Inheritance tax law in international inheritance cases

Introduction

In inheritance cases with an international connection, some problems also arise in the area of inheritance tax. For example, it is possible for inheritance tax to be payable both in Germany and abroad in international inheritance cases (double taxation). This may seem surprising, but it is the result of the tax sovereignty of each country and the frequent absence of international agreements between states. For this reason, we will first discuss the requirements for tax liability in Germany. We will keep these explanations brief, as we have already Contribution to German inheritance tax law which we refer to here. The possibility of offsetting tax paid abroad and the existing double taxation agreements are also discussed.

Tax liability in Germany

As we are developing German inheritance tax law in a own contribution we will only outline the main features that are important for understanding international tax law in probate matters.

When is there a personal tax liability in Germany?

In Germany, a distinction must be made between the unrestricted (taxation of the entire accumulation of assets) and the limited tax liability (taxation only of assets located in Germany).

Unlimited tax liability exists in accordance with Section 2 (1) No. 1 ErbStG if

• the Testator at the time of his death,
• the Schenker at the time of the execution of the gift or
• the Heir, legatee or the donee at the time the tax was incurred National is.

Nationals within the meaning of § 2 ErbStG are

• Persons who have a place of residence or habitual abode in Germany,
• German nationals who abroad for no longer than five years without having a place of residence in Germany,

or

• Irrespective of the five-year period, German nationals who
  • have neither a domicile nor their habitual residence in Germany and
  • are in an employment relationship with a domestic legal entity under public law and receive wages from a domestic public fund in return

Examples:

1) The testator had his last habitual residence in Düsseldorf. His son, who is the sole heir, lives in Amsterdam. The deceased bequeathed several properties in Düsseldorf and the Netherlands. As the deceased was a resident of Germany at the time of his death, the son's estate is subject to unlimited German inheritance tax liability. It is irrelevant that the son was resident in Amsterdam.

2) A daughter living in Düsseldorf inherits real estate and bank deposits in Austria from her father, who lived in Graz. As the heiress lives in Germany, the assets are subject to unlimited German inheritance tax liability. The fact that the inherited assets are located in Austria and the father died there does not change this. It is sufficient for the unlimited tax liability that the acquirer lives in Germany.The unlimited tax liability extends to all domestic and foreign assets acquired by the daughter by reason of death.

The limited tax liability pursuant to Section 2 (1) No. 3 ErbStG only exists if neither the testator at the time of death nor the acquirer (e.g. the heir, legatee) is a resident of Germany at the time the tax arises. In this case, taxation is limited to domestic assets only.

Pursuant to § 121 BewG, the following assets are considered domestic assets:

1. domestic agricultural and forestry assets;
2. domestic real estate;
3. domestic business assets;
4. Shares in a corporation (e.g. GmbH) that has its registered office or management in Germany, if the deceased alone or together with related parties held at least 10% of the company;
5. Copyrights if they are attributable to domestic business assets, are entered in a domestic register or if they have been transferred to a domestic commercial enterprise;
6. typical silent partnerships in a domestic company;
7. Rights of use to an asset that is listed as a domestic asset;
8. Debts and encumbrances insofar as they are economically related to domestic assets.

Examples:

1) The German deceased, who moved from Düsseldorf to Cas Concos on Mallorca over 5 years ago, leaves behind a daughter and a son, both of whom also have German nationality. The daughter has not lived in Germany for 3 years and has Spanish nationality. The son lives in Düsseldorf. The daughter and son are each entitled to ½ of the estate. The estate includes a property in Cas Concos (€1 million) and a condominium in Düsseldorf (€1 million). The assets accruing to the son are subject to unlimited German inheritance tax, regardless of whether the estate assets accruing to the son are located in Germany or Spain. The daughter, on the other hand, is not subject to unlimited tax liability in Germany, as neither her mother as the testator nor she herself as the acquirer are German nationals. Although the daughter only left Germany 3 years ago, she is not a German citizen, so she is not a resident within the meaning of § 2 EstG. She is only subject to limited tax liability in Germany with regard to her share of the condominium in Düsseldorf.

2) The couple are both German nationals and emigrated to Canada in the 1990s. They still have a bank account in Germany at the savings bank branch at their former place of residence in Krefeld. After the husband's death, the wife becomes his heir. As the husband as the testator and the wife as the acquirer had not been resident in Germany for more than 5 years at the time of death, they are not tax residents and the assets acquired by the wife are not subject to unlimited German tax liability. The fact that the wife still has German nationality is not in itself sufficient for tax liability. The acquisition of the credit balance at the savings bank is also not subject to limited tax liability in Germany, as credit balances at banks and savings banks are not domestic assets within the meaning of § 121 para. 1 BewG.

