Outcry after amendment proposal on exit taxation

In line with the draft legislation implementing the Anti-Tax Avoidance Directive ("ATAD"), the rules on the taxation of exit cases are to be significantly tightened. The focus is on the abolition of the time-unlimited, interest-free deferral of a (fictitious) capital gain, which was previously granted in the case of a departure to an EU or EEA state; instead, taxation of the gain is to be able to be deferred only.

Current regulation of exit taxation

The aim of exit taxation is to subject the hidden reserves contained in an investment in a corporation to German taxation when the shareholder moves abroad. § Section 6 of the German Income Tax Act (AStG) contains a so-called de-stratification provision that is based on the fiction of a sale. If a shareholder who has been subject to unlimited tax liability in Germany for at least ten years transfers his residence abroad, all hidden reserves in his shares in corporations in which he has held a significant interest - i.e. at least 1% - in the past five years are taxed. For the determination of the fictitious capital gain, the fair market value is taken as the selling price. Since no sale of the shareholding has taken place from which the shareholder would have received any proceeds, the tax must be paid from other funds. As a "relief", the law provides that the tax due can be paid in five annual installments upon application and if certain conditions are met.

If the termination of unlimited tax liability is based on a temporary absence and the taxpayer becomes liable to unlimited tax again within five years of the termination of unlimited tax liability, the tax entitlement lapses. The period may be extended by a maximum of five additional years.

Exit taxation is not only a German phenomenon, but can also be found in other (European) countries (e.g. France, Austria). The European Court of Justice (ECJ) has already dealt with this issue and ruled in 2004 on the French exit taxation that it was contrary to Community law. In particular, the provision constituted an encroachment on the freedom of establishment. Since the German rules are very similar to the French rules, it was assumed that these were also incompatible with EU law. The EU Commission had therefore initiated infringement proceedings against Germany and called on Germany to repeal its exit taxation or to amend it in line with EU law.

Following this request, the German legislator amended the provision in 2006. Since then, the tax assessed pursuant to Sec. 6 (5) AStG has been deferred ex officio if the taxpayer moves to an EU or EEA country. The deferral is granted without interest, subject to compliance with certain reporting requirements, until the actual disposal of the investment or until the taxpayer relocates to a country outside the EU or EEA.

Hope recently germinated after the ECJ ruling in the Wächtler case at the beginning of 2019, according to which the deferral option could also exist in the event of a move to Switzerland. (PSP article as at 14.11.2019 Update - Moving to Switzerland: tax obstacles removed?!). However, the draft bill now presented makes a U-turn in that indefinite deferral is no longer to be permitted even in the event of a move to an EU or EEA state.

Revision of the exit taxation according to the draft bill

The German legislator would like to adapt the current German regulations on exit taxation to the requirements of the Anti-Tax Avoidance Directive. Since the above-mentioned amendment of the law in 2006, "the case law of the ECJ in this area has developed fundamentally". The draft now presented "takes up these developments and makes Section 6 of the German Income Tax Act more up to date". The focus is on "appropriately balancing the requirements of the increased mobility of taxpayers in a globalized era, fiscal interests and questions of administrability".

The draft law now provides that individuals with unlimited tax liability who have been subject to unlimited income tax liability for a total of seven years within the last twelve years prior to the departure shall, in principle, fall within the (personal) scope of application of the provision. This change is intended to simplify the application of the provision and improve its administrability.

Instead of the unlimited, interest-free deferral previously granted for cases of departure to an EU or EEA country, only an interest-free deferral of the tax payment over a period of seven years is now envisaged. This seven-year "deferral rule" is to be applicable both for cases of departure to a third country and for departure to an EU/EEA country. This is justified by a "differentiation between removals to third countries and EU/EEA removals, which is not required under EU law" and by the improvement of administrative procedures and administrative enforcement.

The deferral is to be granted only upon application and regularly requires a security deposit. If retention rules are violated (such as transfer of shares as a gift during the deferral period, but probably not inheritance), the unpaid tax becomes due for payment within one month.

In the case of temporary absence, the period has now been extended from five to seven years. The period of seven years can be extended to twelve years on request if the intention to return continues unchanged.

The new regulation is to apply to cases of departure that are realized as of 01.01.2020. In the event of a departure by December 31, 2019, the current law shall remain applicable. This also applies to deferral cases that are currently already in progress.

Outlook and conclusion

The draft law not only addresses the exit taxation pursuant to Sec. 6 AStG for individuals, but also regulates for the corporate sector "the obligation arising from Article 5 (5) ATAD to recognize in principle the value assessed by the foreign state within the scope of its de-stratification taxation". In addition, the provisions on the deferral of the taxation of the deconsolidation gain are adapted to the requirements of the ATAD. These new regulations are generally understandable, as they are also based on a joint decision of the Council of the European Union.

The new provisions on exit taxation pursuant to Sec. 6 AStG-E, on the other hand, are to be strongly criticized - at least in some areas. It is true that the legislator wants to accommodate the taxpayer by extending the deadline in the case of temporary residence. However, the abolition of the permanent and interest-free deferral provision in the case of departure to an EU or EEA country represents a significant deterioration for the taxpayer. It is done without necessity and the justification included in the explanatory memorandum, according to which a differentiation between departures to third countries and to EU/EEA countries is not necessary, is not very convincing. There are serious doubts as to whether this is in line with ECJ case law. It is to be hoped that the legislator will come to its senses in the further legislative process and refrain from this tightening.