Family foundations as an instrument of inheritance and gift tax planning
Domestic private-benefit family foundations can have considerable tax significance when structuring asset transfers within a family. The key issue is whether the personal allowance under § 16 Abs. 1 Nr. 2 ErbStG (German Inheritance and Gift Tax Act) can be used multiple times by employing several domestic spend-down family foundations, without aggregation under § 14 ErbStG.
The approach is based on the fact that, when assets are endowed to the foundation under § 7 Abs. 1 Nr. 8 ErbStG, the foundation itself is generally deemed to be the acquirer. The beneficiary, i.e. the person entitled under the foundation’s charter, is not, in this respect, the direct acquirer of the foundation capital. With appropriate structuring, this may open up planning scope alongside direct gifts that parents make to their children while using the personal allowances.
For high-net-worth individuals, entrepreneurial families and investors, this issue is particularly relevant where cash assets are to be transferred. Cash capital is not subject to the special reliefs that inheritance and gift tax law provides for certain other types of assets.
Starting point: spend-down family foundation and personal allowance
Private-benefit foundation with a domestic nexus
A domestic family foundation may be established as a foundation with legal capacity under civil law. If it is structured as a spend-down foundation, its assets are not to be preserved permanently, but rather consumed within a specified period in accordance with the foundation’s charter. § 80 Abs. 1 Satz 2 BGB (German Civil Code) recognises the spend-down foundation under civil law.
For tax purposes, such a foundation may fall within § 1 Abs. 1 Nr. 4 KStG (German Corporation Tax Act). For inheritance and gift tax purposes, the decisive factor is whether it is to be classified as a family foundation within the meaning of the ErbStG. This requires that it be established substantially in the interest of a family or certain families.
Tax class privilege under § 15 Abs. 2 ErbStG
When a family foundation is endowed with assets, the tax class under § 15 Abs. 2 Satz 1 ErbStG is determined by the relationship between the most remote beneficiary entitled under the foundation deed and the founder. If the charter benefits exclusively one child of the founder, tax class I may be applicable. In that case, the personal allowance under § 16 Abs. 1 Nr. 2 ErbStG in the amount of EUR 400,000 may be considered.
The Erbschaftsteuer-Richtlinien (Inheritance Tax Guidelines) likewise refer to the relationship between the most remote beneficiary entitled under the foundation deed and the donor or testator. This perspective is of considerable importance for the practical assessment of the charter.
Example of an asset transfer through gifts and spend-down foundations
Initial facts involving parents and child
For illustration, a purely domestic scenario may be used: A married couple resident in Germany wishes to transfer cash assets in the amount of EUR 2.4 million to their son during their lifetimes. The aim is to avoid a subsequent inheritance tax burden for this portion of the assets while, as far as possible, also excluding a gift tax burden.
As a first step, the father and mother may each make a direct gift of EUR 400,000 to the son. Since there are two different donors, these acquisitions by the son are not aggregated under § 14 ErbStG. The son can claim the personal allowance of EUR 400,000 in relation to each parent.
Further transfer through several spend-down foundations
The remaining amount of EUR 1.6 million can, in the model described, be structured through four domestic family foundations with legal capacity and a spend-down character. The father and mother each establish two foundations and endow each foundation with foundation capital of EUR 400,000. The registered office and place of management of each foundation are in Germany.
The charters provide for a term of ten years. Within this period, the other assets endowed to the foundation are fully consumed. Under the charter, the son is in each case the sole beneficiary.
The charter-based distribution may be made in equal annual amounts. With foundation capital of EUR 400,000 per foundation, this corresponds to an annual amount of EUR 40,000 over ten years.
The structure therefore comprises the following elements:
- direct gift by the father to the son in the amount of EUR 400,000,
- direct gift by the mother to the son in the amount of EUR 400,000,
- establishment and endowment of four domestic spend-down family foundations with EUR 400,000 each,
- charter-based distributions by the foundations to the son over the respective term.
Gift tax classification of the foundation endowment
Foundation as acquirer of the foundation capital
The transfer of the foundation capital to the respective foundation is to be assessed, for inheritance and gift tax purposes, as an acquisition by the foundation. § 7 Abs. 1 Nr. 8 ErbStG classifies the transfer of assets on the basis of a foundation transaction as a transaction subject to gift tax. In this relationship, the acquirer is the respective foundation, not the beneficiary.
