Exit Taxation of Business Assets: Hidden Reserves When Relocating Abroad

Published on 20.09.2026

Hidden Reserves on Business Relocation

Note: Our article on moving a company’s registered office abroad and the tax consequences already covers exit taxation (Entstrickungsbesteuerung) as one of four core tax issues – but only in overview form and summarised across all legal forms. Our article on relocating a freelance or sole-proprietor business abroad already examines exit taxation under Section 4(1) sentences 3 and 4 EStG (German Income Tax Act) in detail for sole proprietors, freelancers and partnerships, including the distinction from the fictitious cessation of business under Section 16(3a) EStG. The present article deliberately sets a different focus: it treats the exit taxation of business assets in technical depth where the earlier articles do not reach – exit taxation of corporations under Section 12 KStG (German Corporation Tax Act), the valuation of function transfers and transfer pricing under Section 1 AStG (German Foreign Tax Act), and the allocation of permanent establishments under the Authorised OECD Approach (AOA). For the income tax details of sole proprietors and freelancers and for the company law aspects of a GmbH relocation of its seat, reference is made to the articles mentioned.

When a company moves assets, functions or entire business units abroad, Germany often loses – wholly or in part – its right to tax hidden reserves that have grown untaxed over the years. The legislature counters this risk with exit taxation: it fictitiously treats the transaction as a disposal at fair market value (gemeiner Wert), although no sale actually takes place and no money flows to the company. Anyone who underestimates this mechanism risks a considerable tax burden that falls due immediately, and at a time when liquid funds are needed for expansion or the move abroad. This article places the exit taxation of business assets in a systematic framework – from the transfer of a single asset, through the more complex function transfer between related enterprises, to the allocation of permanent establishments under internationally agreed principles.

What Is Exit Taxation? Basic Principle and Legal Rationale

The term “Entstrickung” (literally “disentanglement”) describes the exclusion or restriction of the German right to tax an asset or a business activity. In legal-technical terms, the transaction is treated as if the taxpayer had sold the asset concerned at fair market value or – in the case of unincorporated businesses – withdrawn it from the business assets. The hidden reserves contained in the asset, that is, the difference between book value and actual market value, are thereby uncovered and immediately subjected to tax – irrespective of whether any cash flow takes place at all. In tax practice this phenomenon is often called the “dry income problem”: a tax liability arises without any liquid funds coming in from which it could be paid.

The underlying legal rationale is recognised in international tax law as the principle of apportionment: hidden reserves that arose during the period in which an asset was subject to German tax sovereignty should in principle remain taxable by Germany – irrespective of whether they are realised only after a transfer abroad. The mirror image of exit taxation is “Verstrickung” (entanglement): where Germany obtains a new or extended right to tax through the inbound transfer of an asset, the value at the time of the transfer is fixed as the new starting value (acquisition cost).

Legal Bases at a Glance: Which Rule Applies to Whom?

The exit taxation of business assets is not governed by a single provision but is spread across several rules depending on legal form and situation:

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Exit taxation of business assets must be distinguished from the exit tax under Section 6 AStG, which concerns exclusively shares in corporations held as private assets by natural persons. If a GmbH shareholder moves abroad without anything changing in the company’s own assets, Section 6 AStG applies at his level – while the company, if it in turn relocates assets or its registered office, may independently be subject to exit taxation under Section 12 KStG. Both levels must be examined separately as a matter of law and can apply at the same time.

Exit Taxation of Individual Assets Under Section 4(1) Sentences 3 and 4 EStG

For sole proprietors and partnerships, Section 4(1) sentence 3 EStG provides that the exclusion or restriction of the German right to tax the gain from the sale or use of an asset is equivalent to a withdrawal for non-business purposes. Sentence 4 spells out the practically most important case: if an asset previously allocated to a domestic permanent establishment is in future allocated to a foreign permanent establishment of the same taxpayer, such an exclusion or restriction exists in particular. This fictitious withdrawal is valued under Section 6(1) no. 4 EStG not, as is otherwise usual for withdrawals, at the going-concern value (Teilwert) but at fair market value – the higher standard provided by law.

These principles and their distinction from the fictitious cessation of business under Section 16(3a) EStG, the relevant deferral options for sole proprietors and practical structuring questions are covered in detail in the article relocating a freelance or sole-proprietor business abroad. The focus of the present article, by contrast, is exit taxation at the level of the corporation – not yet examined in depth on the firm’s website – as well as the technically more demanding valuation in the group and permanent-establishment context.

Exit Taxation at Corporation Level: Section 12 KStG in Detail

For corporations, associations of persons and pools of assets, Section 12(1) sentence 1 KStG contains a provision modelled on the EStG rule but independently worded: if the right of the Federal Republic of Germany to tax the gain from the sale or use of an asset of the corporation is excluded or restricted, this is deemed a sale or transfer of use of the asset at fair market value. According to the statutory specification, an exclusion or restriction exists in particular where an asset previously allocable to a domestic permanent establishment of the corporation is in future to be allocated to a foreign permanent establishment.

Unlike for sole proprietors and partnerships, no fiction of withdrawal is needed for the corporation, because a corporation conceptually has no private assets outside the business – every asset is always business property. Section 12(1) KStG therefore attaches directly to the loss or restriction of the right to tax, without the detour via a withdrawal. In the course of the 2021 tax law reforms – with effect from 1 January 2022 – the legislature reworded the provision and changed the official heading to “exit and departure taxation” (Entstrickungs- und Wegzugsbesteuerung); since then Section 12(1) sentence 2 KStG expressly provides that Section 4(1) sentence 5, Section 4g and Section 15(1a) EStG apply accordingly. The provision is supplemented by subsection 1a, which regulates the mirror-image case of entanglement, where Germany newly acquires or reacquires a right to tax.

A noteworthy point for practical advice: the special rule formerly contained in Section 12(2) and (3) KStG (old version), under which the transfer of the place of management or registered office of a corporation to a state outside the EU or the EEA was deemed a dissolution and triggered full liquidation taxation under Section 11 KStG, was repealed without replacement with effect from 1 January 2022. Since then, even the complete relocation of a corporation’s seat to a third country is governed uniformly by the general exit rule of Section 12(1) KStG – that is, by the valuation of the individual assets at fair market value, no longer by the stricter liquidation fiction. Anyone who still relies on the outdated system – for example on the basis of older specialist articles – tends to misjudge the law as it stands today, but should equally not overlook that the material tax burden resulting from the comprehensive individual valuation of all assets is often, in the end, hardly lower than it was earlier under the liquidation fiction.

In practice, Section 12(1) KStG triggers exit taxation in particular in the following situations: on the relocation of the place of management or the registered office abroad, on the transfer of individual assets to a newly established or existing foreign permanent establishment, and on a change of treaty residence through a so-called tie-breaker decision under the applicable double taxation treaty. The company law side of a GmbH relocating its seat – in particular the distinction between relocating the administrative seat and the registered seat, the relevant CJEU case law (Daily Mail, Cartesio, Polbud) and the cross-border conversion under the EU Mobility Directive – is set out separately in the article GmbH relocation of its seat abroad: legal and tax fundamentals.

The Compensation Item Under Section 4g EStG – Deferral for Corporations Too

A tax that falls due immediately on unrealised hidden reserves can put companies under considerable liquidity pressure. For relocations within the EU or the EEA, the legislature therefore provides relief: under Section 4g EStG, the taxpayer may, on an irrevocable application, form a compensation item (Ausgleichsposten) for each individual asset that is allocated, in the course of exit taxation, to a permanent establishment in another EU or EEA state. This item is not released immediately but in the financial year of its formation and in the following four financial years, at one fifth each, increasing profit – the tax burden is thus spread over a total of five years instead of arising in full in the year of the transfer.

In the publicly available specialist literature, Section 4g EStG is mostly presented in the context of sole proprietors and partnerships. Less well known, but just as significant for the practice of corporations: through the express reference in Section 12(1) sentence 2 KStG, Section 4g EStG applies accordingly to corporations as well. A GmbH that, in the course of exit taxation, allocates individual assets to a new permanent establishment in another EU or EEA state can therefore likewise spread the resulting tax burden over five years through the compensation item – provided that the assets actually remain in the foreign permanent establishment and are not sold or otherwise transferred in the meantime. For relocations to a third country outside the EU and the EEA, this deferral option is not available; the tax there falls due in full in the year of the transfer.

Valuation: The Fair Market Value of the Hidden Reserves

In all situations, the yardstick of exit taxation is fair market value. Under the statutory definition in the valuation law, Section 9(2) BewG (German Valuation Act), fair market value is determined by the price that would be achievable on a sale in the ordinary course of business, having regard to the nature of the asset; unusual or personal circumstances are disregarded.

For the practical determination of this value – in particular for unlisted businesses, co-entrepreneur interests or shares in corporations for which no market price exists – the simplified capitalised earnings value method under Sections 199 to 203 BewG is frequently applied. Here the sustainably achievable annual earnings are reduced by an appropriate imputed entrepreneur’s salary and then multiplied by the statutory capitalisation factor, which under Section 203(1) BewG has stood unchanged at 13.75 since July 2016. For larger or economically more complex businesses, however, this simplified method reaches its limits; here the net asset value method as a minimum value threshold or an individual valuation report under the IDW S1 standard of the Institute of Public Auditors in Germany (Institut der Wirtschaftsprüfer) is regularly used, especially where considerable intangible values such as a customer base, a trademark or a patent portfolio are to be valued.

In advisory practice, particular care is required in choosing the entrepreneur’s salary to be applied: an excessively high, non-market salary or a merely symbolic residual value for valuable intangible assets is regularly challenged by the tax authorities and, in case of doubt, replaced by their own estimate. Conversely, the value determined must not fall below the demonstrable net assets – such as existing machinery, inventory or bank balances. A robust, comprehensibly documented valuation is therefore indispensable not only for compliance reasons but also to avoid protracted disputes with the tax office.

What Exactly Is Subject to Exit Taxation

Exit taxation can affect both tangible and intangible assets of the business property:

• Tangible assets: machinery and business equipment, inventory, vehicle fleet, bank balances and other liquid funds, land and buildings.
• Intangible assets: customer or client base, long-term supply, commission or cooperation contracts, trademark and patent rights, self-developed software, domains and digital business models, and any original goodwill, to the extent it can be allocated to a specific permanent establishment.

A practically significant special case is cryptocurrencies held as business assets: unlike traditional assets, owing to the lack of physical presence they often cannot be clearly allocated to a specific permanent establishment, so that in practice the place of actual management is regularly used. If crypto assets are in fact placed under the control of a foreign structure in the course of a relocation, this can trigger exit taxation just as with any other business asset – a point that is regularly underestimated in the planning of digital business models.

Active and Passive Exit Taxation

In doctrinal terms, a distinction is drawn between active and passive exit taxation. Active exit taxation is spoken of where the taxpayer himself takes action – for example by physically moving an asset abroad or establishing a foreign permanent establishment. Passive exit taxation, by contrast, exists where the German right to tax shifts solely through a change in the law, without the taxpayer having initiated anything – for example because Germany concludes a new double taxation treaty or amends an existing one and thereby allocates to the other contracting state a right to tax that previously lay with Germany.

This situation was long disputed and has only recently been clarified by the highest court: after the Münster Fiscal Court (Finanzgericht Münster), in its judgment of 10 August 2022 (13 K 559/19 G,F) in connection with the amendment of the Spain treaty as of 1 January 2013, had still decided in favour of the taxpayer and denied passive exit taxation for lack of attributable conduct, the BFH (Federal Fiscal Court) confirmed the opposite position in its judgments of 19 November 2025 (I R 41/22 and I R 6/23): exit taxation can therefore in principle also be triggered solely by a change in statute or treaty law, without any contribution by the taxpayer being required; the time of taxation is the last tax-relevant moment before the change becomes applicable. For companies with foreign structures, this means in practice that not only their own relocation decision but also the development of the relevant double taxation treaties of the respective destination states should be monitored continuously, since the right to tax can shift even without their own involvement.

