Succession planning: Be aware of expensive gifts!

Family businesses continue to grow in their international footprint. At the same time, the families behind them often live in different parts of the world which triggers a variety of challenges: from navigating cultures, time zones and last but not least, complex questions about inheritance and gift tax (IHT / gift tax).

A case study

For example, one of our clients is a family of four who each have an equal interest in a German personal holding company (PHC). The shareholders are the parents, Fred and Mary, and their children, Sebastian and Dorothy, they are all German nationals. A couple of years ago the operating business was sold by the PHC, with the proceeds invested through J.P. Morgan into different types of securities.

Sebastian studied in the UK and married a British woman, who he’s lived with in London for a few years. As of six months ago, he is no longer considered a tax resident (or a deemed tax resident, see below) in Germany. Dorothy has lived in Brittany for three years – she decided to stay after relocating from Germany to manage the French subsidiary of the family business. Fred and Mary are thinking about retiring and have moved to their finca in Mallorca, which previously served as a holiday home. After a few months there, Fred decided to gift his remaining shares in the PHC to Mary, Sebastian and Dorothy.

From a legal and tax perspective, this situation poses a lot of questions. For example, would the change of residency trigger an exit tax? Which civil law applies to the transfer of shares? One of the most important issues is whether Fred’s gifts will trigger IHT in different jurisdictions. We’ve considered the answer to these questions in relation to the laws in Germany, Spain, France and the UK.

Different regions have different rules

A country’s IHT laws are often as much the culmination of decades and even centuries of culture, religion with an overlay of modern tax policy. Historical factors such as whether the country was centre for immigration or emigration – or even whether there was a feudal system – are often still reflected in 21st century IHT laws. As a result, distinctive domestic IHT rules have developed and there is little harmonisation between regions.

In the Anglo–American model, the idea of an undivided estate generally prevails. This method can be seen as a type of capital tax on the person who has died (the donor). The recipient (donee) is not normally subject to taxation.

However, the more common approach in continental Europe is that the acquisition by the individual recipient is the taxable event. Within this legal concept, some areas only look at the residency of the recipient and/or the region where the property is located. They include some regions of Spain, where a potential capital gains tax would already have been triggered on the donor/deceased. Other jurisdictions, such as Germany or France, also look at the residency of the donor/deceased.

In view of the lack of harmonisation between regions and the fact that there are comparatively few double taxation treaties related to IHT (Germany has just entered six of them, one of the six being with France), it is clear that scenarios like the one described above may lead to double taxation of the same gift (or no tax liability at all). However, these effects can be mitigated by national rules, such as being deemed tax resident for a certain period after a change of residency (e.g. a German national remains subject to German IHT for five years after relocation; even 10 years in case of a relocation to the U.S.). Below we take a closer look at Fred’s gifts to Mary, Sebastian and Dorothy and the possible tax implications.¹

What are the IHT rules in relation to the recipients?

• The gift to Mary would be subject to tax in Germany, since Mary is a tax resident in Germany (owing to the five-year-deeming provision). Generally, Spain would also tax Mary as a tax resident recipient, but Spanish IHT tax law² does not tax lifetime gifts between spouses.
• Sebastian is a tax resident of the UK but there is no gift tax on donees in the UK. Broadly speaking, UK capital gains would be triggered if the donor is a UK tax resident at the time of the gift.
• Dorothy will most likely qualify as a tax resident in France. Since Fred is not a tax resident in France, gift tax would only apply if Dorothy (the recipient) had been tax resident in France for at least six years in the past 10 years. Therefore, French gift tax should not be triggered.³

As Mary and Dorothy would still qualify as German tax residents (in Mary’s case because she remains actually resident in Germany and in Dorothy’s case because she is deemed to be German resident), the receipt of the donation from their Father Fred would be subject to German IHT. 

As Fred, the donor, may also either be actually German resident or at least be deemed to be German resident, his gift to his two children will also be subject to German IHT. 

However, for the avoidance of doubt, German IHT would only be charged once in these circumstances.

What’s the outcome?

None of the gifts were taxed twice and they were all taxed in Germany. For various reasons, the gifts were exempt from IHT in the other jurisdictions – Spanish IHT rules (as they apply in the Balearic Islands) do not tax or at the least they mitigate taxation on gifts between spouses; France only levies IHT on a gift by a non-French resident at the recipient level after a minimum stay in the country (unless French assets are involved); and the UK does not tax recipients of gifts.

However, the outcome could have been very different if the family had made other choices. For example, if Dorothy and Sebastian lived with their parents in Mallorca (and would not benefit from the spouse tax treatment), there would be potential for double taxation. Alternatively, if Fred had chosen to retire to the UK he may have qualified as UK domiciled when he died, subjecting his entire estate to UK IHT. Again, there would be potential for double taxation in this situation.

Thinking ahead

A change of residency – whether it’s for marrying, studying or retiring – should always be carefully planned. It’s important to seek legal advice from tax experts in each jurisdiction to avoid any unpleasant surprises.

J.P. Morgan Private Bank provides comprehensive wealth management services for those with international lives and families – for more information, please contact your J.P. Morgan team.

¹ However, other Spanish taxes, such as CGT, may be applicable.

² This refers to Spanish IHT as it applies in the Balearic Islands – Spanish IHT is not harmonized across the country.

³ For gift tax in France – for example, on French property – double taxation would probably be reduced by an exemption and/or credit under the IHT double taxation agreement between Germany and France.