Discretionary Trusts and German Tax: From Settlement to Termination

Published on 15.10.2026

Discretionary Trusts and German Tax

A trust in which the trustee decides at their own discretion who receives how much and when looks like an instrument that escapes the German tax authorities. The opposite is true. The German tax treatment of a discretionary trust is regulated in detail: gift tax on settlement, on distributions to interim beneficiaries and on termination, plus income tax for the beneficiaries, attribution under Section 15 of the Foreign Tax Act (Außensteuergesetz, AStG) and reporting obligations. This article explains the German rules as at October 2026. How the trust is created and operates under the law of the state in which it is established should be clarified with an adviser in that country.

What Makes the Discretionary Trust Special for Tax Purposes

In a trust, the settlor (Errichter) transfers assets to a trustee, who manages them for the beneficiaries in accordance with the trust deed. In a discretionary trust, the deed does not specify who receives which share; the trustee decides on timing, amount and recipient at their discretion. In this basic form, the beneficiaries have no fixed entitlement. Two questions are decisive for tax purposes:

• Is the trust actually independent? If the settlor reserves a right of revocation, far-reaching rights to give instructions or de facto control over distributions, the assets continue to be attributed to the settlor (beneficial ownership, wirtschaftliches Eigentum, Section 39 (2) no. 1 of the Fiscal Code, Abgabenordnung, AO). The trust is then transparent for tax purposes. The word irrevocable in the deed alone is not sufficient; what counts are the rights actually reserved.
• What is the position of the beneficiaries? Whether a beneficiary is an interim beneficiary (Zwischenberechtigter) within the meaning of the Inheritance and Gift Tax Act depends on whether they have a legal entitlement under the applicable foreign law and the deed. In a purely discretionary trust, this is precisely the open question.

The following text assumes a non-transparent, irrevocable discretionary trust. The fundamental comparison between trusts and foundations, recognition under German civil law and the question of which instrument suits whom are covered in the article Common law trust or foundation compared.

When German Tax Law Applies at All

Under Section 2 (1) no. 1 of the Inheritance and Gift Tax Act (Erbschaftsteuer- und Schenkungsteuergesetz, ErbStG), unlimited gift tax liability for the entire acquisition arises if the donor at the time the gift is made or the acquirer at the time the tax arises is a resident (Inländer). Residents are in particular individuals with a residence or habitual abode in Germany, as well as German nationals who have not been continuously abroad for more than five years without having a residence in Germany (Section 2 (1) no. 1 sentence 2 letter b ErbStG). When a habitual abode for tax purposes exists is therefore often the first question to examine.

If there is no resident, limited tax liability remains for domestic assets under Section 2 (1) no. 3 ErbStG, for example for German real estate. For income tax and attribution under Section 15 AStG, by contrast, what matters is the unlimited income tax liability of the settlor or the beneficiary.

The Taxable Events at a Glance

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Settlement: Gift Tax under Section 7 (1) No. 8 Sentence 2 ErbStG

The ErbStG captures the trust through a catch-all term: Section 7 (1) no. 8 sentence 2 ErbStG treats “the formation or endowment of a pool of assets under foreign law whose purpose is to tie up assets” (Vermögensmasse ausländischen Rechts) in the same way as a transfer of assets to a foundation. An irrevocable discretionary trust is the typical case. For the testamentary trust, the parallel provision is Section 3 (2) no. 1 sentence 2 ErbStG. This results in the following:

1. The acquirer is the trust itself. Under Section 20 (1) sentence 2 ErbStG, the pool of assets is the acquirer and tax debtor; in the case of a settlement inter vivos, the person who formed or endowed it, i.e. the settlor, is also a tax debtor. The tax office can therefore look to both.
2. Tax class III. The tax class privilege of Section 15 (2) sentence 1 ErbStG applies only to foundations established essentially in the interest of a family in Germany. The Court of Justice of the European Union, in its judgment of 13 November 2025 (C-142/24) concerning a Liechtenstein family foundation, approved this restriction in principle. For a foreign trust, tax class III therefore continues to apply, with an allowance of EUR 20,000 (Section 16 (1) no. 7 ErbStG) and tax rates of 30 percent up to 6 million euros and 50 percent above that (Section 19 (1) ErbStG), even if only the settlor’s own children are beneficiaries.
3. Timing. For gifts inter vivos, the tax arises when the gift is made (Section 9 (1) no. 2 ErbStG). Every later addition to the trust is a new transaction.

