ViewPoint – Mittelstand tax changes are disturbing

At the end of last year, the German Federal Constitutional Court declared that certain rules regarding the exemption of family businesses from inheritance tax are unconstitutional. Families are worried about the potential changes. Are they right to be? Broadly, no. But on some of the details, yes.

The background is that Germany currently has very favourable tax laws concerning the transfer of family business assets to the next generation. For example, if a limited partnership is valued at €10m and it is transferred as a gift to a son or daughter then only 15% of that is subject to tax. The actual tax amount without exemptions and other corrections is just €285,000, or 19% of €1.5m. So in reality the tax rate is just 2.85%.

In December Gemany’s top court said that this rate is too low, and has to change. The government has until June 30, 2016 to come up with a new system. The worst case scenario is that the government fails to come up with a new law, and the inheritance tax relief for family businesses is abolished.

When it is eventually passed the new law could be back-dated to 2009, although most experts doubt this and reckon it will come into force from December 2014.

It is possible that Germany’s family-owned businesses, which of course form the bedrock of its economy, could be damaged. But in reality things are not as bad as they might seem. Lawmakers are aware of the risks. The state secretary in the ministry of finance, Michael Meister, has said the federal government will always adhere to the inheritance privileges for corporations. He said the court has “merely objected to certain aspects of the existing rules”. The majority of voters are also in favour of the family business exemption.

In fact, the present exemptions for business assets (Betriebsvermögen) of family businesses are in principle accepted by the court, and only certain details have to be changed. Although the situation is not catastrophic, family businesses are rightly worried about the implications of the court’s decision.

For example, the proposed new regime will say that to qualify for exemptions the company cannot be sold for five years, and a minimum of 80% of wages and salaries of the staff in the business must be paid in every year of a five-year period for the business to qualify.

Another point is that so-called administrative assets (Verwaltungsvermögen), which include land and buildings rented to an outsider, shares, bonds and cash should not be more than 50% of the business assets, or tax advantages will be lost.

What this means for small business, ie those employing a maximum of 20 employees, is that they will have to produce more documentation to satisfy the tax authorities.

Big family businesses will also be audited in much more detail, and exemptions will be allowed on a case-by-case basis. There are still lots of areas to be discussed, but what we know so far has led family businesses to be concerned that the new regime will be onerous.

Whatever the implications of the court’s decision there is little doubt that its ruling will become the central political point for family businesses in Germany in the next few years.

As Ulrich Grillo,  president of the Federation of German Industries, said: “Politicians must keep their promise to  protect generational change at family companies. Anything else endangers investments and jobs.” A heavy-handed approach by lawmakers risks damaging a sector that has been built up over generations, and fracturing Germany’s economic backbone.

Dieter Schmidt, is a senior partner in the accountancy firm HLB Treumerkur Dr. Schmidt und Partner KG. He advises many Germany’s family-owned businesses, as well as running his own family business, which is now in its second generation of ownership.