The terms “tax entanglement” and correspondingly also “tax de-entanglement” play decisive roles again and again, especially in situations in international tax law. They denote the acquisition and abolition of German taxation sovereignty in hidden reserves lurking in certain economic goods. Processes covered by the Foreign Tax Act (AStG) – such as exit taxation – are also familiar with the concept of tax entanglement.

1. tax involvement in practice: regulations and examples

There is always talk of tax entanglement when the German Treasury acquires a right to tax hidden reserves and/or other assets. However, “obtaining” does not necessarily mean that such a right is established for the first time. Rather, the taxation sovereignty can already exist for a long time, but only become clear when an asset is sold or transferred. In the following, let’s take a look at some “classics” of tax entanglement.

1.1 Necessary or arbitrary operating assets

According to R 4.2, paragraph 1, EStR, assets belong either to the necessary operating assets, are private assets or arbitrary operating assets. Once an asset is part of the business assets of a sole proprietorship, partnership or corporation, it is called tax involvement.

As of now, the taxpayer no longer has the opportunity to transfer the asset from business assets to private assets in a tax-neutral manner. The so-called withdrawal triggers a taxation of the hidden reserves according to § 4 (1) sentence 2 and § 6 (1) no. 4 EStG. The same applies to the sale, because here too the difference between the sale price and book value is subject to taxation.

1.2 Division of operations

If a natural person leases an essential operating basis to a corporation owned by it, this leads to the so-called division of operations if further conditions are met. The usually private income from renting and leasing becomes commercial income. At a private level, a holding company (‘rental company’) is created whose assets include, in addition to the leased asset, the participation in the limited company.

Both assets are thus tax-related. They constitute necessary assets of the holding company and cannot be sold or withdrawn tax-neutrally. Often there is even an unintentional dissolution of the division of operations, which can lead to a considerable tax burden.

1.3 Justification of German taxation law

If a taxpayer transfers assets from private to business assets, there is a tax entanglement with regard to these values. The same applies according to § 4 (1) sentence 8 half sentence 2 EStG also for the first time justification of the German taxation law. The standard applies in particular to transfers of assets from foreign to domestic assets.

Example: A sole proprietor maintains two premises, one in Germany and a second in the Netherlands. It transfers a vehicle that was previously the operating assets of the Dutch establishment to the German headquarters.

The “deposit” in the German company assets establishes for the first time a taxation right of the German Treasury. The economic asset is subject to German taxation jurisdiction, which gives rise to tax entanglement.

1.4 Tax entanglement in the case of significant holdings pursuant to § 17 EStG

Shares within the meaning of § 17 (1) sentence 1 EStG are tax-related in several constellations. Such a share exists if a natural person has held at least 1 % of a share in a corporation within the preceding five years. Participation for a “legal second” is already sufficient; in addition, it does not matter whether the shares are in a domestic or a foreign corporation.

Even a shareholding of 1 % or more triggers the tax entanglement, since a sale of the shares always falls under § 17 (1) sentence 1 and paragraph 2 EStG. The income is those from business operations (no capital assets according to § 20 (2) no. 1 EStG) and is subject to taxation of up to 45 %. However, the partial income procedure (§ 3 no. 40 letter c EStG) applies.

If the natural person has acquired the shares from a legal predecessor, he enters into his legal status with regard to the five-year period. It is therefore already sufficient here if the former shareholder held at least 1 % of the shares, even if the shares sold are those of less than 1 % of the share capital or share capital of the corporation (Section 17(1), fourth sentence of the EStG).

If the corporation publishes its registered office abroad and this leads to an exclusion of German taxation law, § 17 (5) EStG applies. the operation is equivalent to a sale of the shares; This also applies if the shareholder retains his domestic residence.

2nd Tax Unengagement – Exclusion of German Taxation

Similar to tax entanglement, tax easing exists if the German Treasury loses the right to tax assets and other assets. A so-called “exclusion of taxation sovereignty” is regularly equivalent to the sale of the corresponding asset. Here, too, income tax law knows different facts that are essentially similar to those of tax entanglement.

2.1 Dissolution of the operating property

The definition of ‘operating assets’ has been harmonised by the legislature in R 4.2, paragraph 1, EStR, in such a way that a distinction can be made based on the actual operational use. Where: