Tax and liquidity gifts 2007

The new capital adequacy guidelines for banks and investment firms, Basel II for short, came into force on 1 January 2007. For many entrepreneurs it is therefore high time to deal with it, because with Basel II creditworthiness and liquidity are becoming more and more important for bank customers. When it comes to lending, it is increasingly the credit-dependent SME sector that is being hit. Small businesses in particular, with little collateral and little equity, have to worry about getting debt financing, and if they do get it, it will usually be very expensive. That is why Basel II has now become a dirty word among many entrepreneurs – even reputable bank advisors assure us. However, there are ways out of targeted advice on alternative liquidity concepts, but these are little known, as they are often not pointed out by the banks, even to their own customers, out of ignorance or self-interest.
For some years now, one of the most interesting concepts for raising liquidity for medium-sized companies has been the so-called charitable trust foundation. The federal government, in particular Finance Minister Peer Steinbrück (SPD), now wants to expand and strongly promote this commitment with extensive tax relief in 2007.
It is to be the biggest reform in six years and make charitable activities more attractive, especially for the well-heeled, self-employed and freelancers. This is because, in addition to the promotion of charitable objectives, it is also a question of generous tax incentives in order to release corresponding activities and to provide the entrepreneur with additional substantial liquidity from tax reductions in the coming years, thus strengthening the creditworthiness of the companies.
The advantage lies in the fact that this can be used without the use of equity or borrowed capital, by any entrepreneur who can contribute a certain assessable asset (shares in a limited company, real estate, securities, art, etc.) to his own trust foundation within the framework of the foundation support. This form of foundation is relatively uncomplicated to set up at the private level of the entrepreneur with a recognised professional.
Advantages for medium-sized businesses
What advantages this can now offer the medium-sized entrepreneur is explained by the foundation expert Frank M. Strobelt, Managing Director of the Gesellschaft für Stiftungsförderung e.V. (GFS). (GFS) with regard to a charitable trust foundation: “Using the example of a privately held property and securities worth approx. 860,000 euros, this promotion is relatively easy to describe. If the value of 860,000 euros is transferred to a separate trust foundation, this leads to an immediate deduction as special expenses in the tax return in the amount of 860,000 euros.
In the private sector, this results in a final tax refund of approximately EUR 344 000 for married couples with a corresponding tax rate. The tax deduction of this EUR 860 000 will be spread over five years. The total tax-deductible annual amount under the foundation support scheme is thus approximately EUR 172 000 per year.
The entrepreneur can now freely dispose of the capital from the tax savings in the amount of 344,000 euros minus the set-up fees and costs for the trust foundation.
If, for example, the capital of a total of 300,000 euros (5 x 60,000 euros annually) is invested at an interest rate of 6 percent p.a. on average, then after 12 years there will be a payout capital of approx. 470,000 euros or a lifelong old-age pension of 35,000 euros annually.
In this way, the entrepreneur has built up a second pillar of old-age provision for himself and his family with real estate, which otherwise often only causes high costs, and securities, which are placed in a charitable foundation. Mind you – without any effort of your own!
For this additional old-age provision, a self-employed entrepreneur would have to pay maximum contributions into the statutory pension (Federal Insurance Institution or State Insurance Institution) from his own resources for about 45 years in order to receive an equivalent pension.
In addition, the pension from the foundation support is fully inheritable or the entrepreneur chooses the lump-sum settlement in the amount of approx. 470,000 euros, which, as is well known, is not possible with the statutory pension.
Of course, the amount of EUR 470 000 can also be used to repay mortgages on real estate ahead of schedule. This is an invaluable advantage, as real estate is usually assigned to the banks as security for overdraft or personal loans, and the entrepreneur can then actually no longer freely dispose of his real estate.
A further advantage of the contribution of a real estate into the non-profit trust results in the context of the inheritance and gift tax, which as is well known becomes substantially more expensive for the heirs starting from 2007, since then real estates are bequeathed with approx. 100 per cent of the market value at the place of the object.
If, for example, a property worth approx. 600,000 euros is bequeathed to a spouse, then after deducting the tax allowance of 307,000 euros, approx. 293,000 euros are still liable to inheritance tax. At a tax rate of 15 percent in tax class 1 for spouses, this results in an inheritance tax of approx. 43,950 euros, which is immediately due and payable to the tax office in the event of death.
If this property is placed in a trust foundation, then the inheritance tax is waived for the family and they even receive a tax refund of 240,000 euros for setting up their own trust foundation at an appropriate tax rate. This results in a total tax advantage of 283 950 euros, which in turn benefits the entrepreneur and the entire family.
The property brought into the foundation is formally legally the property of the foundation, but the entrepreneur as chairman of the board of trustees can continue to dispose of the property and look after it himself on the basis of foundation statutes and other special contractual regulations.
Another plus point for old-age provision
Especially for medium-sized companies that operate a corporation as a form of business within the framework of a limited liability company, there is an additional interesting component of old-age provision through the foundation subsidy.
The capital amounts built up in the private sector from the tax refund amounting to approx. 470,000 euros can also be used to finance a pension commitment for the GmbH managing director. Why is this so important?
The legislator has focused on the financial viability of pension commitments with the latest rulings and BMF letters. In particular, the definition of financeability was precisely regulated by the current case law of the Federal Fiscal Court (BMF letter dated 6.9.2005 – IV B 7 – S.2742 – 69/05).
