If a shareholder with shares in corporations that are held as private assets transfers their place of residence to another country then there, normally, the shareholder will create an unrestricted right for the destination country to tax all their domestic and foreign income in accordance with the so-called world income principle. The country of departure as well as the destination country are able to settle the right to tax in such a case via a provision in their double taxation agreement whereby the right to tax the disposal gains from such shares is usually conferred on the destination country if the disposal occurs after the relocation. In order to protect itself against the cessation of this right to tax, the country of departure is able to tax the capital gain in the shares in a corporation up until the relocation happens. Some EU countries do not have exit tax regimes and others, after a certain period, waive the tax that has been determined.
Therefore, in the run-up to the relocation, it will be important to take into account how the exit tax regimes have been specifically designed by the individual member states. If the final levying of tax takes place in the country of departure then Section 17(2) sentence 3 of the German Income Tax Act mandates that there has to be a link between the departure country and the destination country with respect to the economic value of the taxed shares in order to avoid double taxation in principle. This occurs via a notional increase in the acquisition costs for the shares in corporations that are held and this has the effect of reducing tax when there is a subsequent (actual) disposal in Germany.
BFH ruling on the economic value link
The BFH, in its ruling of 26.10.2021 (case reference: IX R 13/20), had to decide for the first time what requirements should be set for this value link. Legislators in Germany require that the shares have to have been subject to a comparable tax regime in the departure country within the meaning of Section 6 of the German External Tax Relations Act. To this end, it is necessary for the foreign fiscal authorities to calculate and determine the amount of tax that is due upon departure and to provide this in a tax assessment notice.
In the view of the BFH, it is however not important for the tax to have actually been paid. The tax office and the tax court previously held this view. In the case in question, a certificate or an official letter from the Dutch fiscal administration was not deemed to be sufficient for this purpose because it was not a tax assessment notice within the meaning of the so-called ‘preservation assessment notice’ [Konservierungsbescheid] for the purpose of linking both countries with respect to the economic value.
Implications in practice
In order to achieve the best possible outcome in a targeted manner it would be absolutely essential for tax consultants in the departure country as well as the destination country to coordinate with each other, in advance, on the respective applicable tax regulations; in particular, if in the departure country it would be possible for taxes to be waived after ten years, or if the country of origin does not have an exit tax regime. Under the world income principle, Germany would also impose a comprehensive tax for the capital gains during the period when the place of residence was still abroad and Germany therefore did not have the right to tax.
Ultimately, the ECJ will have to examine not only the question as to whether or not Germany is violating the freedom of establishment through its national regulation, applicable since 2022, pertaining to exit taxation without interest-free deferral, but also the question as to whether or not Germany may impose comprehensive taxes in the absence of a point of reference. This was not addressed in the BFH ruling.
Recommendation: For such scenarios, it would be advisable to lodge an appeal first and, in the event of further pending cases, to request a suspension of proceedings, or to review the prospects of success of an action with respect to the tax implications. In the context of planning a relocation to Germany, it could make sense to generate an increase in the acquisition costs through a sale or a qualified exchange of shares at fair market value if the tax law of the foreign country permits this in a tax-neutral way or provides for other concessions or, in the best case, does not even tax capital gains from the sale of shares in corporations.