The deregulation tax as well as the exit tax affects entrepreneurs who relocate their residence abroad. As a result, they lose their status as unlimited taxpayers in Germany. For the German Treasury, this means that when it moves abroad, its right to tax a future capital gain also expires. In order to tax at least the previous increase in the value of companies, the legislature has created several legal bases so that this is ensured at the time of the departure of the entrepreneurs. We refer to this as either the deregulation tax or the exit tax, depending on whether it is a German partnership (single company or partnership) or a corporation. This leads to a number of important differences which we are highlighting here.

1st Untangling Tax Compared to Exit Tax – Introduction

We have often pointed out that the departure of a GmbH shareholder or a GmbH shareholder abroad triggers the departure tax. Often we have added an accompanying comment that the conversion of the GmbH into a partnership or a sole proprietorship helps avoid the removal tax. And we usually left it at that. But what if an entrepreneur of a sole proprietorship or partnership moves abroad? Is this automatically tax-free? That would actually be a huge advantage over shareholders of corporations. Surely that would have the potential for someone to go to court against this unequal treatment, right?

To anticipate it right away, yes, there is unequal treatment. But this is only because we are talking about two fundamentally different legal areas in tax law. On the one hand, tax law must take into account natural persons, but on the other, legal persons. Nevertheless, the legislature has had every reason to record both the departure of entrepreneurs of one group and the other for tax purposes. Thus, while there is on the one hand an exit tax for shareholders of corporations, there is also a counterpart for entrepreneurs of partnerships, namely the so-called deregulation tax.

Logically, in addition to this central parallel, there are also various differences between exit tax and derailment tax, including the indicated potential elimination of taxation for the latter. Therefore, in this article we want to discuss these differences in more detail, so that you can more easily understand why we use the conversion of a GmbH into a partnership as a vehicle to avoid an exit taxation.

At this point we would also like to point out a convention to which we refer in order to optimize the readability of this article. So from now on we will use the term partnership as a collective term for individual companies and all kinds of partnerships.

2. derailment tax and exit tax: legal bases

Before discussing in detail the differences between the de-entrainment tax and the departure tax, let us specify the necessary legal bases. Many readers may be aware from our earlier contributions to the Exit Tax that the statutory regulation for this can be found in § 6 AStG. In contrast, the deregulation tax is part of § 4 EStG. More specifically, the authorities responsible for the deregulation tax can be found in § 4 (1) sentences 3 to 5 EStG.

So, as you can see, this is already a difference between de-knitting tax and exit tax. While the deregulation tax is regulated by the law which stipulates the income taxation of natural persons, the exit tax outside the corporate tax law is housed in the special external tax law.

Furthermore, it can be stated here that both the exit tax and the derailment tax are summarized under the tax term tax derailment. In doing so, they are part of personal tax easing. In addition, however, there is also the factual tax easing, which includes the so-called functional relocation. Thus, the transfer of business assets abroad is also subject to tax easing.

Last but not least, a reference to a synonym for the term de-tricking tax. In addition, one often finds in the literature the term de-knitting taxation. However, since this describes the process rather than the tax itself and we want to make the comparison with the exit tax, we have opted for the use of the deregulation tax in this contribution.

3. Essential features of the Exit Tax

§ 6 (1) AStG states that the restriction or even loss of the right of taxation of the Federal Republic of Germany on a potential capital gain of a limited company triggers immediate taxation of the hidden reserves. If, as a shareholder of a corporation, you cease to be subject to unlimited tax in Germany, you pay exit tax. This is, of course, the case when moving abroad by giving up residence in Germany. But also the free transfer of the shares of such a shareholder to a person who is not subject to unlimited tax liability in Germany (because he is resident abroad or has no permanent residence as a Perpetual Traveler) leads to the collection of an exit tax.

Conversely, you have to conclude that moving abroad alone does not trigger an exit tax, provided you remain unrestrictedly taxable in Germany. The trigger of the exit taxation is therefore less the departure abroad or the possession of shares in a German corporation. Rather, this is about maintaining the unlimited tax liability in Germany. Because only if Germany loses its unrestricted taxation sovereignty, it sees the time for an exit taxation. By the way, this also applies to many other countries in the world, where this is similar. Others, on the other hand, manage without tax easing (for example, the United Arab Emirates).

4. Essential characteristics of the deregulation tax

It is of course in the nature of the matter that the departure of entrepreneurs who own or are involved in a company leads to tax easing. The tax paid on the hidden reserves thus to be uncovered is therefore called the de-entangling tax. In this context, the deregulation tax must only be levied if a transfer of assets abroad is accompanied by the departure of the owners or shareholders there. This is the case, for example, if a sole proprietor does not employ employees in Germany and then moves abroad. If you do not hire a managing director in Germany and continue business from abroad, you are exposed to the taxation of de-tricking. Because as a relocation of economic goods is to be regarded if one opens another company abroad after moving. This can be, for example, an administration or production unit. This also includes setting up a management office. Even this then leads to the levying of the deregulation tax.

Advantages and Disadvantages of the Untricking Tax – Conclusion

The biggest difference between the deregulation tax and the exit tax is that a simple departure of the entrepreneur always causes the exit tax at a corporation, but this alone does not trigger taxation at a partnership. This is therefore also the biggest advantage of the de-knitting tax compared to the exit tax.

As an entrepreneur or entrepreneur of a partnership, you can actually move abroad tax-free. But this begins the concerns about a tax easing in Germany. For example, if you move abroad as a sole proprietor, you need someone to continue business in Germany. As a limited partnership, this is certainly of no importance. However, as soon as you operate the management from abroad, under whatever circumstances, the creation of a permanent establishment abroad provides the prerequisite for the collection of the de-knitting tax. Furthermore, if entrepreneurs of a German partnership move abroad and set up a permanent establishment there, a de-tricking tax must also be paid. The same applies if instead a cross-border expansion of the German partnership follows the departure of the entrepreneurs.