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24. March 2022 | Taxation of foreign trusts with income tax and corporate income tax (this contribution)

A trust is a legal relationship in which assets are transferred to a person which it is to manage or use for certain beneficiary persons under the rules of the trust deed. Especially in the USA, such a trust serves for succession planning. In this article, we explain which German income taxes are incurred in connection with a trust, how you can minimize them and what you have to consider. What a trust is and how it is subject to gift tax or inheritance tax, we have already explained in one of our other contributions.

A trust is a legal relationship in which assets are transferred to a person which it is to manage or use for certain beneficiary persons under the rules of the trust deed. In the USA, people regularly use a trust for succession planning. In Germany, however, this legal institute is not recognized and can have significant tax disadvantages for the beneficiaries. In particular, gift tax, inheritance tax, income tax and corporate income tax are important. We explain the tax consequences of the beneficiaries of a trust in the individual phases, from establishment, current distributions to dissolution. In particular, we provide practical tips to keep an eye on and minimize the tax consequences.

As part of the establishment of the trust, there may be problems with the exit taxation according to § 16 AStG. This becomes relevant, for example, when shares in corporations are transferred to the foreign trust. Exit tax is applicable in Germany whenever the taxpayer has been unrestrictedly taxable in Germany for at least seven years in the last 12 years before the departure. The free transfer to the foreign trust is then subject to exit taxation in accordance with § 6 (1) no. 2 AStG, since the trust is not subject to unlimited taxation in Germany. The difference between the acquisition costs and the common value of the shares is then taxable. The purpose of this rule is to tax the hidden reserves created in Germany also in Germany.

The transfer of assets of the company assets to a US trust, however, is generally not subject to exit taxation, since the taxation right of Germany is not excluded or limited. The German tax can be counted against the US tax under the double taxation agreement USA and Germany pursuant to Article 7, Article 23(1)(a) DTA USA. Therefore, exit taxation is only relevant if the builder holds the shares in the corporation in private assets. If, on the other hand, he keeps the shares in the business assets, the right of Germany to taxation is not excluded and there is no exit taxation as a result of the unbundling of hidden reserves.

For beneficiaries of a foreign trust, the additional taxation is also meant. According to § 15 (1) AStG, this applies in principle to foreign family foundations and enables the taxation of income generated by foreign family foundations. To this end, the additional taxation attributes the income generated by the foundation proportionally to the subscribers and founders resident in Germany, regardless of the inflow.

However, additional taxation is also relevant in connection with a trust, because family foundations are equal to other assets according to § 15 (4) AStG. Thus, the trust also falls under this taxation. The builder of a foreign trust is usually not based in Germany. For him, the German additional taxation is therefore irrelevant. This alone is therefore decisive for the beneficiaries of the trust who live in Germany.

In order for the beneficiaries to be subject to additional taxation, however, they must be eligible or eligible. Subscribers of a trust usually participate in the current income, while the beneficiary acquires the assets of the trust upon its dissolution. However, the beneficiary does not have to be entitled to the advantage. Rather, it is sufficient that a secured legal position exists. Therefore, only at an absolute discretion no subscription entitlement is given. Absolute discretion of the administrator, however, is probably only in the rarest cases. In summary, therefore, it can in principle be assumed that a person resident in Germany, who is also designated in the trust deed or whose circumstances indicate that he could receive a renunciation as a beneficiary, assumes that the additional taxation applies.

The actual attribution is determined by the eligibility rate resulting from the trust deed. The income is determined according to the rules of German tax law. Therefore, for example, German flat-rate amounts also apply. According to § 15(8), first sentence of the AStG, the attributable income belongs to fictitious income from capital assets. Therefore, a tax rate of 25 % applies. The benefits for box holdings pursuant to § 8b (1), (2) KStG or the partial income procedure pursuant to § 3 no. 40 sentence 1 letter d EStG are only applicable if they would also be applicable to the taxable person in the case of direct purchase. The foreign and domestic taxes charged by the trust shall be charged to the beneficiary in accordance with § 15 (5) in conjunction with § 12 (1) AStG.

Actual distributions are subject to income tax. According to § 20 (1) no. 9 sentence 2 EStG, the current distributions from the trust are in principle subject to the withholding tax for capital income. However, this only comes into consideration if, from an economic point of view, the performance is prompted by the transfer of capital. Once again, this requires a capital participation in the distributing trust. However, this is usually not the case with the beneficiary from a trust. Then only a taxation of other income in the form of recurring emoluments according to § 22 no. 1 sentence 1, 2 EStG comes into consideration. The tax administration, on the other hand, normally assumes, contrary to the system, taxation with the withholding tax under § 20 (9) second sentence EStG.

However, if the distribution has already been subject to additional taxation, no further taxation takes place at the level of income tax according to § 15 paragraph 11 AStG. Therefore, you should clearly state to what extent an additional taxation has already taken place and explain this to the tax office in detail.

Since remittances from the trust are subject to both income tax and gift tax, there can be double taxation with gift tax and income tax. On the one hand, contributions added under Section 15 of the AStG may be subject to gift tax. On the other hand, amounts issued may be subject to both income tax and income from capital assets, but may also constitute a gift among living persons under § 7 (1) no. 9 sentence 2 EStG. Jurisdiction has not yet clarified whether such double taxation is permissible. If your income is double taxed, you should contest your decision with an objection. We are happy to inform you about this.

The trust is subject to corporate tax under the conditions of § 1 (1) no. 5 KStG. Accordingly, the trust must be a special-purpose asset under private law. By special-purpose assets is meant an independent wealth of assets dedicated to a specific purpose, which has left the assets of the builder and receives its own income. This requires that the builder cannot reclaim the property arbitrarily, but that it is permanently due to the trust. Only then can the assets be economically allocated to the trust and not to the builder. This can only be considered if the trust is irrevocable.