Function Transfer and Transfer Pricing Under Section 1 AStG

If not merely an individual asset but an entire business function – such as a production, distribution or development unit – is transferred to a related foreign enterprise, together with the associated opportunities and risks and the assets transferred with it, the more specific rule of Section 1 AStG on function transfers applies in addition to the general exit rule. The statutory definition is found in Section 1(3b) AStG: a function transfer exists where a function, including the associated opportunities and risks and the assets or other advantages transferred or made available with it, is relocated so that the transferring part of the enterprise no longer performs the function concerned, or performs it only to a limited extent.

The central difference from the simple exit taxation of a single asset lies in the valuation standard: instead of valuing each affected asset in isolation, Section 1 AStG in principle requires an overall valuation as a so-called transfer package, comprising all tangible and intangible values transferred as well as the transfer of profit potential associated with the function. Where no actual market prices exist – which is regularly the case within a group – a hypothetical arm’s length comparison must be carried out: the tax authorities determine a range of agreement between the minimum price the transferring part of the enterprise would reasonably accept and the maximum price the receiving part would be willing to pay; if no more probable value can be substantiated, the mean is assumed in case of doubt. The Function Transfer Ordinance (Funktionsverlagerungsverordnung, FVerlV) was reissued in the course of the Withholding Tax Relief Modernisation Act and applies in its current form from the 2022 assessment period; among other things, it specifies when intangible assets are regarded as “material” for the overall valuation – namely where their arm’s length price accounts for more than 25 percent of the sum of all individual prices of the transfer package.

The taxpayer may refrain from an overall valuation as a transfer package if he can credibly show that neither material intangible assets nor other advantages were the subject of the transfer – this so-called escape clause, however, requires robust documentation and was tightened in the recent reforms compared with the earlier legal position, as two of the originally three exception provisions were dropped without replacement. In practice this means: anyone planning a function transfer should check early whether an overall valuation is threatened at all or whether the values transferred can be captured by individual valuation under the general exit rules of Section 4 EStG or Section 12 KStG – the difference can significantly affect the tax base.

Permanent Establishment Allocation Under the Authorised OECD Approach (AOA)

Whether an asset or a function is actually “to be allocated to a foreign permanent establishment” within the meaning of the exit taxation rules is not decided at free discretion but according to internationally agreed allocation principles: the Authorised OECD Approach. It was transposed into German law by the Act Implementing the Mutual Assistance Directive (Amtshilferichtlinie-Umsetzungsgesetz) of 26 June 2013 in Section 1(4) and (5) AStG and further specified by the Permanent Establishment Profit Allocation Ordinance (Betriebsstättengewinnaufteilungsverordnung, BsGaV) of 18 October 2014, which applies to financial years after 31 December 2014.

At the core of the AOA is the so-called Functionally Separate Entity Approach: for tax purposes, a permanent establishment is treated as if it were an independent, separate enterprise. The allocation takes place in two steps. In the first step, the associated assets, opportunities and risks as well as appropriate endowment capital are assigned to the permanent establishment on the basis of the “significant people functions” actually performed there – the actual exercise of entrepreneurial decision-making functions on the spot is thus the central connecting factor of the allocation, not the formal legal ownership. In the second step, the internal service relationships arising between head office and permanent establishment are priced under the arm’s length principle – as if they had been agreed between unrelated third parties.

For exit taxation this has a twofold significance. First, it is precisely these allocation principles that determine whether and when an asset is deemed “to be allocated to the foreign permanent establishment” within the meaning of Section 4(1) sentence 4 EStG or Section 12(1) sentence 2 KStG – the AOA is in this respect the doctrinal hinge that co-determines whether, and to what extent, exit taxation occurs. Second, Section 1(4) AStG treats the company’s own foreign permanent establishment, for the purposes of the arm’s length comparison, as a related person within the meaning of Section 1 AStG. This has a practically significant consequence: even the mere transfer of significant people functions from the domestic head office to one’s own foreign permanent establishment – that is, without any foreign legal entity being involved at all – can be subject to the rules on function transfer and transfer package valuation under Section 1 AStG, provided the transaction meets the requirements of Section 1(3b) AStG. The relocation of know-how or development capacity to one’s own foreign branch is thus by no means “internal to the company” and therefore tax-neutral, but can require the same depth of valuation and documentation as a transfer to a foreign related company.