As a result, the identity of the acquirer required for aggregation under § 14 ErbStG is lacking. The direct gifts from the parents to the son and the endowments of assets to the foundations concern different acquirers. The foundations are each independent acquirers.
Under current law, § 14 ErbStG contains no provision attributing acquisitions by a foundation to the beneficiary pro rata as the beneficiary’s own prior acquisitions. Likewise, § 15 Abs. 2 Satz 1 ErbStG merely determines which family relationship is to be used for the foundation’s tax class. The provision does not deem the beneficiary to have received the foundation capital himself.
Personal allowance where only a child is benefited
If, under the foundation charter, only the founder’s child is benefited, tax class I may have to be used for the foundation endowment. This may result in an allowance of EUR 400,000 for each foundation under § 16 Abs. 1 Nr. 2 ErbStG. If each foundation is endowed with EUR 400,000, no gift tax would arise in this model for the foundation endowment.
However, this assessment depends materially on the circle of persons potentially entitled under the charter. The Bundesfinanzhof (BFH, Federal Fiscal Court) held in its judgment of 28 February 2024, Case No. II R 25/21, that the most remote beneficiary is the person who may potentially receive economic benefits under the foundation charter. It is irrelevant in this regard whether that person has already been born at the time of the foundation transaction, will ever be born, or actually receives benefits from the foundation.
In the dispute decided by the Bundesfinanzhof, the charter-based potential benefit also of a great-grandchildren generation resulted in the allowance of EUR 400,000 for children not being granted, but only the allowance of EUR 100,000 for other persons in tax class I. The gift tax in that case had most recently been assessed at EUR 59,175 by amended notice dated 11 June 2020. The lower court decision is published as a Gerichtsbescheid (court ruling without oral hearing) in Entscheidungen der Finanzgerichte 2021, 1558.
The Bundesfinanzhof expressly distinguished its decision from its AdV-Beschluss (order in suspension-of-enforcement proceedings) of 27 July 2020, Case No. II B 39/20. In that proceeding, great-grandchildren were immediately entitled to benefits. The specific provisions of the charter governing the circle of entitled persons therefore remain decisive for the tax classification of the foundation endowment.
Charter-based distributions by the foundation to the beneficiary
No gratuitous transfer in the case of charter-compliant performance
According to settled case law, ongoing payments by a domestic foundation to the persons entitled under its charter are not to be regarded as gratuitous transfers within the meaning of § 7 Abs. 1 Nr. 1 ErbStG. In this respect, gratuitousness in the legal sense is lacking. The foundation is merely fulfilling its charter-defined purpose.
Nor is § 7 Abs. 1 Nr. 9 Satz 1 ErbStG applicable to ongoing charter-based distributions by an existing spend-down foundation. This provision concerns acquisitions upon dissolution, termination, accession or merger of foundations. Ongoing payment during the existence of the foundation does not automatically fall within this taxable event.
No substitute inheritance tax in the case of a ten-year spend-down foundation
The substitute inheritance tax under § 1 Abs. 1 Nr. 4 ErbStG is linked, in the case of family foundations, to a period of 30 years in each case since the first transfer of assets to the foundation. If a spend-down foundation ceases to exist after only ten years, such a 30-year period does not expire in the model described. The foundation would then no longer exist when the relevant point in time occurs.
In addition, the approach described refers to the preferential treatment under § 15 Abs. 2 Satz 3 ErbStG. The taxpayer liable for substitute inheritance tax would be the foundation itself. In the example, however, no substitute inheritance tax burden is triggered.
Income tax treatment of payments to the beneficiary
Return of contributions by a domestic private foundation
In the case of payments by a domestic private foundation with legal capacity to beneficiaries, it must be examined for income tax purposes whether taxable income under § 20 Abs. 1 Nr. 9 EStG (German Income Tax Act) exists or whether a non-taxable return of contributions is to be assumed. The Bundesfinanzhof has held in this regard that § 20 Abs. 1 Nr. 1 Satz 3 EStG may apply mutatis mutandis. Accordingly, repayments from the tax contribution account do not form part of income.
In the case of private foundations with legal capacity, the case law does not necessarily require a separate determination under § 27 Abs. 7 KStG for the tax treatment at the level of the beneficiary. Rather, in the beneficiary’s assessment proceedings it may be examined whether the distribution economically corresponds to a non-taxable return of contributions.
