Trust and taxation in Germany
Trusts are basically unknown in German Civil law and Anglo – American trusts are seen as a tax avoidance instrument by the German Government. Thus, German Tax law contains several provisions that significantly impact the taxation of a trust created by a person with fiscal domicile in Germany. The following article outlines the legal framework and gives recommendations to avoid the tax traps of German tax law.
Taxation in Germany: German fiscal Domicile
Unlimited taxation in Germany is mainly linked to the fiscal Domicile of the taxpayer. Therefore, I would like to start with a definition of this expression. According to Art. 4 of the 
German – American Convention for the Avoidance of Double Taxation with respect to taxes on estates, inheritances, and gifts (hereafter: “Double taxation agreement) a person has a fiscal Domicile with respect to the German inheritance and gift taxes (hereafter “IHT”) in Germany if has his domicile (“Wohnsitz”) or habitual abode (“gewöhnlicher Aufenthalt”) in Germany as defined by German tax law. According to § 8 German General Tax Code (“Abgabenordnung”) a person is domiciled in Germany if he possess a home in Germany under circumstances from which it can be assumed that he will keep this home and use it. Habitual abode is found when somebody stays in a place under circumstances from which it can be assumed that his stay is more than temporary (e.g. a long-term rented hotel suite). If the person (e.g. the settlor) has a domicile in the US and Germany, the domicile is deemed to be in the State with which his personal and economic relations are closest (for further information see Art. 4 of the Double taxation agreement, Annex 3). Additionally, a German national who moves to the US is deemed to have German fiscal domicile for another 10 years (see Article 4 sec. 4 c. Double taxation agreement).
Taxation of the transfer of the assets to an inter vivos trust
Under § 7 Abs. 1 Nr. 8 German inheritance and gift tax Act (hereafter “inheritance tax act”) any lifetime transfer to another person without adequate compensation is taxable. The transferor (e.g. settlor) and the transferee (e.g. trust) are liable for the payment of the tax.
In principle there is no “transfer” in the meaning of the German inheritance tax Act if the transferee is not a separate legal entity. Thus, while any transfer of assets to a Delaware Statutory Trust (legal entity) by a German tax payer is taxable in Germany, a transfer to a common law trust would not be taxable in Germany.
However, in its 1999 special provisions, the German government provided for the taxation of transfers to trusts that are not legal entities. Thus, under § 7 Section 1 Nr. 8, Satz 2, the transfer of assets to a trust is taxable in Germany regardless if the trust is defined as legal entity or not. As the transfer is taxed in the tax class III the consequences of this taxation may be crucial.
Example 1:
Settlor A transfers EURO 500,000 to the AB Trust. Taxes payable at transfer:
| EURO |
Transfer to the Trust = Taxable acquisition of the trust | 500,000 |
- 20,000 | |
Tax Base | 480,000 |
x 0,5 | |
Tax Due | 240,000 |
Exceptions of the taxation of the transfer to the trust
A transfer of assets is not taxable in Germany if the transferor doesn’t lose control of the transferred assets. Thus, the transfer of assets to a (common law or statutory) trust is not taxable under the following conditions:
- The settlor has the right to change the trust document at any time and
- he has the right to revoke the trust at any time and
- he has the right to give the trustee instructions with respect to the management of the trust assets and the distribution to the beneficiaries.
German Federal Finance Court, decision dated Juni 28th 2007, file number II R 21/05
Please note: If the settlor loses control of the trust assets after the creation of the trust e.g. because he dies or because he becomes mentally incapacitated, IHT is triggered.
Taxation in the case of final distribution (dissolution of the trust)
The final distribution of the trust assets to the beneficiary is subject to German gift tax under § 7 Abs. 1 Nr. 9 Satz 2 ErbStG; tax class is determined by the family relation between the settlor and the beneficiary (see § 15 Abs. 2 Satz 2 ErbStG). Any distribution within the last 10 years prior to the final distribution is added to the taxable acquisition for the calculation of the tax (see § 14 ErbStG).
Example 2: Settlor A transfers in 2001 EURO 500,000 to the AB trust. The trustee is T, a professional trust manager. Under the terms of the trust document T is free to administer the trust assets. The income of the trust (EURO 100,000) is distributed to the A`s son B during the lifetime of A. Upon the death of A the trust assets are distributed to his A´s son, B (beneficiary).
| EURO |
Tax due for the transfer to the Trust (see example 1) | 240,000 |
| EURO |
Final distribution | 500,000 |
Distributions to S in the last 10 years | 100,000 |
Total taxable acquisition | 600,000 |
Tax allowance | - 400,000 |
Tax base | 200,000 |
Application of tax rate according to § 19 ErbStG | x 0,11 |
Tax due | 22,000 |
| EURO |
Tax due | 262,000 |
Example 3:
Same as example 2 but the Trustee is not free to trust assets and the successor Trustee B.
| EURO |
Tax due for the transfer to the trust (see example 1) | 0 |
Tax due for the distribution | 22,000 |
Total tax due | 22,000 |
Income Taxation during the existence of the trust
A Trust is not subject to income taxation under German income law. However, according to § 15 German Foreign Tax Act (see Annex 5), the income of a US trust may be subject to income taxation in Germany: The income is attributed to the settlor’s taxable income if he has fiscal domicile in Germany irrespective of whether the income is reinvested or distributed to the settlor or the beneficiaries. If the settlor has no fiscal domicile in Germany the income of the trust is attributed to the taxable income of the beneficiaries with fiscal domicile in Germany even if no payments are made to them.
Under § 15 section 2 German Foreign Tax Act (herafter: AStG) a trust is a “family trust” if the settlor, his close relatives or their offspring are beneficiaries of at least 50 % of the trust assets.
Please note: § 15 AStG is not applicable if the settlor does not lose control of the transferred assets (see more details above). Of course, in this case the trust assets and the income of the trust will be attributed to the settlor.
Distributions during the existence of the trust
Distributions during the existence of the trust are subject to German gift tax under § 7 Abs. 1 Nr. 9 Satz 2 ErbStG; tax class is determined by the family relation between the settlor and the beneficiary (see § 15 Abs. 2 Satz 2 ErbStG). In addition income tax may be payable. This may be the case if payments are made to a beneficiary in fixed intervals (routine payments). Thus, the distributions of a trust may be taxed twice!
Recommendations for the avoidance of German taxes
If the settlor has a fiscal Domicile in Germany the trust document should contain the following provisions:
(1) The settlor has the right to change the trust document at any time.
(2) The settlor has the right to revoke the trust at any time.
(3) The settlor has the right to give the trustee instructions with respect to the management of the trust assets and the distribution to the beneficiaries.
(4) The successor Trustee and the beneficiary upon death must be the same person
(5) Distribute money to all family members – each family member has a tax free allowance!
(6) Make distributions to the beneficiary during lifetime of the settlor – the tax free allowance can be used every 10 years again!
(7) Distribute money to offspring of beneficiary - there is no generation skipping transfer tax in Germany
(8) Avoid routine payments to the beneficiary to minimize the danger of German income taxation