In its case law, the Federal Fiscal Court consistently requires that pension commitments to GmbH shareholder managing directors must be financeable by the GmbH in order for them to be recognised for tax purposes. They cannot be financed if the GmbH would become insolvent if it had to fulfil the commitment. Whether the commitment can be financed must be checked twice. Firstly, at the time the commitment is made and secondly, over time, if the economic situation of the GmbH deteriorates.
This BMF letter resembles a ticking time bomb, since almost all pension commitments are underfunded as a result of the crash on the stock markets in the years 2000 to 2003. At the same time, new DAV and Heubeck 2005 G mortality tables have been created, which mean that there is an even greater gap in the ability to finance pension commitments.
In practice, this means that, due to current case law, every pension commitment must actually be re-examined with regard to its financial viability, especially if the reinsurance was structured via a German endowment policy.
For example, the present value of old-age pensions – calculated in accordance with the Heubeck 2005 G tables – is no longer up-to-date due to the considerable decline in returns on the capital markets.
German insurers have to invest most of their customers’ money in fixed-income securities due to regulations by the federal supervisory authorities and the guarantees included in the policies. The stock market remains virtually closed to them as an investment market, especially after the stock market crash of 2000 to 2003.
Usually only between ten to 15 percent of the cover pool is invested in the stock market, depending on the credit rating of the insurance company. This, of course, also considerably restricts the potential for returns. This is already evident from the fact that despite the dramatic rise in share prices over the past two years, German insurers have nevertheless had to lower the guaranteed interest rate to 2.25 per cent p.a.
Over the past six years, the payout amounts promised at the time have dropped by nearly 40 percent for many insurers. With a payout sum of originally 100,000 euros, only approx. 60,000 euros will be paid out at the expiry of the policy, based on current calculation examples of the insurers. Despite the currently favourable capital market situation on the stock market, there is no improvement in sight.
However, there are further hurdles to consider when reinsuring pension commitments:
Example: In order to be able to finance an old-age pension of EUR 12,000 at the age of 65 for a managing director, approx. EUR 118,000 of accumulated capital is still sufficient at an interest rate of six percent p.a. according to the old Heubeck mortality tables 1998. However, with an interest rate of approx. four percent p.a. according to the new DAV mortality tables 2004 R, the required capital amount is already approx. 146,000 euros, but with a calculated interest rate of 2.75 percent p.a. this is already 158,000 euros.
However, if we assume the amount calculated by German life insurance companies for an annual pension of 12,000 euros with a guaranteed interest rate of 2.75 percent p.a., then a capital sum of approx. 180,000 euros is required to finance the old-age pension.
From 1.1.2007 this guaranteed interest of the German insurers was lowered now again and lies at present only with approx. 2.25 per cent p.a.. This of course increases the capital to be saved for a German pension insurance again considerably.
What is being projected here is just the retirement pension alone, not including the usual 60 percent widow’s pension and not including the cost of disability insurance.
The coverage of occupational disability pensions for GmbH managing directors in the context of pension commitments is problematic anyway, since due to recent case law the payment of an occupational disability pension to the GmbH shareholder managing director can be refused by the insurer. Then the contributions for the payment of an occupational disability pension are practically paid for nothing and are later missing when the old-age pension is funded. This is not peanuts, but about 30 percent of the total premium of the reinsurance policy, so that contributions in the double-digit range are quickly lost for the funding of the commitment. This results in coverage gaps of 40 to 50 percent for the GmbH and the managing director, at the latest when payment of the old-age pension becomes due, i.e. the old-age pension can only be financed from the existing capital over a period of perhaps a maximum of 7 to 10 years. The heirs, i.e. the spouse, are then often left empty-handed with regard to the occupational pension, as the capital for the payment of a widow’s pension within the framework of the pension commitment is then often no longer available or has been used up.
However, with the additional liquidity from the tax refund within the scope of the foundation support via a trust foundation in the amount of approx. 470,000 Euro, this coverage gap can be closed excellently under certain circumstances.
In principle, however, the financeability of the pension commitment via alternative reinsurance concepts should always be examined, because a net interest rate of two to three percent p.a., which is currently offered by German life insurers within the framework of reinsurance, can never finance the Heubeck values with a return of 6 percent p.a., let alone provide the necessary capital amounts for a German pension insurance. The insolvency of the company is then only a matter of time at the latest when the pension starts.
In this context, it also seems primarily important to think about the protection of one’s own private assets (real estate, securities, antiques, works of art, etc.). With almost 35,000 mostly medium-sized companies going bankrupt in 2006, the very survival strategy demands that every entrepreneur at least put all his private assets under insolvency protection for himself and his family in the future and thus secure them from the access of creditors.
Within the framework of a charitable trust foundation, assets can be secured against access by third parties; corresponding legal regulations must be observed.
Johannes Fiala Andreas M. Bosl
(Hearing Acoustics 5/2007, 98)
Courtesy ofwww.median-verlag.de.

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About the author

Dr. Johannes Fiala
PhD, MBA, MM

Dr. Johannes Fiala has been working for more than 25 years as a lawyer and attorney with his own law firm in Munich. He is intensively involved in real estate, financial law, tax and insurance law. The numerous stages of his professional career enable him to provide his clients with comprehensive advice and to act as a lawyer in the event of disputes.
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