In addition to the above-mentioned assets, which are counted as domestic assets in accordance with Section 121 (1) BewG, the inheritance tax liability is extended to other assets under the conditions of Section 4 AStG (Foreign Tax Act). This so-called extended limited tax liability arises if the inheritance tax liability has arisen by the end of ten years after the end of the year in which the deceased's unlimited income tax liability ended and the requirements of section 2 para. 1 sentence 1 AStG were met at the time the tax arose. These requirements are met if the taxpayer is resident in a foreign territory and has significant economic interests in Germany. The extended limited tax liability extends taxation to the following assets in Germany:

1. Savings deposits and bank balances at financial institutions in Germany;
2. Shares and units in corporations, investment funds and open-ended property funds as well as business assets in cooperatives in Germany;
3. Capital claims against debtors in Germany;
4. Claims to pensions and other recurring benefits against debtors in Germany as well as usufructuary rights and rights of use to assets in Germany;
5. Inventions and copyrights that are exploited domestically;
6. Insurance claims against insurance companies in Germany;
7. Movable assets located in Germany;
8. Assets whose income is subject to extended limited tax liability in accordance with section 5 AStG;
9. Assets that are attributable to the extended limited taxpayer in accordance with Section 15 AStG. The

Which transactions are subject to tax?

According to § 1 ErbStG

• acquisition by reason of death;
• inter vivos gifts and
• Other special-purpose grants

German inheritance tax. As German inheritance tax law is interpreted broadly, the acquisition is also covered if a foreign inheritance law is applicable.

Double taxation

The basics of German inheritance and gift tax can be found in our article on national German inheritance law. Some basic features of the inheritance tax laws of other countries can be found in our respective country reports.

• Belgian inheritance case
• French inheritance case
• Dutch inheritance case
• Polish inheritance case
• Austrian inheritance case

As already explained, tax liability in Germany exists both if the testator was domiciled or last resided in Germany and if the transferee (e.g. heir, legatee, beneficiary of a compulsory portion, etc.) is domiciled or resident in Germany at the time the tax is due. Other countries also link the tax liability alternatively to the residence of the testator or the acquirer. Therefore, if the testator lives in one country and the heir in another, this alone may result in double taxation. In addition, the states have different connecting factors for the levying of taxes. Some states tax the estate, others the acquisition.

There are no standardised European rules in the area of international tax law, even within the EU. However, there are bilateral double taxation agreements that regulate the taxing rights of countries and are intended to avoid double taxation. Germany has concluded a double taxation agreement with six countries. These countries are Denmark, France, Greece, Sweden, Switzerland and the USA. In the case of inheritances with links to other countries, only the national regulations can avoid double taxation.

Exemption method

The exemption method can be anchored in a double taxation agreement. In this case, one state waives its right to tax and the other state is then entitled to do so. This may be the case with regard to the entire estate or only with regard to parts of the estate. 

Example: 

The couple are both German nationals and emigrated to the USA in the 1990s. They still have a bank account in Germany at the savings bank branch at their former place of residence in Krefeld. After the husband's death, the wife becomes his heir.

The double taxation agreement between the Federal Republic of Germany and the USA applies with regard to the taxation of the inheritance. The testator had his tax residence in the United States in accordance with Art. 4 para. 1 of the DBA FRG-USA. The bank balance at Sparkasse Krefeld is not one of the types of assets expressly mentioned in Art. 5 to 8 of the DTA FRG-USA. According to Art. 9 of the DTA D-USA, assets that form part of the estate or a gift of a person resident in a contracting state and do not fall under Articles 5, 6, 7 or 8 can only be taxed in that state (i.e. in the state in which the testator or donor was resident), irrespective of their location. As this is the USA in the example case, the bank assets are not subject to taxation in Germany under the DTA between Germany and the USA. If there are also small amounts of other assets that could be subject to taxation in Germany under Articles 5-8, there is no taxation in Germany at all. 

If the Federal Republic of Germany only waives its right to tax individual assets, this is done by applying the progression proviso in accordance with Section 19 (2) ErbStG. The following example should serve as an illustration:

The testator E dies with his habitual residence in Germany without having made a choice of law. German inheritance law is therefore applicable. His son A is appointed as his sole heir. He lives in Germany and is a German national. The assets consist of a bank account in Germany with a balance of EUR 500,000 and assets (property, etc.) of EUR 500,000 exempt under a double taxation agreement.

A is subject to unlimited tax liability in Germany, Section 2 ErbStG. The double taxation agreement withdraws part of the assets from German taxation law. Germany therefore has the right to tax the EUR 500,000 in the bank account. The real estate assets remain tax-free. After deducting the tax-free amount of EUR 400,000, A has a taxable acquisition of EUR 100,000. This would now be subject to a tax rate of 7 per cent in accordance with Section 19 (1) ErbStG. This is where the progression proviso pursuant to para. 2 comes into play, which also adds the assets exempted by the double taxation agreement as a basis for the taxation of the bank assets. If these assets are added, this results in a total estate value of EUR 600,000 (EUR 100,000 taxable bank assets and EUR 500,000 foreign assets). However, this is subject to a tax rate of 15 per cent. This means that 15 per cent tax is payable on the taxable EUR 100,000, i.e. EUR 15,000.