Deferral and Payment Relief at a Glance

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Further Tax Side Effects at a Glance

Besides exit taxation itself, a transfer of business assets abroad regularly raises further tax questions: the possible cessation of German trade tax liability under Section 2 GewStG (German Trade Tax Act) where the domestic permanent establishment ceases entirely, an apportionment of trade tax under Sections 28 et seq. GewStG where the relocation is only partial, and VAT registration obligations in the destination country, in particular in the case of an intra-Community transfer of goods under Section 3(1a) UStG (German VAT Act). A complete presentation of these side effects across all legal forms, including a practical checklist, is contained in the article moving a company’s registered office abroad and the tax consequences.

Avoidance and Structuring Strategies

Even though exit taxation cannot be avoided entirely, careful planning can often reduce the actual burden considerably:

• Realistic, documented valuation: A robustly reasoned valuation – with a market-standard entrepreneur’s salary and a comprehensible choice of method – prevents excessive valuations by the tax office and creates legal certainty.
• Examining the escape clause for function transfers: Where no material intangible assets are in fact transferred, the more onerous overall valuation as a transfer package can be avoided and the individual valuation of the assets transferred used instead.
• Deliberate allocation of significant people functions: Anyone who deliberately allocates decisive people functions and the associated assets to a permanent establishment remaining in Germany, and documents this according to the AOA principles, can limit the scope of exit taxation to the values actually transferred.
• Early applications for deferral: The applications for the compensation item under Section 4g EStG or for payment in instalments under Section 36(5) EStG are irrevocable and subject to deadlines – they should therefore be prepared already in the planning phase of the relocation.
• Transfer pricing documentation before completion: Documentation of the transfer prices applied in accordance with Section 90(3) AO (German Fiscal Code) should be prepared not only upon request by the tax audit but already before the relocation.
• Monitoring treaty amendments: In view of the passive exit taxation confirmed by the highest court, changes to the relevant double taxation treaties of the destination states should continue to be monitored even after a relocation has been completed.

Hypothetical Example

Purely for illustration, with no connection to any real client matter: a German GmbH with its own development department holds a patent portfolio for a process it developed itself. It establishes a subsidiary in another EU member state and transfers to it both the patents and part of the developer team that is to continue developing the patents in future. Because material intangible assets are transferred with the patents, the escape clause of Section 1 AStG does not apply; the relocation is to be treated as a function transfer, and the entire transfer package is to be valued by means of a hypothetical arm’s length comparison. At the level of the GmbH, this at the same time triggers exit taxation under Section 12(1) KStG, since the assets concerned are henceforth to be allocated to the new foreign structure; because the relocation takes place within the EU, the GmbH can apply for a compensation item under Section 4g EStG in conjunction with Section 12(1) sentence 2 KStG for the individual assets and thus spread the resulting tax over five years. If, on the other hand, individual developers with significant people functions remain in Germany, the assets attributable to them remain, under the AOA principles, allocated to the domestic permanent establishment and are to that extent exempt from exit taxation – a circumstance that should be taken into account already when planning the team transfer.

Conclusion

The exit taxation of business assets is not an isolated individual problem but the result of the interplay of several regulatory levels: the general exit rules in Section 4 EStG and Section 12 KStG, the more specific valuation requirements for function transfers and transfer pricing under Section 1 AStG, and the internationally agreed permanent establishment allocation under the Authorised OECD Approach. Anyone who does not consider these levels together when planning a relocation abroad regularly underestimates both the amount of the tax burden threatened and the scope of the documentation required. An early, coordinated review – from the valuation of the assets concerned, through the choice of deferral options, to the proper allocation of people functions and assets – by contrast creates planning certainty and avoids unpleasant surprises after a tax audit.

Attorney Johannes Fiala and the firm, with a focus on international tax and corporate law in Munich, accompany companies in the tax planning of a transfer of business assets abroad – from the valuation of hidden reserves, through the review of function transfers, to coordination with foreign tax advisors. Contact the firm without obligation to discuss your project in an initial consultation.