Cornelia Barnbrook (cornelia.barnbrook@ber-auren.de), Tax advisor and specialist consultant for international tax law. Member of the Auren Team Global Taxperts – our experts for cross-border tax issues

Need to take action by the end of the year

A significant tightening of exit taxation will come into effect on 1 January 2022. One of the most significant changes is the elimination of the deferral option in EU/EEA cases. This article describes the options for action available until 31 December 2021 where moving abroad is already planned and multiple residences are involved. in cases where moving abroad has already been planned and in the case of multiple residences.

What is behind all this?

Exit taxation applies, inter alia, to private individuals who have a shareholding of more than 1% in a company as part of their private assets and who have been subjected to unlimited tax liability in Germany for a total of at least ten years. The purpose of Exit Taxation within the scope of Section 6 of the German External Tax Relations Act (Aussensteuergesetz, AStG) is to ensure that unrealised capital gains on shares are taxed virtually at the last moment before Germany loses its right of taxation. There are other circumstances that may trigger Exit Taxation under Section 6 AStG. This article only deals with cases under Section 6(1) No. 1 AStG where the individual is relocating his or her residence or habitual abode. If residence is transferred abroad and Germany loses the right of taxation, unrealised capital gains as defined in Section 17 of the German Income Tax Act (Einkommensteuergesetz, ESTG) are subject to imputed taxation as if the share had been sold at its fair market value. This results in a de facto tax burden without an actual inflow of liquidity through a sale.

Up to now, the Exit Tax could be deferred indefinitely when relocating to an EU/EEA State. When the place of residence is changed after 1 January 2022, the previous distinction between moving to a third country and moving within the EU/EEA will cease to apply and with it the possibility of deferral. In future, this deferral will be replaced by instalment payments; the tax can be paid in seven equal annual instalments on application, provided that collateral is provided.

Who needs to take action?

1. Persons who have already considered changing their place of residence to an EU Member State/contracting State of the EEA
   Recommendation:
   Move quickly by 31 December 2021 and actually give up your residence in Germany. This means that you can still benefit from the old rules. Although Exit Taxation applies, it can be deferred without interest for an unlimited period and therefore does not represent an actual burden. The tax only becomes due at the time of a later sale of the shares.

2. Persons who have several residences in the EU/EEA
   Those who maintain additional residences in other countries may also be subject to an unlimited Income Tax liability in other countries. For these persons, there is a risk that Germany will lose the right to tax the shares, for example, through a gradual shift of the main place of residence without this terminating the unlimited tax liability. This is where a nasty surprise lurks, as Exit Taxation may be triggered unknowingly and unexpectedly. If this occurs from 2022 onwards, the tax office will be pleased and will collect the Exit Tax.
   
   Recommendation: Create a clear and unambiguous legal situation by 31December 2021. There are two ways to do this:
   • Relinquish German residency before the end of 2021. This means that Exit Taxation will take effect in 2021, and Germany will lose the right to tax the shareholding in the company in favour of another Member State of the EU/EEA. The tax can be deferred indefinitely
   • Strengthening the German residence position so that Germany is clearly seen to be the principal place of residence from 1 January 2022.
     
     If the previous personal living arrangements are maintained, it will be difficult to avoid the risk of Exit Taxation in the future. Arrangements made under company law to avoid Exit Taxation are not recommended in the short term, but are nevertheless, worth considering in the medium term.  The following arrangements may provide a way of avoiding Exit Taxation:
     – Transfer of shares to a German family foundation
     – Transfer of shares within the framework of anticipated succession
     – Change of the legal form of the company into a partnership
     All arrangements made to avoid Exit Taxation entail other financial disadvantages; the advantages and disadvantages must be weighed up carefully
     

Conclusion

If you belong to the group of persons for whom urgent action is required, you should take the above measures immediately after consulting your tax advisor. If you are already subject to tax in other countries, you should bring the tax advisors there on board so that the team of advisors involved can work out an optimal global tax strategy for you.

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