Advantages and risks: retention of usufruct in the transfer of partnership shares

As part of lifetime business succession planning, businesses or partnership shares are frequently transferred by way of gift to successors—often with a retained usufruct (beneficial interest) in favor of the donor. To maximize available tax benefits—particularly exemption allowances—stringent compliance with specific regulatory requirements is essential.

Donation of companies or partnership shares: planning company succession during your lifetime

Many companies organised as partnerships – e.g. GbR or KG – are intended to be transferred by their owners to the next generation during their lifetime. These are often family businesses that are intended to be continued.

To ensure that these companies are not financially overburdened by a transfer to the next generation, tax law provides for exceptions that significantly relieve the ‘acquirers’ of the company and avoid liquidity bottlenecks due to an enormous tax burden – but only under certain conditions. One such exception is the tax relief provided for in the relevant provisions of the Inheritance and Gift Tax Act (ErbStG).

Exemption allowances

Under certain conditions, gift tax or inheritance tax on the transfer of businesses/co-ownership shares is reduced by up to 100%. These are known as exemption allowances and are regulated in Sections 13a, 13b and 13c of the German Inheritance Tax Act (ErbStG).

Transfer subject to usufruct

When planning company succession, involving the next generation by gifting company shares subject to usufruct is still a common model. However, there is still legal uncertainty regarding issues relating to so-called dual co-ownership.

The purpose of usufruct of a share in a company is to ensure that the recipient of the gift becomes the owner of the shares, but the donor retains his profit share and a significant influence on the company.

However, the tax exemption under the provisions of the German Inheritance Tax Act (ErbStG) does not apply to the acquirer if the acquirer does not become a co-partner.

This can happen if the donor reserves too high a ‘share’ in the partnership and the acquirer therefore does not meet the requirements for typical co-ownership. This risk may exist in the case of a transfer of company shares subject to a reservation of usufruct.

This is because the prerequisite for the exemption rule under Section 13a/b ErbStG is that the acquirer (donee) also obtains a so-called tax co-entrepreneurial status. To this end, they must retain a certain degree of co-entrepreneurial risk and initiative.

Co-entrepreneurial risk and co-entrepreneurial initiative: decisive for tax relief

Co-entrepreneurial risk means that the recipient of a gift receives a participation in the success or failure of the company that is comparable in terms of company law or economic terms. This includes participation in profits and losses as well as participation in the hidden reserves of fixed assets, including goodwill.

According to the case law of the Federal Fiscal Court (BFH), in the case of a reservation of usufruct, a co-entrepreneurial risk exists if the usufruct is limited to the withdrawable income.

The co-entrepreneurial initiative includes the acquirer being entitled to certain decision-making powers and thus influence. According to the BFH, the donee should at least be able to exercise company rights that are similar to the voting, control and revocation rights of a limited partner or correspond to the control rights under company law pursuant to Section 716 (1) of the German Civil Code (BGB). Various court decisions have been handed down in recent years on the specific question of the co-entrepreneurial initiative.

Dogma of dual co-ownership

Until a few years ago, it was argued that, with the appropriate structure, both the usufructuary and the shareholder could be treated as co-entrepreneurs. This meant that, when the company share was transferred, inheritance tax exemption could be granted in accordance with Sections 13a and 13b of the German Inheritance Tax Act (ErbStG) and, at the same time, the income could be allocated to the usufructuary and taxed in their hands.

However, recent rulings by the Federal Fiscal Court (BFH) have called this into question, arguing that only one person per share can be a co-partner. Nevertheless, the literature and some case law continue to consider dual co-partnership possible.

Practical consequences and recommendations

If the aim is to regulate company succession during the lifetime of the owner and, for this purpose, to transfer a company or company shares to the next generation by way of gift, caution should be exercised when transferring the property subject to a right of usufruct.

In order to realise tax advantages on the part of the acquirer through exemption allowances, the acquirer must become a co-partner despite the usufruct. This is simply a prerequisite for benefiting from the allowances. Opinions differ as to when this is the case and when it is not.

In view of this uncertainty, it is therefore advisable to draw up a careful and clearly regulated contract and to obtain binding information from the tax office regarding the requirements of Sections 13a and 13b of the German Inheritance Tax Act (ErbStG) in order to ensure that the intended (double) co-ownership is recognised.