In two recently published rulings, the German Federal Fiscal Court (Bundesfinanzhof, BFH) has commented on the gift taxability of distributions made by foreign trusts to beneficiaries in Germany (BFH, ruling dated June 25, 2021 – II R 31/19 as well as BFH, ruling dated June 25, 2021 – II R 32/19).
In the almost identical BFH rulings, the court had to decide on the following case: The plaintiff was the beneficiary of various trusts that were to pay their income to the plaintiff on a quarterly basis for the plaintiff’s provision. The current income of these trusts was attributed to the plaintiff (irrespective of its payment) and subjected to income tax within the scope of attribution taxation. When the trust income was subsequently actually paid out to the plaintiff, the German tax authorities again classified this as an acquisition of an intermediate beneficiary and assessed gift tax on it. As a result, the plaintiff was burdened twice with income tax and gift tax.
However, the plaintiff now successfully challenged the assessment of gift tax before the BFH. In its rulings, the BFH made it clear that the term „intermediary beneficiary“ is to be interpreted in exactly the same way for foreign trusts as for foreign foundations. While this was almost unanimously recognized by the relevant literature, the BFH had not clearly clarified this point in its ruling of July 3, 2019 (BFH II R 6/16, see blog post from November 2019), as it had to decide on distributions from a Swiss family foundation. Until now, this had led to German tax offices continuing to assess gift tax on trust distributions, so that in some cases there was a ongoing double burden of income tax and gift tax for trust beneficiaries.
In its current decisions, however, the BFH specifically commented on trusts and confirmed that the same principles apply to the gift taxability of trust distributions as to distributions by foreign foundations to their domestic beneficiaries. An intermediary beneficiary is a person who, irrespective of a specific distribution resolution, has rights in rem or claims under the law of obligations with respect to the assets or income of the trust. This is the case with so-called fixed interest trusts. According to the BFH, the trust beneficiary must provide the necessary evidence that he is not entitled to the distribution under foreign law.
The trust beneficiary who merely receives a distribution as a result of a specific decision by the trustee in an individual case is not an intermediate beneficiary. Thus, distributions based on the discretion of the trustee in the case of so-called discretionary trusts will remain free of gift tax in the future. If, however, distributions are made to a beneficiary not listed in the trust deed, gift tax will continue to be levied in the same way as in the case of the foreign family foundation.
In the cases decided by the BFH, the German attribution taxation was not particularly dramatic for the plaintiff, since the income of the trust was actually paid out to her in a timely manner. However, this is not always the case. The trustee can also use the trust income for further investments. Moreover, according to the tax authorities, attribution taxation may also apply to posterior classes of trust beneficiaries who initially have no prospect of receiving any distributions, even if the trust makes such distributions. This practice applies in particular if there is only one trust beneficiary within the trust structure that is taxable in Germany. This can lead to considerable liquidity difficulties for trust beneficiaries resident in Germany, as they pay income tax on income that may not be paid out to them. If the trust income is not declared accordingly in the trust beneficiary’s income tax return, this in turn constitutes tax evasion.
In order to avoid the attribution taxation in problematic cases, the interposition of a foundation in the EU/EEA abroad is an option. If this is may not be viable, an exit of the trust beneficiary from the trust structure by selling his beneficiary position may also be a solution. This is particularly attractive if, apart from the German trust beneficiary, there are only foreign beneficiaries who are not affected by the negative consequences of attribution taxation.
Overall, it should be noted that for trust beneficiaries the double tax burden is a thing of the past, in the case of discretionary distributions of foreign trusts in accordance with the articles of association. However, this does not apply to distributions that do not comply with the articles of association or distributions that are based on established claims of the beneficiary. For German trust beneficiaries, the problem of attribution taxation remains, where there is still a need for action.
If you have any questions regarding the taxation of foreign trusts and their beneficiaries, please do not hesitate to contact Dr. Benjamin Rothmund (Benjamin.Rothmund@rittershaus.net).