Goodbye Germany - Focus on exit taxation
Many entrepreneurs seek their (tax) fortune abroad and why not, when the prospects are brighter abroad. For shareholders of corporations, however, moving abroad often means paying high taxes in Germany.
The reason for this is the so-called exit taxation (Section 6 of the Foreign Tax Act). This provision has existed in German tax law since 1972 and will be significantly tightened from January 1, 2022.
Essentially, the German legislator wants to tax the assets created in Germany before the move. This is because this is generally no longer possible after moving away.
Despite new regulations from 2022, the basic concept of exit taxation remains fundamentally unchanged. The following article mainly refers to the new regulations.
What is exit taxation?
Anyone who has been subject to unlimited tax liability in Germany for at least 7 of the last 12 years and holds shares in a German or foreign corporation as private assets is subject to the so-called German exit tax when moving away. Provided the shareholder meets the minimum shareholding requirement of 1% within the last five years prior to departure. This is also referred to as shares within the meaning of Section 17 of the Income Tax Act.
If exit taxation is applied, a sale of the investment is deemed to have taken place at the time of exit. A “notional capital gain” is therefore taxed. Taxation therefore takes place without an inflow of liquidity.
Note: The term “exit tax” is used in everyday language, but in legal terms this is income tax.
Moving away - what does that mean?
Moving away generally means giving up your German place of residence. The following cases are covered by the law:
- The shareholder gives up his German domicile or habitual residence. Both conditions entitle the shareholder to unlimited tax liability in Germany.
- The participation is transferred to a person not resident in Germany, e.g. after death or by way of a gift.
- The German right to tax the profit from the sale of the investment is restricted or excluded.
A move away does not always have to be obvious or planned. If the shareholder dies in a car accident, for example, and his children (heirs) live abroad, e.g. because they are studying abroad, they may be subject to exit taxation in addition to any inheritance tax liability.
How is the exit tax calculated?
A sale of the shares is deemed to have taken place upon departure. The shares are then deemed to have been sold at fair market value. The shares must therefore be valued before the move. The valuation is carried out using the simplified capitalized earnings value method (pursuant to sections 199 et seq. of the German Valuation Act (BewG)).
The notional capital gain is calculated on the basis of the fair market value of the shareholding less the shareholder’s acquisition costs.
This profit is taxed at the shareholder’s personal income tax rate (plus solidarity surcharge and, if applicable, church tax). However, the so-called partial income method applies. This means that only 60% of the profit is taxed, 40% is tax-free.
If the shareholder is subject to the top tax rate of currently 45%, the tax rate is approx. 27% plus solidarity surcharge and, if applicable, church tax.
Payment of exit tax
The departure must be declared in the tax return for the year of departure. The tax must therefore be paid when the tax return is submitted or upon receipt of the tax assessment notice.
However, the shareholder can apply to pay the exit tax in seven interest-free installments. Payment in installments is generally only granted if the shareholder provides a security deposit.
The following securities are provided for by law in the event of exit taxation: Depositing money with the tax office, pledging securities, handing over a savings book, mortgages, land charges, promises of debt, guarantees, etc.
Payment by installments is a payment facility. Several conditions must be observed in order to obtain this payment relief. For example, the installment payments must be made on time; certain obligations to cooperate must be fulfilled; profit distributions are possible to a limited extent, etc.
If these conditions are violated, the installment payment will be revoked and the outstanding tax will become due within one month.
Temporary absence
If the shareholder moves back to Germany within 7 years of moving away and thus becomes subject to unlimited tax liability in Germany again, the exit tax does not apply under certain conditions (e.g. the shares have not been sold in the meantime). A temporary absence is therefore an exception.
However, the tax authorities are restrictive in this respect. This applies in particular under the old legal situation. According to this, a temporary absence can only be assumed if there was already an intention to return to Germany at the time of departure. Mere declarations of intent are not sufficient. Each individual case must be assessed according to the overall circumstances.
As the new legal situation from 2022 will hardly change in this respect, it can be assumed that the tax office will continue to require an intention to return at the time of departure.
If the shareholder intends to move away only temporarily, arrangements for the return should already be organized and documented at the time of departure.
How do you avoid exit taxation?
Avoiding exit taxation requires planning in advance. In this respect, the move should not be rushed. In most cases, a time horizon of six months to one year is required.
There are many ways to avoid exit taxation. These include:
- Maintaining a place of residence in Germany
- Planning to move away only temporarily
- Giving away the shares in advance of moving away (note: gift tax)
- Transferring the shares to a foundation
- To contribute the shares to an operating partnership
- Etc.
The tax structuring options essentially depend on the wishes of the shareholder and the type of business operations in Germany. Every tax structure also has advantages and disadvantages, so a detailed tax audit is recommended in every case.
From an economic point of view, in some cases it may even make sense to accept the exit tax. This is the case if the foreign country has a lower tax burden than Germany and the company value increases many times over in the years following the departure. In this case, the total tax burden could be lower when the investment is sold abroad. This is a speculative option and should be considered in detail in advance.
Practical tip
The exit tax relates to the taxation of shares in a company and does not generally affect the company itself, which often continues to operate in Germany. However, the departure of the shareholder can certainly result in tax pitfalls for the company.
Moving away from Germany does not per se end your tax liability in Germany.
Within the scope of the so-called limited tax liability, the shareholder can remain liable to pay tax in Germany. Limited tax liability exists if the shareholder receives domestic, i.e. German income, such as rental income.
In addition, the extended limited tax liability must also be taken into account.
It is therefore advisable to also keep an eye on the legal tax consequences after moving away.
Are you planning to move away and need tax advice?
I am happy to support you in the following areas:
- Checking the requirements for exit taxation
- Arrangements to avoid exit taxation
- Assistance with appeals and lawsuits before the tax courts in connection with exit taxation
- Expert opinion on individual questions of exit taxation
Please feel free to contact me!
Disclaimer
This article does not constitute legal or tax advice, but is for general information purposes only. Every situation is individual, so I always recommend professional advice to avoid tax disadvantages.
The article uses simple language for better understanding and is also abbreviated with regard to the individual conditions required by law.
Last updated December 01, 2021
