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How to mitigate German inheritance tax

Checklist for UK testators who own assets in Germany

If someone who is domiciled in England, Wales or Scotland owns assets in Germany, they need to be aware of the fact that the German tax authorities (Finanzamt) may levy tax on these German assets or – in the worst case scenario – on the testator’s entire global estate (in additon to HMRC taxing that same estate as well).

Summary of German inheritance tax rules for UK solicitors, estate planners and will writers

Here is a (somewhat simplified) explanation of the various factual situations in which Germany levies inheritance tax:

Case scenario 1: The deceased had no residence in Germany and is not a German national

Then it depends on which kinds of assets the deceased owned in Germany. If the deceased owned merely moveable assets like bank accounts or publicly traded stocks, then there is NO GERMAN INHERITANCE TAX payable (unless, of course, the beneficiary is resident in Germany).

If, however, the deceased owned so called “Inlandsvermögen” (special national assets) in Germany, as they are defined in the rather difficult to understand section 121 Bewertungsgesetz, then these assets TRIGGER GERMAN IHT. The main examples of what constitutes such German Inlandsvermögen are the ownership of:

  • property in Germany (house, flat, plot of land)
  • a German business
  • a shareholding of 10% or more in a German company or corporation
  • certain German intellectual property (patents, trade marks etc.)
  • certain legal interests in connection with real estate
  • etc. 

In this situation, the German tax authorities levy tax “only” on these specific German assets (Inlandsvermögen). Assets outside of Germany are not subject to German IHT. However, the downside to this limited taxation is that the tax authorities also do NOT grant the full personal tax allowances. The matter is complex and I have explained the issue to “limited inheritance taxation” in this separate article here:

The Perils of German Inheritance Tax and Gift Tax

It may in certain situation be the wiser approach, to voluntarily opt for the “unlimited taxation” of all global assets, for example if the assets out of Germany are relatively low value compared to the German estate. This secures that the full personal allowances are available. What these tax allowances are is explained here:

German Inheritance Tax Rates and Personal Tax Exempt Amounts

Case scenario 2: The deceased had no residence in Germany at the time of death, but was a German national

Then the German tax authorities will check whether the deceased did have a residence in Germany at any time within the last five years before his death. If so, he is considered “deemed resident” in Germany for IHT purposes and his global estate is subject to German inheritance tax, regardless of which kinds of assets and regardless of whether the beneficiaries are resident in Germany or not. The reason nhind this five year rule is that a wealthy person shall not be able to move out of the country to avoid German inheritance tax shortly before they pass away (for example because they have been told they have final stage cancer).

If the German national had left Germany “early enough”, i.e. did not have any residence in germany during the last five years of their life, then the tax situation is as in scenario 1 above. 

Case scenario 3: The deceased did have a residence in Germany

This is the nightmare scenario from an international inheritance tax perspective which, unfortunately, not all UK solicitors are aware of. If someone is domiciled in England, Wales or Scotland, but also has a holiday flat or a cottage in Germany, which they use for more than once or twice a year for brief vacations, then the German tax office considers that British national as having a residence (Wohnsitz) in Germany. And this residence triggers the unlimited German inheritance tax to apply.

Since HMRC will also levy IHT on this person’s global estate, we now have the unfortunate result that both tax authorities, the UK HMRC as well as the German Finanzamt, levy inheritance tax on the entire global estate! This can lead to cumulative taxation of the same asset, because there is no double taxation agareement between the UK and Germany when it comes to inheritance tax. In many case, the so called unilateral relief rules (einseitige Anrechnung), which permit that IHT paid in another country may be set off against the domestic IHT, prevent the worst injustices, but there are some situations where unilateral relief does not really help either. 

Can foreign Taxes be set off against UK Inheritance Tax?

The better solution is to avoid such double taxation situations from the outset by smart cross-border estate planning and will drafting. 

Every will and estate planning solicitor who advises international families or British clients who own assets abroad should be aware of this “secondary residence” tax risk.

The ultimate horror: German gift tax (Schenkungssteuer)! 

As if all this were not bad enough: If someone has a residence in Germany as described above, all the lifetime gifts this person makes (regardless of whether the gifted asset is in Germany or outside of Germany), is subject to German gift tax! The same is true if someone does not have a German residence but gifts a German Inladsvermögen (specific national asset). 

Gifts (Schenkungen) are subject to immediate taxation in Germany, not only if the donor dies within seven years from the time of making the gift. The personal tax allowances (Steuerfreibeträge) are identical to the inheritance tax allowances. In fact, it is the same act, the German Inheritance and Gift Tax Act (Erbschafts und Schenkungssteuergesetz).

To make myself absolutely clear, here’s a simple example:

Imagine a wealthy English family with every family member domiciled in England. The father inherits a flat in Bavaria from his German aunt. He likes the flat and where it is located, so he neither sells it nor does he rent it out. Instead, he thinks it is a great idea to have the flat readily available and use it for multiple trips to Germany during the year. So, from then on, he and the family use the flat to spend their summer and Christmas holidays and he also uses the flat whenever he is in Germany on business.

Two years later, the father gifts his daughter a flat in London worth 500,000 pounds. No, problem, right? The gift has nothing to do with Germany, right? WRONG!

Since the father is resident in Germany (although this is merely a secondary home at best), all gifts made by him (or to him, by the way) are subject to German gift tax. The daughter is entitled to a personal allowance of 400,000 Euros, but the exceeding 110,000 pounds are subject to German gift tax. Immediately!

The fact that neither the British father in our case example nor hardly any English solicitor knows this, does not change the fact that it constitutes tax evasion in Germany not to declare and pay this. But surely German law must apply some sort of statute of limitation for such gift tax issues, right? Wrong again: The German Finanzamt can demand gift tax to be paid even decades later if they find out about the gift. Plus accrued default interest.

More on German-British probate matters and international will drafting in these posts:

The law firm Graf & Partners was established in 2003 and specialises in British-German probate matters and international estate planning ever since. Contact German solicitor Bernhard Schmeilzl, LL.M. (Leicester) at +49 941 463 7070.

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