to the law itself explicitly addresses this contradiction, but refers to other, older ECJ case law in connection with the tax “disjunction” (Entstrickung) of business assets. According to the legislator, on the basis of this case law, the new regulation “should” (wording of the explanatory memorandum) be in conformity with European law.
In particular, the extensive equalisation of relocations to Switzerland with EU/EEA relocations on the basis of the Agreement on the Free Movement of Persons between Switzerland and the EU (Freizügigkeitsabkommen) by the Wächtler judgement of the ECJ may have been (one) reason for the tightening of the German exit tax which has now been passed. The explanatory memorandum to the law states that an extension of the deferral option to third countries, “especially Switzerland”, would have been a “wrong signal in terms of tax policy”.
Overall, the stricter regulations are to be classified as excessively restrictive. They impose a direct and substantial restriction of Intra-European mobility particularly for shareholders of medium-sized businesses. The freedom of capital movements and the freedom of establishment within the EU and the EEA are significantly more restricted by the planned new regulations than it is the case under the current law. For relocations to Non-EU/EEA-countries (especially also to countries without a free movement agreement (Freizügigkeitsabkommen) with the EU and even to countries without a DTT with Germany), on the other hand, the new regime brings a substantial improvement of the legal status due to the easier possibility of making payments in instalments – at least also a certain “fiscal policy signal”.
Since the new rules only apply to relocations from 1 January 2022, the existing exit tax regime can still be used until the end of the year. For deferrals granted on removals up to 31 December 2021, the old law continues to apply unchanged from 1 January 2022. We will be happy to advise you.