Managing and planning international wealth through foundations is a complex task, posing a myriad of legal and tax challenges. This is particularly true for German family foundations with beneficiaries who are tax residents abroad, as they often face specific issues.
To elucidate, let’s use the example of a German family foundation with a beneficiary who is a tax resident in Italy. We will delve into three primary areas of concern that are likely to occur in similar forms for beneficiaries in other countries:
- Whether the foundation establishes an Italian tax presence,
- The need for disclosure obligations and the potential risk of the beneficiary being burdened with Italian wealth tax, and
- The taxation process of the foundation’s distributions to the Italian beneficiary.
Tax presence of foundation in Italy through beneficiary’s board activity
The question of whether the activities of an Italy-based beneficiary constitute a business presence in Italy comes into play when the beneficiary is also a board member of the German family foundation. This could result in the establishment of a so-called managerial presence in Italy. However, if the beneficiary merely resides in Italy without operating a foundation-owned office or similar, the risk should be minimal. A business presence, in the tax sense, requires a permanent business establishment where a company conducts its activities, either fully or partially.
If the beneficiary is sparingly active for the foundation and does not sign contracts on behalf of the foundation, leaving this responsibility to other board members from Germany, it could be concluded that there is no business presence in Italy. After all, establishing a business presence in Italy may not be feasible, as it generally requires a commercial enterprise, which a purely asset-managing family foundation is not.
Disclosure obligations and Italian wealth tax burden
Unlike Germany, Italy levies a wealth tax. Consequently, Italian tax residents are required to disclose their foreign-held assets, which often impacts the beneficiaries of German family foundations.
The disclosure obligation encompasses not just the owners of foreign assets but also those deemed as economic owners. This includes founders, identified or easily identifiable beneficiaries of the foundation, and individuals with powers of legal representation, management, and administration of the foundation.
As a result, it is plausible that an Italian beneficiary must disclose the assets contributed to the foundation in his Italian tax return, including the proportional assets of the foundation.
The Italian wealth tax must be paid for certain foreign-held assets, such as financial products and real estate (but typically not for shares).
Taxation of foundation distributions to the Italian beneficiary
If the beneficiary has significant control over the foundation, he may be subject to Controlled Foreign Corporation rules. In this scenario, the income of the German foundation is directly attributed to the beneficiary in Italy and must be taxed by him in Italy as soon as the foundation earns it, regardless of whether he receives any funds.
However, if the Italian law recognizes the German foundation as an opaque foundation, only the actual distributions are taxable. In this case, the Italian tax imposed on the beneficiary is 26 percent.
In Germany, foundation distributions are also taxable. A capital gains tax of 25 percent is generally applied, which can be reduced to 15 percent due to the double taxation agreement (DTA) between Germany and Italy. The DTA also provides for a credit of the tax against the tax payable in Italy. In theory, only an additional 11 percent tax burden would be expected in Italy (26 percent – 15 percent = 11 percent). The issue arises when the Italian tax administration does not officially recognize the possibility of crediting German withholding taxes (unlike Italian case law). This could lead to an unappealingly high total tax burden of 15 percent + 26 percent = 41 percent.
International foundation solutions: Legal and tax challenges
Cross-border foundation solutions invariably require addressing legal and tax issues from various perspectives, taking into account the respective foreign law. It’s important to note that one-size-fits-all solutions do not exist.
Countries vary in their tax regulations: some have wealth taxes or attribution rules, some have stricter or laxer rules for establishing business presences. Double taxation agreements, which often include foundations, are prevalent, but not universal. Moreover, the credits of German tax against foreign tax agreed in the DTA do not function in every country.
Consultation for foundations with beneficiaries abroad
If tax residents are situated abroad or have unlimited tax liability, it’s crucial that the aforementioned three problem areas are clarified by experts. Thorough planning and consultation are key to steering clear of tax pitfalls and minimizing the tax burden. If you require assistance in this area, we are here to help.
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