The Bundesfinanzhof (BFH) has recently ruled on a case that reveals a legal loophole in inheritance tax law. In certain situations, no inheritance tax is incurred in Germany. The prerequisite for this is that both the decedent and the heir live abroad, but the property to be transferred is located in Germany. This is the case with properties located in Germany, for example. Thus, there is a limited inheritance tax obligation in Deutschlach. However, if the testator does not note an inheritance, but a legacy in his will, there is no provision for this in the evaluation law. This is because the Valuation Act defines what is also to be regarded as domestic assets under inheritance tax law. However, since the legacy is missing in this scheme, there is no inheritance tax in such a case.

1st Inheritance Tax on a Legacy – Introduction

The inheritance tax is already a very idiosyncratic tax. So she misses a certain degree of piety. In addition, it resorts to assets that have mostly already been the subject of a previous income taxation. And for many other people, it appears to be hollowed out by far too many exceptions and loopholes.

No wonder, then, that many countries have abolished or never introduced inheritance tax. It is also not surprising, however, that one is looking for ways to circumvent the inheritance tax for asset succession. It is obvious that one tries to avoid taxation in Germany by moving to a country without inheritance tax. This avoids the unlimited inheritance tax liability in Germany. But when it comes to assets that remain in Germany because they are immobile, one usually has to deal with the limited inheritance tax liability in this country.

The fact that we are also taking a look over the trees on our external borders is no coincidence in connection with this article. Because despite the application of the locality principle in the taxation of property subject to inheritance tax in the country, one can avoid the inheritance tax with a legacy. We would like to explain this to you on the occasion of a current decision of the BFH with regard to the legacy.

2nd inheritance tax on legacy: legal bases

After this general introduction, we focus on the legal bases that led the BFH to confirm the legal loophole in inheritance tax law discussed here. For this we first look at § 2 ErbStG. Here, the legislator defines when an unlimited and when a limited tax liability in the sense of the inheritance and gift tax law exists.

While the first paragraph of the standard lists the general regulations that address unlimited tax liability under number 1, the number 3 is of particular interest to us. According to § 2 (1) no. 1 ErbStG, all persons involved in a capital transfer who are resident in Germany are considered to be taxable without restriction. This also applies if only one affected person is resident in Germany and the others are abroad. In addition, the world income principle applies. So no matter where the property to be transferred is, it is subject to the German inheritance tax.

However, if we now investigate the case that neither the testator nor the heir are resident in Germany, but the property is located in Germany, we are bound by the number 3 of the paragraph. Here, the law speaks about the limited tax liability of reference persons abroad, albeit indirectly in exclusion proceedings. Because if neither number 1 nor number 2 are relevant, number 3 has to apply. Here the law refers for the first time to the so-called domestic assets. Domestic assets are what § 121 BewG defines as such.

This brings us to the second important legal basis for our legacy without inheritance tax. For limited taxpayers, domestic assets are the only relevant point of reference that binds them to Germany for tax purposes. Thus, § 121 BewG lists in nine points what counts as domestic assets. This includes, among other things, real estate, company shares or operating assets.

You may already suspect it: right here is a loophole in the law, with which you can avoid inheritance tax through legacy.

3rd Inheritance Tax: The Difference Between Heritage and Legacy

But before we can get to the exciting details about avoiding inheritance tax through legacy, we should first explain where the difference between an inheritance and a legacy lies.

An inheritance is relatively easily explained. After death, one leaves behind a property that passes as an inheritance to another natural or legal person. The property changes hands by inheritance.

In a legacy there is also an heir and an heir. But in addition, a testator can determine testamentary or contractual inheritance over a legacy. In this way, it regulates that another person, the legatee, is entitled to a certain property. In this case, the heir represents more of a kind of intermediate station, administering the legacy until it passes to the legatee by fulfilling the claim. So an inheriting person is burdened by a legacy.

Here you can distinguish a whole series of different possibilities for shaping a legacy. For our considerations, however, these differences are meaningless. The only important thing here is that the legatee only receives a claim for restitution of the bequeathed object.

So the question is whether a legatee abroad receives inheritance taxable domestic property limited by a legacy. The answer to this should be in § 121 BewG, but is missing there.

Avoiding Inheritance Tax by a Legacy

But now in medias res: how to avoid the inheritance tax with a legacy?

As we now know, a legacy is merely a claim to an asset. However, since § 121 BewG defines exactly what is domestic property in the sense of inheritance tax and does not mention the legacy in this final listing, the conclusion about inheritance tax is clear. Therefore, anyone who receives a legacy as a limited taxable person from another also limited taxable person can rely on the fact that this does not constitute domestic property. Even if someone receives a castle or industrial plant as a legacy in this way, that person is spared the inheritance tax. This applies both to the preservation of the claim to the legacy and to the fulfillment of the claim.

5th Conclusion: No inheritance tax on legacy abroad

Now the BFH has confirmed that you can legally avoid the inheritance tax with a legacy under the described conditions. It is a first-rate loophole. Therefore, it is questionable how long it may now take until the legislator donates an update to § 121 BewG in order to close this gap. Although this legal gap does not seem to be very important at first glance, its exploitation could well occur more in the near future. This is too tempting, especially for those affected, who find themselves particularly easy in their private situation here. And even if this is only a small niche of the much broader options for avoiding inheritance tax, avoiding inheritance tax through legacy certainly usually affects larger assets. Moreover, the control design resulting therefrom is quite suitable for having an advantageous effect over generations.