On 17 December 2014 the German Constitutional Court (Bundesverfassungsgericht – BVerfG) handed down a decision on the constitutionality of the current exemption regulations for business assets pursuant to Sec. 13a, 13b Inheritance Tax Law (ErbStG). The BVerfG confirmed that the current rules are unconstitutional as they allow the taxpayer to qualify non-operating private assets as business assets by using legal arrangements, and to transfer an unlimited amount with a low or nil donation or inheritance tax burden. The Constitutional Court is of the opinion that this treatment is, and always has been, inconsistent with the purpose of the current law and is incompatible with the German Constitution (Article 3 para. 1).

Given that, in general, the BVerfG considers exemptions from the taxation of transferred business assets as constitutionally permissible, exemptions of up to 100% are theoretically possible. However, this principle should not apply to exemptions granted to small- and medium-sized companies without a needs test (Bedürfnisprüfung). The payroll control (Lohnsummenregelung) should also be kept in the law, if the critical limit is set at a few employees only and the potential to establish arrangements that circumvent the payroll control – by dividing a company into ownership and operating companies – is eliminated. Lastly, the Constitutional Court criticised the current system of allowing an administrative asset ratio (Verwaltungsvermögensquote) of up to 50%, as currently a 50% ratio has no negative effect on the tax exemption under Sec. 13a, 13b ErbStG. Instead, it considers that sound justification should be required if administrative assets are to be exempt from taxation in the future.

It is now for the legislature to draft the necessary changes to the law and implement them by 30 June 2016, thereby ensuring the constitutionality of the exemption regulations for business assets. For the time being, the provisions of Sec. 13a, 13b ErbStG continue to be applicable. However, being unconstitutional, they should not be used excessively. The BVerfG clearly states that such excessive use would not benefit from the usual protections and the legislature could foreseeably impose new rules from the date of the decision and with retroactive effect. Provided the above statements of the BVerfG on excessive use are observed, transfers of business assets under the current tax regime should still be possible until 30 June 2016. A first draft law is expected to be presented in the near future with information in the market suggesting that the new law may be finalised by the end of this year at the latest.

We are following the legislative procedure closely and will inform you about the changes in the law as soon as they are published. Please do not hesitate to contact us if you have any questions on how to structure an appropriate solution for German clients to achieve the afore-mentioned benefits.