Crediting method

If no double taxation agreement is applicable, the tax paid abroad can still be credited. The basis for this can be found in § 21 ErbStG. However, a credit is subject to certain conditions:

• Application
• Unlimited tax liability of the heir in Germany
• Burden with comparable tax
• German tax liability arises within five years of the foreign tax liability arising

Only inheritance tax that is comparable to German tax can be offset. If the tax is not comparable, it can only be cited as an inheritance liability within the meaning of Section 10 (5) sentence 1 ErbStG and thus reduce the taxable acquisition. However, as the tax is usually comparable, problems rarely arise here. Only if the tax is structured as a type of income tax (e.g. Canada), the only option is to recognise it as a liability of the estate.

In addition, the tax must actually have been paid and the heir must not be entitled to a reduction from the foreign tax authorities. If he has such a claim, he must actually enforce it, as failure to do so would have a detrimental effect on German tax revenue.

If the tax paid abroad is higher than the German tax, the excess amount will not be refunded.

Concept of foreign assets

However, offsetting can only take place if the assets are foreign assets within the meaning of Section 21 ErbStG. Just because the assets are not located in Germany does not mean that they are foreign assets within the meaning of Section 21 ErbStG. The German Inheritance Tax Act follows its own definition here. Foreign assets according to § 21 ErbStG are,

• if the deceased was a resident at the time of death:

all assets pursuant to § 121 BewG that are attributable to a foreign state and

• if the deceased was not a resident:

all assets with the exception of domestic assets.

The imputation therefore depends on whether the unlimited tax liability in Germany applies because the testator was a German national or because the acquirer (e.g. heir) is a German national.

In the first case, i.e. if the deceased was a resident of Germany, the German tax authorities take into account the taxes levied by the foreign state if these relate to the assets specified in Section 121 BewG.

Example: The deceased resident in Germany (German national) leaves assets in an account at a Spanish bank. Spanish inheritance tax cannot be offset because bank assets are not mentioned in § 121 BewG. If unlimited tax liability applies in Germany because the acquirer is a German national and not the testator, it is easier to offset the tax. The German tax authorities then allow the tax levied by the foreign state to be offset almost in full. Only insofar as the tax levied by the foreign state relates to the assets located in Germany is not offset.

Offsetting in the case of unlimited German tax liability if the estate consists exclusively of foreign assets:

If the estate consists exclusively of foreign assets, the entire foreign tax is credited against the German tax.

Example: Testator E is inherited by his son S as sole heir. S is a German citizen and also lives in Germany. The assets consist exclusively of foreign assets (e.g. property in Spain) with a value of EUR 500,000. It is assumed that EUR 20,000 of this is subject to tax abroad. In Germany, S would have a tax-free allowance of EUR 400,000. The taxable amount here would therefore be EUR 100,000. This is subject to a tax rate of 7 per cent (EUR 7,000). The S can now offset the Spanish inheritance tax. As the amount exceeds the German inheritance tax, no tax has to be paid in Germany, but the excess amount is not refunded.

Foreign tax credit in the case of unlimited German tax liability if the estate includes foreign assets and domestic assets.

If the deceased's assets consist in part of domestic and foreign assets, a division is made. The foreign inheritance tax can only be offset to the extent that the foreign assets are also subject to German inheritance tax. Otherwise, a high foreign tax could also reduce the tax due on the domestic assets.

For this purpose, the partial amount of tax due on the foreign assets must be determined. This is done in three steps:

1. Calculation of total taxable assets

The total assets consist of domestic and foreign assets. The value of the entire estate is determined at this point.

1. Determination of taxable foreign assets

The share of foreign assets is then calculated. Estate liabilities and debts can only reduce the value if they have a direct economic connection with the foreign assets.

1. Determination of the ratio and application

The ratio is calculated by comparing the total taxable assets and the taxable foreign assets. This ratio is now applied to the German inheritance tax. This results in the German inheritance tax due on the foreign assets. Only this amount can be offset.

Example: Daughter T is the sole heir of the deceased E. He had bank assets totalling EUR 1,000,000 at a savings bank in Germany. The foreign assets consist of a property in Spain worth EUR 500,000. T has already had to pay tax on this in the amount of EUR 50,000. She now wants to offset this.

Step 1Total assets amount to EUR 1,500,000.

Step 2The value of the taxable foreign assets is EUR 500,000.

Step 3The ratio of foreign assets to total assets is one third. The assets of EUR 1,500,000 less the lump sum for inheritance costs (Section 10 para. 5 no. 3 ErbStG) of EUR 10,300 and the tax-free amount (Section 16 para. 1 no. 2 ErbStG) of EUR 400,000 results in a taxable acquisition of EUR 1,089,700. The tax rate is 15 per cent, i.e. EUR 163,455. The taxes paid abroad can be offset against this up to a maximum rate of one third (EUR 54,485). The Spanish inheritance tax (EUR 50,000) can therefore be offset in full. This means that EUR 113,455 in tax still has to be paid in Germany. 

If you have any further questions, please contact your specialist inheritance lawyer in Düsseldorf and Krefeld, Dr Michael Gottschalk.