Key Facts at a glance
- Beneficiaries of a foreign trust who are tax resident in Germany should seek legal tax advice to avoid significant disadvantages.
- One of these disadvantages is the possible double burden of gift tax and income tax if the beneficiary is entitled to income and/or principal. Therefore, a beneficiary resident for tax purposes in Germany should, if possible, not be granted any legal claim.
FG München, Urteil vom 3. Juli 2024, Az.: 4 K 2033/16
BFH, Urteil vom 25. Juni 2021, Az.: II R 31/19
Potential Double Tax Burden
Beneficiaries of a tax-opaque family trust may be subject to the attributional taxation in Germany (Sec. 15 Foreign Tax Act – Außensteuergesetz, AStG).
This means that the income at the trust level is attributed directly to the beneficiary on a pro rata basis and then taxed, even though there was no actual cash inflow (dry income taxation).
In general, the subsequent actual distribution is not subject to taxation anymore, if it can be proven that the distributed funds were previously subject to attributional taxation. This avoids double taxation for income tax purposes.
However, in the opinion of the courts, the subsequent distribution may be subject to German gift tax if the beneficiary is a so-called intermediate beneficiary (Sec. 7 para. 1 no. 9 sentence 2 Inheritance and Gift Tax Act – Erbschaft- und Schenkungsteuergesetz, ErbStG).
Intermediate beneficiaries are generally beneficiaries who have a legal claim to the income and/or principal of the Trust. On the other hand, those who only receive discretionary distributions are not intermediate beneficiaries.
Distributions of amounts previously taxed under the attributional taxation may therefore be fully subject to gift tax in individual cases, regardless of whether the distribution is made out of trust income or principal (economic double tax burden).
However, in the view of the courts, there is no inadmissible double taxation. In this respect, there are two different actual situations (attribution of trust income and distribution of trust assets), which lead to a double tax burden accepted by the legislator.
No Breach of Superior Law
However, the Federal Fiscal Court had so far left open the question of whether this double tax burden violates superior law (constitutional or European law).
Contrary to the opinion of many in the legal literature, the Munich Fiscal Court has now answered this question in the negative. According to the Court, there was neither a violation of the German constitution nor a violation of the free movement of capital under EU law.
Consequences for Practice
At least for the time being, the chances for taxpayers have diminished to be successful arguing against gift tax if they are entitled to certain distributions. However, the taxpayer has been given the chance to appeal to the Federal Fiscal Court again.
This is all the more relevant as the gift tax often cannot be mitigated by a double tax treaty, as Germany has only a few treaties applicable to gift and inheritance tax (e.g. with the U.S., France and Switzerland).
The same is true for the attributional taxation of the income earned by trust, which is expressly excluded from the treaty protection (treaty override; Sec. 20 AStG). Therefore, maintaining a mere residence (Wohnsitz) in Germany (key power over an apartment/room suitable for sleeping there) may trigger German tax liability.
This makes it all the more important for the beneficiaries of a foreign trust to seek legal tax advice in order to avoid significant disadvantages in advance.