Planned tightening of exit taxation in the ATAD Implementation Act strains mobility of international entrepreneurs

On 24 March 2021, the German Federal Cabinet passed the draft (in German only) of a law to implement the Anti-Tax Avoidance Directive (ATAD-UmsG), which is expected to lead to a deterioration in exit taxation.

When a first ATAD draft law was taken off the Cabinet's agenda in December 2019 on short notice, the draft was not implemented before the deadline of 31 December 2019. Despite infringement proceedings initiated by the EU Commission in January 2020, the German legislator took another year, even after a second draft law was published in March 2020, to decide on the possible content of the law.

This content includes tightening of the mobility of international entrepreneurs, which was already looming in the two previous drafts and implementation of several requirements of ATAD Directives I and II from 2016 and 2017. In addition to comprehensive regulations on transfer pricing and add-back tax, the draft law also contains changes to exit taxation.

The new regulations on exit taxation contained in the draft law passed by the Cabinet go far beyond the extent of adjustment required by the Directive. In this respect, the ministerial draft has not been changed from the previous December 2019 and March 2020 drafts. If the law is implemented on the basis of the current draft, entrepreneurs may face considerable strains on liquidity, not only when moving to a third country, but also when moving within the EU.

Compared to the last draft bill of 24 March 2020 (in German only), the temporal application of the law has essentially been adjusted in such a way that taxpayers ought to have time until the end of 2021 to move within the EU/EEA in a manner which is still "favourable".

Current regulations on exit taxation – indefinite tax deferral without interest when moving within the EU

Under most double taxation treaties, the country in which the shareholder is resident for tax purposes has the right to tax capital gains on shares in corporations held as private assets. If the shareholder moves abroad (i.e. moving a place of residence or just the tax residence or the Ansässigkeit), Germany normally loses the right to tax the shares in the corporation. This would mean that it would no longer be possible to tax hidden reserves formed in Germany in Germany after the move. In order to avoid losing the taxable substrate in this way, a fictitious sale is assumed at the time of the move and any increases in value accruing to the shares up to the time of the move are taxed, according to section 6 (1) sentence 1 and sentence 2 no. 2 German External Tax Relations Act (AStG).

The same applies if shares are bequeathed or given as a gift to a party abroad (see section 6 (1) sentence 2 no. 1 German External Tax Relations Act (AStG)). Exit taxation therefore applies not only when the shareholder leaves Germany, but also in cases of succession or potential gifts.

On the basis of the current law, if the shareholder moves to an EU country (and is an EU national), the tax due can be deferred for an indefinite period of time without interest or security (section 6 (5) German External Tax Relations Act (AStG)). The consequence of this is that the mobility of the shareholder, which is normally desired, remains unaffected for tax purposes since the deferral means that there is no outflow of liquidity. Only a further move to a non-EU country or the sale of shares leads to the tax becoming due.

If the shareholder moves to a third country, the law only provides for a deferral over five years with interest. The additional requirement for this is that immediate tax payment would lead to significant hardship.

Exit taxation in the ATAD Implementation Act (ATAD-UmsG) eliminates relief for moves within the EU

Under the draft law, exit taxation deferral within the EU is to be abolished in the future. The intention is for the exit tax to become due immediately, even in the case of a move within the EU with the only possible alternative being payment of the tax in instalments over seven years and normally with security. Payment in instalments would apply, independent of the country to which the shareholder is moving, and would in the future apply to a move to an EU country in the same way as a move to a third non-EU country. For the mobility of the entrepreneurial shareholder, especially in small and medium-sized enterprises, the resulting direct strain on liquidity is likely to lead to considerable restrictions.

The new regulations only offer relief in the event of a return to Germany. If certain requirements are met, including the shares still being owned and a return to Germany within seven years, the tax assessed can be waived retroactively. If it is proven that there is a continuous intention to return, this period can be extended by a maximum of five years to a total of twelve years further to an application to this effect. In this case, on application the payment in instalments can be suspended until the return, but this application is only recommended if a return is really expected since interest will otherwise be incurred.

Application of the planned new regulations in the 2022 assessment period

After concern was expressed that earlier drafts could be applied as early as 2021, the present draft clarifies that the change in the law is to apply for the first time for moves taking place on or after 1 January 2022. This means that entrepreneurs planning to move to an EU/EEA country should still be able to move under the regime of the current law until the end of the year and therefore have the possibility of indefinitely deferring the exit tax without interest. According to the current explanatory notes on the legislation, the previous deferral regulations are to continue to apply to moves, which take place up to midnight on 31 December 2021. However, the wording of the draft law, which refers to "deferrals already in progress on 31 December 2021", is unfortunately unclear in this respect. If there is no further clarification in the course of the legislative process, it will have to be hoped that an explanation will be provided in a BMF application letter.

Conclusion: exit taxation in the current draft threatens mobility and raises concerns under EU law

The draft law, which has now been passed by the Cabinet, also provides for exit taxation to be tightened in ways that the Directive itself does not call for. If the new regulations are implemented as planned, free mobility for international entrepreneurs within the EU would be severely restricted in future due to impending tax burdens. Whether the planned new regulations in this form are compatible with free movement under EU law seems doubtful in any case. The European Court of Justice (CJEU) ruled in February 2019 in the Wächtler case (C-581/17) that moves from Germany to Switzerland must be treated in the same way as moves within the EU/EEA area if they are covered by the Agreement on the Free Movement of Persons between Switzerland and the EU. In particular, the CJEU did not consider the deferral to be suitable to remove the liquidity disadvantage caused by the exit tax. On this basis, it would in principle have been reasonable to expect that a tightening of the provisions for moves within the EU is not impending, but that an amended law would provide for relief for moves to third countries.

However, doubt was already cast on this by the response of the tax authorities in the Federal Ministry of Finance's letter of 13 November 2019 on the consequences of the Wächtler ruling. This is because the tax authorities continued to adhere to the deferral, merely waiving the hardship test, and explicitly said that they were only doing this "until a change in the law". The resulting concerns that an indefinite deferral without interest could be abolished for moves even within the EU/EEA area have been confirmed by the new regulations currently planned.

Due to the extensive criticism of the two previous drafts already voiced, there was still hope that the legislator might address the concerns under EU law on this point and defuse the deferral regulation. However, since the legislator has even supplemented the explanatory notes on the legislation and explained the planned regulation in further detail, it appears that no further relief is now to be expected in this respect.

Family businesses, in particular, should therefore use the remaining time to address this issue and examine the tax protection measures that should be taken to protect cross-border mobility.

For more information on this draft law and exit taxation in Germany, contact your regular CMS partner or local CMS experts: Philine Lindner and Luise Uhl-Ludäscher.