Gift tax issues related to the reservation of usufruct – Part I: Removing a usufructuary encumbrance
Conceptual and systematic definitions
Content and legal nature of usufruct
A usufructuary right refers to an in rem right to the use and enjoyment of an encumbered asset. Therefore, the encumbered item may, in particular, be rented out or leased out by the usufructuary on his or her own account, or indeed may also be made available for temporary use free of charge. However, the usufructuary is generally not entitled to impair or alter the substance of the encumbered item or to dispose of it.
Surrogate for a waiver of the usufruct
In the event of the sale of an asset that is encumbered with a reservation of usufruct, as a rule, the seller should endeavour beforehand to obtain a waiver from the usufructuary of his or her right. To this end, the seller would normally have to offer the usufructuary
- either compensation in the form of a (compensation) payment
- or else usufruct over a replacement asset as a surrogate.
In personam surrogation by re-establishing a usufruct
If – as is usual – there is no in rem surrogation then, in connection with the waiver of his or her usufructuary right, the usufructuary will have to have such a right granted by contract. A usufructuary right to the sale proceeds or to a replacement asset would then be expressly (newly) granted. From a legal point of view, the question then arises as to whether, in the case of a so-called in personam surrogation, this would in substance still constitute the previous reservation of usufruct or whether the newly established usufruct should be regarded as a donation usufruct. A surrogate is legally created in two acts. The previous usufructuary right is removed. At the same time, a donation usufruct is established over the new asset.
Tax treatment of reservation of usufruct in the case of gifts
Under the German gift tax law that has been in force since 1.1.2009, the reservation of usufruct results in the full deductibility of this as debt. The calculation involves capitalising the annual value of the usufructuary right on the basis of the statistical life expectancy of the usufructuary determined from the current mortality tables.
Reduction in the case of exempt assets
However, the principle of full deductibility of a usufruct encumbrance does not apply without any exceptions. In the event of the establishment of a usufruct over assets that are exempt from tax under German inheritance tax law (e.g. company assets) the deductible amount will be reduced in proportion to the amount of basic relief that is granted.
Example – Gifting of a limited partner’s ownership interest
A father F (60 years old) wishes to give a gift of his ownership interest in a limited partnership, with a fair/tax value of € 4 m, to his son S under reservation of usufruct. The conditions for the tax-privileged gifting of business assets in accordance with Section 13a of the Inheritance Tax Act (Erbschaftsteuergesetz, ErbStG) have been met. The annual value of the usufruct is € 200,000.
Limited partner’s ownership interest recognised at fair market value in accordance with Section 11(2) of the
German Valuation Act € 4,000,000
Basic relief: 85 % € -3,400,000
Taxable difference € 600,000
Usufruct: € 200,000 x 12.475 = € 2,495,000, deduction of 15 % € -374,250
Gain: € 225,750
Tax-exempt allowance pursuant to Section 16(1) no. 2 ErbStG € -225.750
Taxable amount € 0
In the example, the impact of the usufruct amounts to only 15% since just 15% of the value of the limited partner’s ownership interest is taxable.
Advice and Outlook: It is advantageous that only part of the personal tax-exempt allowance is used up and would thus still be available for another gift. In Part II of this series we will explain the consequences in the event of a waiver of usufruct or surrendering it and re-establishing usufruct (surrogation scenarios).