Germany Must Revise Estate Tax Exemptions for Businesses

The German government must revise rules that allow families to transfer companies from one generation to the next without paying estate tax after the country’s top court ruled the current exemption is unconstitutional.

The inheritance law gives an unfair advantage to family-owned businesses over individuals passing on non-company assets, the Karlsruhe-based Federal Constitutional Court said in a ruling today. The court gave the government until the end of June 2016 to amend the tax rules.

Political and business leaders have expressed concern about the impact of the ruling on the country’s 3 million small and medium-sized companies, most of which are privately owned and serve as the backbone of Europe’s largest economy. Collectively known as the Mittelstand, owners of these companies have said losing the exemption threatens their ability to finance growth.

“Politicians must now keep their promise to continue to enable generational handover at family enterprises,” Ulrich Grillo, head of the BDI industry group, said in a statement. “Anything else will endanger investments and jobs.”

Under the current law, corporate assets can be passed on tax free as long as the heirs keep the business for at least seven years without substantial firings. More than 130,000 family businesses with 1.6 million employees are set to change hands by 2018, according to the BVMW industry association.

Fewer Exemptions

Exemptions in 2012 were nearly 40 billion euros ($50 billion), while revenue from the tax was only 4.3 billion euros, said Ferdinand Kirchhof, the court’s vice president.

The court ruled that the country’s bigger family-owned companies must pay the tax unless they can prove that the exemption is necessary for financial reasons.

“Big companies, particularly those competing internationally, won’t be happy about the ruling,” Rainer Kirchdoerfer, board member of the Munich-based Family Business Foundation, told reporters in Karlsruhe. “This will result in a few companies relocating abroad.”

Lawmakers also need to eliminate loopholes that allow companies to pass on assets tax-free that are not directly linked to the operations, the court said. Some small businesses can still receive the exemption, it said.

Investment Endangered

About 20 percent of Mittelstand companies are concerned that an end to the tax privilege would threaten their continued operations, according to preliminary figures from the BVMW’s end-of-year survey of its 270,000 Mittelstand members. Another 10 percent say they’d have to invest less as a result.

“I don’t expect major redundancies in the next two years,” Kirchdoerfer said. “But in the long run the job situation will be negatively affected by the ruling.”

More than 90 percent of German companies are family-owned, generating more than half of private sector revenue and employ more than 50 percent of the workforce, according to the family foundation.

A group that represents companies that manufacture heavy equipment called on the government to completely scrap the inheritance tax.

“The loss in revenue would be a well made investment to ensure that Germany will remain attractive for the industrial Mittelstand following generational changes,” said Hannes Hesse, head of the Frankfurt-based machine makers’ association.

Merkel’s Christian Democrats promised ahead of the decision to take action if necessary. Finance Minister Wolfgang Schaeuble told magazine Der Spiegel in an article published over the weekend that he could introduce new discounts to spare family-owned companies from a higher tax burden.

“The federal government welcomes the legal clarity established now,” German Deputy Finance Minister Michael Meister said in a statement. “After careful consideration of the written reasons for the judgment, the legislature will decide on the necessary revision.”

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