Gift tax issues related to the reservation of usufruct Part II: Waiver, renunciation and re-establishment
Consequences of the waiver of a reserved right of usufruct during the usufructuary’s lifetime
The early waiver of a reserved right of usufruct fulfils the elements of gifting if it takes place without payment, thus for no consideration. The waiver is then a further separate taxable gift from the waiving party to the (previous) beneficiary and could thus potentially attract gift tax. As a further gift, under Section 14(1) of the Inheritance Tax Act (Erbschaftsteuergesetz, ErbStG), the waiver by the previous donor would result in this new gift having to be added to the prior acquisition, at any rate, if ten years had not yet elapsed since the date of the gifting with reservation.
Particularities will apply in the case of a non-remunerated waiver of the right of usufruct reserved before 1.1.2009 because, as a result of Section 25 ErbStG (old version), it had not been possible to deduct the usufructuary encumbrance, or the tax on this had been deferred. In this respect, a taxable transaction would only arise if, at the time when the right of usufruct was waved, its cash value were higher than at the time when it was established. In practice, this is rather rarely likely to be the case as the donor will be older and, thus, the multiplier in the mortality table lower, which means that when the usufructuary rights are waived their cash value is normally lower than at the time when they were established.
Please note: It has been clarified that the case law of the Federal Fiscal Court (Bundesfinanzhof, BFH) relating to Section 25 ErbStG (old version) does not cover those waiver cases where the usufruct was established after 31.12.2008.
Consequences of a renunciation of the right of usufruct and its re-establishment
Not a termination of the right of usufruct
In cases of in rem surrogation (in exceptional circumstances) mandated by law, it can be assumed that under civil law as well as from a gift tax perspective the right of usufruct would not be terminated. In rem surrogation therefore does not create any gift tax consequences. It is not the case that the previous donor has been given a gift.
In personam surrogation
However, since in rem surrogation mandated by law is not normally the case, in personam surrogation provides a possibility for avoiding gift tax. In such a case, the first step, namely, the waiver would likewise not result in a (another) donation to the previous beneficiary that would be subject to gift tax. This situation arises because, in this case, the waiver would not take place without payment. The counter-performance could lie either in the re-establishment of usufruct over a new asset (= surrogate) or a compensation payment. Committing to re-establish a usufruct is thus a counter-performance that the previous beneficiary owes (as “payment”) to the waiving party. As a result of this causal link made in the waiving agreement, the waiver of the reserved right by the donor is not unremunerated. In that respect, it cannot be viewed as a gift.
Please note: At all events, something else would ensue if the cash value of the usufructuary right when it is waived were higher than the value of the replacement asset. In that case, in accordance with the principles of partial gifting, a donation to the previous beneficiary would be deemed to have occurred in the amount of the non-remunerated portion.
The point of view of the beneficiary
The tax treatment is also questionable from the point of view of the beneficiary. If the value of the donated usufructuary right over a replacement asset is higher than the value of the original reserved right of usufruct then it could be deemed that the beneficiary has made a gift to the donor.
Recommendation: That is why the values should correspond to each other as closely as possible. In such a case, proportional usufruct rights could provide a potential solution.
The implications in the case of re-establishment
Currently, it is yet to be clarified whether or not a re-established usufruct should (continue) to be regarded as a reserved right of usufruct for gift tax purposes. Based on the BFH ruling on Section 25 ErbStG (old version) (BFH judgement of 11.11.2009, case reference: II R 31/07) it may be inferred that, at least in legacy cases (until 31.12.2008), a reserved right continues to exist where usufruct has been re-established over a replacement asset.
Orientation towards the requirements under civil law
In addition, gift tax law is oriented towards the requirements under civil law. Under civil law, at all events, the previous right is renounced and a new one is established. However, this is of no great significance for the calculation of the values that are relevant for gift tax purposes as the calculation methods are alike. By contrast, for the consequences under income tax law, the classification under civil law is of great significance.
Please note: As Section 25 ErbStG (old version) was deleted under the new law, what (still) matters for gift tax assessments for a lifetime waiver since 1.1.2009 is solely whether this is done in return for payment or for no consideration.