Example (fictitious): Bernd, resident in Germany, transfers securities worth 2 million euros to an irrevocable discretionary trust; only his two children are beneficiaries. After deducting the allowance of EUR 20,000, EUR 1,980,000 remains, which is taxed at 30 percent. The gift tax amounts arithmetically to EUR 594,000. Had Bernd given each child 1 million euros directly, then after deducting the allowance of EUR 400,000, EUR 600,000 per child would have been taxed at 15 percent, EUR 180,000 in total. Valuation issues and prior acquisitions are disregarded here.

Different rules apply to a German family foundation, which are explained in the article Family foundation as asset protection for emigrants.

Distributions During the Term: Interim Beneficiaries under Section 7 (1) No. 9 Sentence 2 ErbStG

In addition to termination, Section 7 (1) no. 9 sentence 2 ErbStG covers “the acquisition by interim beneficiaries during the existence of the pool of assets”. A distribution to a beneficiary resident in Germany may therefore be subject to gift tax even though the settlor already paid gift tax on settlement.

Who Is an Interim Beneficiary?

In its judgment of 25 June 2021 (II R 31/19, BStBl II 2022, 497) concerning an irrevocable US trust, the Federal Fiscal Court (Bundesfinanzhof, BFH) held: an interim beneficiary is anyone who, independently of a specific distribution decision, has rights in rem or contractual claims in relation to the assets or income of the pool of assets. This also applies to Anglo-American trusts. Which rights the beneficiary has is determined by the foreign trust law.

Anyone who, under the deed and the applicable law, can only hope for a discretionary decision of the trustee is therefore not an interim beneficiary. This does not automatically make the distribution tax-free; according to the Federal Fiscal Court, it must then be examined whether there is a gratuitous transfer (freigebige Zuwendung) under Section 7 (1) no. 1 ErbStG.

The Burden of Proof Lies with the Recipient

Of greater practical importance is the rule on the burden of proof in the same judgment: the recipient must set out the facts and, where necessary, procure the evidence that they had no entitlement to the distribution under the applicable law. Anyone who cannot produce the trust deed, side agreements (such as letters of wishes) and an assessment of the trust law of the state of establishment bears the risk.

After the case was referred back, the Munich Fiscal Court (Finanzgericht München, judgment of 3 July 2024, 4 K 2033/16) concluded that the beneficiary of the Florida trust in question had a payment claim under the deed that could not readily be withdrawn, because the trustees were obliged to make regular instalment payments. The distributions remained subject to gift tax. What counts is therefore the deed, not the label discretionary.

Tax Class for Distributions

For the tax class under Section 7 (1) no. 9 sentence 2 ErbStG, a legal fiction applies: under Section 15 (2) sentence 2 ErbStG, the person who formed or endowed the pool of assets is deemed to be the donor. If the settlor’s child receives a distribution, tax class I with the child allowance of EUR 400,000 therefore applies in principle, aggregated with other acquisitions from the same donor within ten years. In the Munich case, the spousal allowance was applied for the widow. For distributions that could only be captured as a gratuitous transfer under Section 7 (1) no. 1 ErbStG, the question of who is deemed to be the donor is not expressly regulated.

Termination of the Trust

If the trust ends and the assets are distributed to the final beneficiaries, this is taxable under Section 7 (1) no. 9 sentence 2 ErbStG as an “acquisition on the dissolution of a pool of assets under foreign law”. Here too, under Section 15 (2) sentence 2 ErbStG, the settlor is deemed to be the donor for the purposes of the tax class. The termination should therefore be calculated in advance, also with regard to allowances that earlier distributions have used up.

For income tax purposes, termination is disputed. In its judgment of 27 February 2018 (VIII R 30/15) concerning a domestic foundation, the Federal Fiscal Court held that the distribution of assets on dissolution, as a repayment of capital, is not comparable to a profit distribution and therefore does not fall under Section 20 (1) no. 9 of the Income Tax Act (Einkommensteuergesetz, EStG). Whether this can be transferred to foreign pools of assets was not decided there. In its judgment of 23 March 2023 (1 K 2478/21 E), the Münster Fiscal Court (Finanzgericht Münster) treated asset transfers from the termination of US trusts as investment income, but only for increases in value from the new rules introduced by the Annual Tax Act 2010 (Jahressteuergesetz 2010) in December 2010. Whether and to what extent the termination of a discretionary trust triggers income tax in addition to gift tax has therefore not been conclusively settled.

