The German Federal Tax Court recently published a decision stating that distributions from a foreign trust to beneficiaries resident in Germany are subject to German gift tax (Bundesfinanzhof, September 27, 2012 – II R 45/10).
According to the court, distributions by an irrevocable trust before its termination – be they principal or income, discretionary or fixed-interest – to beneficiaries resident in Germany are subject to German gift tax. An exception should apply only for the settlor himself. This view had been taken by several German tax authorities before, but was controversial. With the recent Federal Court ruling there is hardly any room left for a differing reasoning.
The recent ruling did not address thequestion of how this gift taxation relates to income tax imposed on trust distributions. Trust distributions have usually been considered as being taxable under the German Income Tax Act. Therefore, it may be assumed by tax authorities that trust distributions trigger double taxation, both income and gift tax. Though from a systematic standpoint, a distribution should be subject only to either income tax or gift tax. The Federal Tax Court did not have to address this issue.
In short, foreign trusts as estate planning tools involve significant risks, if the settlor or one of the beneficiaries has his or her residence or habitual abode in Germany. Distributions may trigger a heavy tax burden. The same applies to the formation and dissolution of a trust. Moreover, undistributed income of a trust may be attributed to a settlor or beneficiary with German tax residence.
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