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The Federal Fiscal Court recently passed a judgement that may have far-reaching consequences for the future enforcement of tax exemption for transfers of certain company shares. The case in question concerned the so-called 90 per cent test. The judges relativised a previously rigid regulation - a significant development that could affect a large number of companies in the future.

It is now to be hoped that the tax authorities will take a position on this judgement in a timely manner and thus provide greater planning certainty. Background and details in a compact overview:

The initial situation

Under Sections 13a and b of the German Inheritance and Gift Tax Act (Erbschaft- und Schenkungsteuergesetz - ErbStG), shares in commercially active companies are generally eligible for preferential treatment of 85 per cent. The shares are exempt from tax as favoured business assets for both gift and inheritance tax purposes. Under certain conditions, it is also possible to apply for 100 per cent tax exemption. This so-called option exemption requires that the proportion of administrative assets transferred does not exceed 20 per cent of the company value.

In practice, however, there are an increasing number of cases in which significant tax burdens arise despite the exemption - although these can often be identified and even prevented in advance by taking measures at an operational level.

The 90 per cent test: legal situation

In the case of transfers, existing administrative assets generally only lead to a partial tax liability, namely on the excess value of the administrative assets. More significant are cases in which preferential treatment is completely denied. This can occur if a company does not pass the 90 per cent test to be carried out as an "entry test" in accordance with section 13b para. 2 sentence 2 ErbStG. But what exactly does this mean?

According to the current legal situation, shares in a company are not eligible for inheritance tax if the sum of the administrative assets - including all financial resources (receivables and liquidity) - is greater than 90 per cent of the company value.

A critical aspect of this test is that the gross value of all non-favoured assets, including the entire receivables portfolio without debt deduction - at least for liabilities outside the group - is set in relation to the enterprise value. Based on the experience of recent years, this means that a company with a high level of receivables is more likely to fail the test. The result: shares cannot be transferred with tax relief.

The 90 per cent test: practical example

The following example shows what the legal situation can mean in practice:

B-GmbH has an enterprise value of 80 million euros. The company conducts its business in a manner typical of the industry by financing itself with supplier credits. The company's balance sheet total is approximately 400 million euros. 150 million euros of this amount are customer receivables, which are offset by supplier credits of a comparable amount. There are no other administrative assets. This means that the total of all financial resources of 150 million euros is greater than the enterprise value of 80 million euros. The 90 per cent limit would already be reached at 72 million euros.

This exceeding of the 90 per cent limit means that the company as a whole cannot be transferred with tax relief, i.e. it is taxed as private assets. This rule has also been strictly applied by the tax authorities in practice to date on the basis of the binding inheritance tax guidelines.

The judgement of the Federal Fiscal Court

In a recent judgement, the Federal Fiscal Court (BFH) ruled that the rule on the 90 percent test, which was actually created to prevent abuse, also affects regular operating companies. It ruled as such on 13 September 2023:

Section 13b para. 2 sentence 2 of the Inheritance and Gift Tax Act must be interpreted in such a way that, in the case of commercial enterprises whose eligible assets consist of financial resources and, according to their main purpose, serve a commercial activity, the debts incurred for business purposes must be deducted from the financial resources for the 90 per cent entry test enshrined therein.

The judgement expressly only mentions trading companies because this was the individual case to be assessed. However, we expect the judgement to be transferable to other situations*. In its judgement, the BFH focused on trade receivables of a trading company. However, it obviously distinguishes between "good" commercial receivables and other non-operational receivables, which the legislator does not wish to favour as administrative assets.

The effects: What does the judgement mean for transfers?

At the moment, it remains to be seen what the tax authorities will do about this judgement. It seems quite promising to enforce tax exemption in court in comparable cases. In the case of a planned transfer, it is nevertheless advisable to wait for actual certainty of judgement first.

*One of the judges of the 2nd Senate involved in the judgement, Anette Kugelmüller-Pugh, commented on the judgement in a specialist journal (DStR 2023, p. 2788 ff.):

"The case in dispute concerned a trading company in the form of a corporation. However, the decision can be applied to companies in the form of partnerships which, according to their main purpose, are commercially active or are self-employed due to their partners and have a high level of financial resources and productive debts as a result of this activity."

If one follows this statement, the BFH appears to be leaning towards a more comprehensive restriction of the 90 per cent rule.