Income Tax for the Beneficiaries

Ongoing distributions may additionally be subject to income tax. Section 20 (1) no. 9 sentence 2 EStG covers payments by foreign pools of assets that are economically comparable to profit distributions. In autumn 2024, in judgment VIII R 25/21 concerning a Swiss family foundation, the Federal Fiscal Court interpreted this criterion broadly: it is sufficient that the recipient meets the requirements of the articles, belongs to the group of beneficiaries and provides no consideration. They do not need ownership, property or participation rights. However, only payments out of generated surpluses are covered, not the distribution of the endowed capital. Whether the same applies to trusts must be examined in each individual case. For the discretionary trust, this line means: precisely the discretionary distribution out of income, which may not be captured for gift tax purposes, may be captured for income tax purposes. It is therefore all the more important to record whether a payment comes from income or from the contributed assets.

Double Burden of Gift Tax and Income Tax

If both apply, the same distribution is taxed twice. In judgment II R 31/19, the Federal Fiscal Court expressed doubts as to whether there is a genuine double burden in this respect and rejected an unconstitutional double burden. Statutory relief exists only on the income tax side: under Section 15 (11) AStG, distributions remain tax-free to the extent that the underlying income has demonstrably already been attributed under Section 15 (1) AStG. The law does not provide for a credit against gift tax. Anyone receiving distributions should therefore document which income was already attributed and taxed in which year.

Ongoing Attribution under Section 15 AStG

Even undistributed income can be captured. Section 15 (1) AStG attributes the assets and income of a foreign family foundation to the founder if they have unlimited tax liability, otherwise to the persons with unlimited tax liability who are entitled to income or capital (bezugs- oder anfallsberechtigt). A family foundation exists if the founder, their relatives and their descendants are entitled to more than half of the income or capital (Section 15 (2) AStG). Under Section 15 (4) AStG, “other special-purpose assets, pools of assets and associations of persons with or without legal capacity” are treated in the same way; this covers the family trust.

The order is central for emigrants: as long as the settlor has unlimited tax liability in Germany, the trust income is attributed to them, even if they receive nothing themselves. If they move abroad and their unlimited tax liability ends, attribution passes to the beneficiaries remaining in Germany. With a discretionary trust, it is difficult to determine who is entitled to income or capital and to what extent, because fixed shares are lacking. Under Section 15 (8) AStG, the attributed income is generally deemed to be income from capital assets.

Section 15 (6) AStG provides an exception for structures with their registered office or place of management in an EU or EEA state if the assets are legally and actually removed from the control of the persons involved and there is a basis for the exchange of information between the states. According to its wording, this exception applies only to EU and EEA states. However, in its judgment of 3 December 2024 (IX R 15/24) concerning a Swiss family foundation, the Federal Fiscal Court held that this restriction infringes the free movement of capital under Article 63 of the Treaty on the Functioning of the European Union (TFEU), which also applies in relation to third countries. Accordingly, the exception can also be applied to foundations and trusts in third countries such as Jersey or the Cayman Islands if the other requirements are met, in particular if the assets are legally and actually removed from the control of the beneficiaries. These requirements should be carefully documented. Whether and how the tax authorities apply the judgment beyond the case decided must be examined in each individual case.

Emigration of the Settlor or Beneficiaries

On emigration, the connecting factors shift depending on the type of tax:

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If the new state of residence also levies an inheritance or gift tax, there is a risk of double taxation. Germany has a treaty in this area with only a few states; the details are set out in the article Inheritance tax and double taxation treaties. The treaties allocate taxing rights and regulate the tax credit, but they do not automatically lead to exemption from tax in Germany.

Notification and Reporting Obligations

• Notification under Section 30 ErbStG: Every acquisition subject to gift tax must be notified to the tax office in writing within three months of becoming aware of it; for acquisitions inter vivos, the person from whose assets the acquisition derives is also obliged. This concerns settlement and distributions.
• Notification under Section 138 (2) AO: Among other things, the acquisition of interests in a foreign pool of assets of 10 percent or more or with acquisition costs exceeding EUR 150,000 (no. 3) and first-time controlling or decisive influence over a third-country company, which also includes pools of assets outside the EU and EFTA (no. 4, subsection 3), must be reported. Whether a discretionary trust triggers these requirements must be examined in each individual case. Deadline: with the tax return, at the latest 14 months after the end of the assessment period (Section 138 (5) AO).
• Transparency register: Trustees with their registered office or residence in Germany and, under certain conditions, also foreign trustees with a business relationship or real estate connection in Germany must report the beneficial owners under Section 21 of the Money Laundering Act (Geldwäschegesetz, GwG).
• Exchange of information: Through the Common Reporting Standard, the tax office in many cases learns about trust accounts and the persons involved anyway.

