BERLIN (Reuters) - Germany’s Constitutional Court will rule this week whether it is legal to grant family-run firms inheritance tax breaks, in a decision that could deal a heavy blow to “Mittelstand” firms that form the backbone of the economy.
Around 90 percent of German companies are family-run and they make a huge contribution to economy, employing more than half the working population and creating 50 percent of Germany’s gross domestic product (GDP).
However, the Federal Fiscal Court is challenging a 2009 law which allows ownership of such firms to be passed from one generation to the next tax free, provided the heirs keep it going for seven years and preserve jobs. It has taken its complaint to the Constitutional Court.
Some experts believe the law, which also grants an 85 percent reduction in inheritance tax for those who continue to run their family firms for only five years, is excessively generous. They say Germany’s top court is likely to strike down the law or demand that the tax breaks be tightened up when it delivers its verdict on Wednesday.
But firms have warned that an adverse ruling by the court in the western city of Karlsruhe might force them to curtail their investment plans and shed staff, hurting an already slowing German economy.
Almost 70 percent of family-owned industrial companies say loss of the tax exemptions would put their firms at risk, a recent survey by the BDI, Germany’s main industry lobby, showed.
It found around two-thirds of firms facing a generational transition before 2019 would be likely to reduce investments while around half would probably have to cut jobs.
Manfred Fuchs, vice-chairman of the supervisory board of Fuchs Petrolub SE, a lubricant supplier founded in 1931, said he had transferred the majority of his shares in the company to his children by the end of 2013 to make use of the tax break.
Fuchs, formerly chairman of the company’s executive board, told Reuters his children could not have paid the full inheritance tax and may have had to sell parts of the firm.
Thanks to the exemption it invested in factories, capital equipment and investment instead. However, the Federal Fiscal Court argues the 2009 tax reform breaches Germany’s post-war Basic Law because the benefit is too great for the heirs.
Fuchs remains worried about how the firm can be passed eventually to his grandchildren should the judges rule in favor of the Fiscal Court, the top court for tax issues.
“The fourth generation wouldn’t be able to afford the inheritance tax so they’d have to try to take the money for it out of the company and then it couldn’t be used for making investments and employing people,” he said.
If the law changes, 138,000 companies which together employ more than 2 million people could be hit by 2018, the BDI said.
In a hearing in July, judges at the Supreme court, which was set up in 1951 to avoid a return to Nazi tyranny, made clear by the questions they asked that they wanted to investigate whether lawmakers had gone too far with the 2009 reform.
“It’s very likely the constitutional court will scrap the inheritance tax law in its current form – the hearing has already strongly suggested this so the court will rule that the extremely extensive privileges are disproportionate,” said Johanna Hey, a professor in tax law at Cologne University.
Anton Steiner, head of the German forum for inheritance law, said the law was unconstitutional, offered company heirs “tax gifts” and could not be justified on the basis of equality.
“If you inherit a small number of shares in BMW, you pay normal inheritance tax but if you inherit more than 25 percent of BMW and hold on to the shares for seven years, you don’t pay any inheritance tax at all. I can’t understand that,” he said.
He said the court would probably impose stricter rules on companies to qualify for privileges such as by demanding that they keep a company going for at least 10 or 12 years.
But Lutz Goebel, president of a German lobby group for family-run firms, remains hopeful the court will tell lawmakers to do some fine-tuning rather than scrap tax breaks altogether.
“It remains right and important to protect responsible entrepreneurs in family businesses from losing the majority of their investment capital and reserves every time they pass their company on to the next generation,” he said.
editing by David Stamp