Tax and liquidity gifts for medium-sized companies

On 1 January 2007, the new capital adequacy guidelines for banks and investment firms, Basel II for short, will come into force.


For many entrepreneurs it is therefore high time to deal with it, because with Basell 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 become a dirty word for many entrepreneurs, even serious bank advisors assure us. As always, there are also ways out of targeted advice on alternative liquidity concepts, which are, however, little known, as they are often not pointed out by the banks, even to their own customers, due to 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.


With extensive tax breaks, the federal government, in particular Finance Minister Peer Steinbrück (SPD) in 2007 now wants to expand and strongly promote this commitment. It is supposed to be the biggest reform in 6 years and make charitable activities more attractive, especially for well-heeled people, the self-employed and freelancers. For in addition to the promotion of charitable objectives, it is also a question of generous tax incentives 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, and indeed by any entrepreneur who can contribute a certain assessable asset (GmbH shares, 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.


Using the example of a privately held property and securities worth around 860,000 euros, this promotion is relatively simple to describe. If the value of 860,000 euros is transferred to a separate trust foundation, this leads to an immediate deduction of 860,000 euros as special expenses in the tax return. In the private sector, this results in a final tax refund of approximately 344,000 euros for married couples with an appropriate tax rate. The tax deduction of these 860,000 euros will be spread over five years.


The total tax-deductible annual amount within the framework of foundation funding is thus approximately 172,000 euros 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 6.0 percent p.a. on average, then after 12 years there is 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 approx. 45 years in order to receive an equivalent pension. In addition, the pension from the foundation subsidy is fully inheritable or the entrepreneur chooses the lump-sum settlement of approx. 470,000 euros, which, as is well known, is not possible with the statutory pension. Of course, the amount of 470,000 euros can also be used to repay mortgages on real estate ahead of time.


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 with a value of 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 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, then the inheritance tax does not apply to the family and they even receive a tax refund of 240,000 euros for setting up their own trust 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 the foundation statutes and other special contractual regulations. 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 due to the crash at the stock exchanges in the years 2000 to 2003. At the same time, new DAV and Heubeck mortality tables 2005 G were created, which mean that there is an even larger gap in the financial viability of 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 your German endowment policy. For example, the present value of old-age pensions – calculated according to the Heubeck Tables 2005 G – is no longer up-to-date due to the considerable decline in returns on the capital markets. German insurers, due to regulations of the federal supervisory authorities and the guarantees included in the policies, have to invest most of their customers’ money in fixed-interest securities; 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 10 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. This has led to a significant increase in the interest rate on the German insurance market. Over the past 6 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 end 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 a retirement pension of 12,000 euros at the age of 65 of a managing director, approx. 118,000 euros of accumulated capital are still sufficient at six percent p.a. interest according to the old Heubeck mortality tables 1998.


However, with an interest rate of approx. 4 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 one assumes 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 one would need a capital sum of approx. 180,000 euros to finance the old-age pension. Starting from 01.01.2007 now this guarantee interest of the German insurers was lowered 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 calculated here is only the pure old-age pension, without the usual 60 percent widow’s pension and without the costs of the occupational 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 company 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 2 to 3 percent p.a., which German life insurers currently offer within the framework of reinsurance, can never finance the Heubeck values with a return of 6.0 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, pure survival strategy demands that every entrepreneur at least protect all his private assets for himself and his family against future insolvency 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.


by Dr. Johannes Fiala and Andreas M. Bosl

by courtesy of (published on 07.02.2007)

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About the author

Dr. Johannes Fiala Dr. Johannes Fiala

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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