Handing over the company to the children: New ruling!

The Federal Fiscal Court has decided: What applies when a business is handed over to the next generation?

Frankfurt am Main

October 13, 2024

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Gratuitous transfer of business: transferor of business can claim subsequent business expenses

The transfer of a business to the next family generation is often free of charge. Income taxes are not levied on such free transfers, as the transferee is required to continue to use the book values, thus avoiding the disclosure of hidden reserves such as goodwill. Furthermore, any gift tax can often be avoided when transferring business assets due to tax privileges.

In this respect, the Federal Fiscal Court has now clarified important detailed questions with its decision of 6 May 2024 (case number III R 7/22). Regarding the transfer of a business without consideration, the Federal Fiscal Court states that

• the transfer of a business between family members can be free of charge even if the purchaser assumes all business debts and the equity is negative at the time of the transfer.

• In the case of a business transfer without consideration, the principle of formal accounting consistency also applies to the legal successor. Therefore, any incorrect balance sheet entries that have been included in the final assessment of the legal predecessor (the transferor of the business), which can no longer be amended, and that have an impact on its profit or loss, must be corrected by the transferee, if necessary, with an impact on the result.

• Despite the principle of formal balance sheet connection, subsequent operating expenses of the transferor of the business may arise following a gratuitous transfer of the business if the transferor incurs expenses related to his previous management of the business.

First, a distinction must be made between a gratuitous transfer of a business and a transfer for consideration. A gratuitous transfer of a business for income tax purposes does not always occur if no consideration can be determined, but rather requires that the transferor intends to enrich the transferee by way of a gift. The assumption of liabilities alone does not lead to consideration.

A business transfer between family members can therefore be gratuitous if the transferee assumes not only the assets but also the liabilities of the business (business debts). This applies even if the equity is negative at the time of the transfer. In the case of a business transfer within the family, there is at least a (rebuttable) presumption that the mutual contributions have not been balanced against each other according to commercial considerations and that the transaction is entirely gratuitous, or at least partially gratuitous.

However, even in the case of a free transfer of a business, the principle of formal balance sheet consistency applies to the legal successor. This principle states that any accounting errors that can no longer be corrected in the erroneous balance sheet must be corrected in the first, procedurally still open balance sheet. In the case of a free transfer of a business, incorrect balance sheet entries that have been included in the final assessment of the predecessor in title, which is already final and can no longer be changed, and which affect its profit or loss, must be corrected in the legal successor's balance sheet with an impact on the income statement. In the case in dispute, liabilities/provisions for liabilities were not recognized as liabilities, which had to be rectified in the legal successor's first, still open balance sheet.

However, if the business transferor still had to settle business liabilities after the transfer of the business that were not previously accounted for, this constitutes subsequent business expenses. Subsequent business expenses relating to income from a business operation are all expenses incurred after the termination of the business activity that are caused by the previous commercial income or by the generation of subsequent commercial business income, provided they do not lead to a retroactive change in the profit from the sale or disposal. Subsequent business expenses can also arise following a gratuitous transfer of the business if the business transferor bears expenses related to the previous management of the business.

TaxPro recommendation:

In particular, the Federal Fiscal Court's rulings on the gratuitous transfer of a business demonstrate the broad scope of application in practice. However, such transfers should always be examined on a case-by-case basis with tax advice regarding potential income tax and gift tax consequences.