Repayment of foundation capital instead of distribution of income
In the model described, the spend-down foundations do not generate income that is distributed to the son. Their charter-defined task consists of distributing the dedicated other assets to the beneficiary over the term. This therefore constitutes repayment of the foundation capital or other foundation assets.
For the assessment, the foundation’s accounting records in particular may be used. These include the statement of assets, annual accounts and accountability report. Within this framework, the distributions by the spend-down family foundations are, at the beneficiary level, non-taxable repayments of contributions under § 20 Abs. 1 Nr. 1 Satz 3 in conjunction with § 20 Abs. 1 Nr. 9 Satz 1 Halbsatz 2 EStG.
This is not precluded by the fact that the foundation capital was originally transferred by the founders to the foundation. § 20 Abs. 1 Nr. 9 EStG orders the tax assessment in the relationship between the foundation and the beneficiary. The relationship between the founder and the foundation must be distinguished from this.
Robustness of the structure and limits of tax recognition
Use of legally provided structures
The approach described is based on legally recognised structures. Domestic family foundations are expressly taken into account in inheritance and gift tax law. Spend-down foundations are recognised under civil law and may also be capable of tax classification.
According to the understanding described, there is no room for application of § 42 AO (German Fiscal Code) if the structure uses only options provided by law. Taxpayers may, as a general rule, arrange their affairs in such a way as to produce a lower tax burden. This also applies in the area of inheritance and gift tax.
Importance of the charter for the allowances
The tax effect depends materially on the specific foundation charter. In particular, the circle of persons potentially entitled determines which family relationship under § 15 Abs. 2 Satz 1 ErbStG is decisive for the tax class. The decision of the Bundesfinanzhof of 28 February 2024 makes clear that even a merely potential benefit for more remote generations can alter the applicable allowance.
The tax-optimising use of spend-down foundations was already the subject of a specialist lecture on 10 September 2024 at the 5th September Conference of the Centre for NPO Law at Leipzig University. This shows that the structure is attracting particular attention in tax law discussions.
Summary of the key tax points
Domestic private-benefit spend-down family foundations can help, in the context of asset succession, to make personal allowances under inheritance and gift tax law usable multiple times. The essential approach is that, when endowed with assets, the foundation itself is the acquirer and the acquisitions are not attributed to the beneficiary as the beneficiary’s own acquisitions without a statutory basis.
In the case of direct gifts by parents to a child, the respective allowances in relation to each parent must be examined separately. If, in addition, several domestic spend-down family foundations are established and each is endowed with foundation capital, a further allowance effect may arise where only the child is benefited. The prerequisite is that the charter does not provide for more remote persons potentially entitled who would reduce the relevant allowance.
According to the case law described, the ongoing charter-based payments by the spend-down foundation to the beneficiary are not to be treated as gratuitous transfers by the foundation. For income tax purposes, they may be classified at the beneficiary level as a non-taxable return of contributions if foundation capital, and not income generated, is in fact distributed.
Frequently asked questions
BFH II R 25/21 family foundation: When does the EUR 400,000 allowance apply?
The EUR 400,000 allowance can be considered when endowing a family foundation only if the most remote beneficiary entitled under the foundation charter has a corresponding close relationship to the founder, for example as a child. According to the BFH judgment of 28 February 2024, even a merely potential benefit for more remote generations may lead to a lower allowance.
§ 14 ErbStG spend-down foundation: Are foundation acquisitions attributed to the child?
According to the approach described, acquisitions by the foundation are not aggregated under § 14 ErbStG with direct gifts to the child, because the foundation itself is the acquirer. Under current law, § 14 ErbStG does not provide for statutory attribution of these foundation acquisitions to the beneficiary.
Spend-down family foundation for businesses: What practical consequences does the structure have?
For entrepreneurial families and high-net-worth individuals, the spend-down family foundation can be significant from a tax perspective in lifetime asset succession. However, the content of the charter, the circle of beneficiaries, the term and the tax classification of later distributions are particularly decisive.
Tax structuring requires careful review
Integrating domestic spend-down family foundations into asset succession can have considerable effects on gift tax, substitute inheritance tax and income tax. At the same time, the case law of the Bundesfinanzhof and the importance of the circle of beneficiaries defined in the charter show that the tax assessment depends materially on the details of the specific facts. Anyone with questions regarding the tax classification of such structures can find support from MTR Legal in the context of legal advice on tax law.