Typical Mistakes from a German Perspective

1. Not knowing the deed and side agreements. Without knowledge of the beneficiaries’ rights, interim entitlement cannot be assessed; the burden of proof lies with the recipient.
2. Not notifying distributions. The notification obligation under Section 30 ErbStG also applies if the recipient believes no tax is owed.
3. Not documenting attributed income. Without evidence, the relief under Section 15 (11) AStG is lost.
4. Planning emigration in isolation. The five-year period and the transfer of attribution to beneficiaries in Germany are often overlooked.
5. Not coordinating trust law and German law. An arrangement that is advantageous in the state of establishment may have unfavourable effects in Germany.

Because interim entitlement, income tax on termination and administrative practice on Section 15 (6) AStG for third countries have not been conclusively settled, a binding ruling (verbindliche Auskunft) from the tax office under Section 89 (2) AO should be applied for before settlement, larger distributions or termination. It binds the tax office for a precisely described set of facts that has not yet been implemented and is subject to a fee. Where there is a foreign connection, a ruling in the other state may also be advisable. How transfers can be planned legally overall is shown in the article Avoiding inheritance tax legally.

Conclusion

Under German tax law, the discretionary trust is captured as a pool of assets under foreign law. On settlement by a German settlor, gift tax is levied under tax class III. Distributions are subject to gift tax if the recipient is an interim beneficiary; in a genuinely discretionary trust this may be lacking, but the burden of proof lies with the recipient. In addition, there is income tax, attribution under Section 15 AStG and notification obligations. On emigration, the connecting factors shift without German tax liability ending immediately. The trust deed should therefore be reviewed from a German perspective in advance.

Frequently Asked Questions

Is the settlement of a discretionary trust subject to gift tax in Germany?

Yes, if the settlor is a resident. Section 7 (1) no. 8 sentence 2 ErbStG covers the formation or endowment of a pool of assets under foreign law. The trust is the acquirer and tax debtor, and the settlor also owes the tax. Tax class III with an allowance of EUR 20,000 applies, even if only children are beneficiaries.

Do I have to pay gift tax if I receive a discretionary distribution?

That depends on whether you are an interim beneficiary, i.e. whether you have an entitlement under the deed and the applicable law. According to the Federal Fiscal Court (II R 31/19), you must set out and prove that there was no entitlement. If there is no interim entitlement, a gratuitous transfer under Section 7 (1) no. 1 ErbStG must still be examined.

Which tax class applies to distributions and on termination?

Under Section 15 (2) sentence 2 ErbStG, the settlor is deemed to be the donor. Your family relationship to the settlor is therefore decisive; for children, tax class I with an allowance of EUR 400,000 applies, aggregated with other acquisitions from the settlor within ten years.

Will the trust’s income be attributed to me even though I receive nothing?

That is possible under Section 15 AStG. Attribution primarily applies to the settlor with unlimited tax liability in Germany, otherwise to the beneficiaries with unlimited tax liability who are entitled to income or capital. Income already attributed remains free of income tax on a later distribution under Section 15 (11) AStG if you can prove this.

Does German tax liability end if I emigrate?

Not immediately, and not in the same way for every type of tax. For inheritance and gift tax purposes, German nationals continue to be treated as residents for up to five years after moving away, even without a residence in Germany. Attribution under Section 15 AStG ends for the settlor when their unlimited tax liability ends, but may then affect beneficiaries living in Germany.

Attorney Dr. Johannes Fiala and the Munich-based firm, which focuses on international succession law, tax law and asset protection, advise settlors and beneficiaries on the German taxation of discretionary trusts, from gift tax on settlement through distributions and attribution under Section 15 AStG to the consequences of emigration. Dr. Fiala has published extensively on questions of emigration and asset protection. Please get in touch with the firm without obligation to discuss your individual situation in an initial consultation.