Exit Tax in Relation to Your Relocation to Dubai

If you’re an entrepreneur planning to move from Germany to Dubai, the exit tax is triggered if you own at least 1% of a corporation. As our client, you’ll receive comprehensive tax guidance and, if needed, access to top international tax experts specializing in entrepreneur relocation from Germany to Dubai.

What is the Exit Tax?

An exit tax is a measure used by various countries to tax capital gains that have accrued on significant assets before individuals relocate abroad. Designed to prevent tax avoidance, this regulation applies differently across jurisdictions, making it essential for those planning an international move to understand and plan for potential tax implications.

An Overview of Exit Tax

The exit tax is a fiscal measure implemented by several countries, including Germany, France, and the United States, to tax unrealized capital gains when an individual relocates their tax residency abroad. This regulation primarily affects individuals who hold significant shares in corporations. For instance, in Germany, it applies to those who have owned at least 1% of a company’s shares within the five years preceding their departure. Similarly, France imposes an exit tax on individuals holding substantial shareholdings when they transfer their tax domicile outside the country.

The primary objective of the exit tax is to prevent taxpayers from avoiding taxation on capital gains accrued during their period of residence by moving abroad. In practice, this means that upon relocation, the tax authorities calculate the hypothetical gain based on the difference between the original purchase price of the shares and their market value at the time of departure, and tax this amount accordingly. This taxation occurs regardless of whether the shares are actually sold, ensuring that the country does not lose tax revenue due to the taxpayer’s relocation.

It’s important to note that the specifics of the exit tax, including thresholds, applicable rates, and deferral options, vary between countries. For example, in the United States, the exit tax applies to certain expatriates who meet specific income or net worth criteria. Therefore, individuals planning to move abroad should consult with tax professionals to understand the implications of the exit tax in their home country and explore potential strategies to manage this tax liability effectively.

Options When You Are Tax Liable in Germany and Want to Emigrate to Dubai

If you are taxed in Germany, hold at least a 1% share in a corporation, and are planning a move to Dubai, there are key tax considerations to keep in mind. With this shareholding, German tax law may apply specific regulations, including the exit tax.

Option 1: Conversion to a GmbH & Co. KG

Transforming shares in a German GmbH into a GmbH & Co. KG can be a strategic approach to managing the tax implications of relocating to Dubai, particularly the exit tax. This transformation involves changing the legal structure of the GmbH (a limited liability company) to a GmbH & Co. KG, a limited partnership with the GmbH as the general partner (Komplementär) and the shareholder(s) as limited partners (Kommanditisten). Here’s how the process works, along with its advantages and disadvantages.

Process of Conversion

Preparation of the Conversion Plan:

  • Draft a detailed conversion plan in line with the German Transformation Act (Umwandlungsgesetz), which regulates changes in business structures.
  • This document should outline the new structure, the roles of all partners, and the division of profits and liabilities.

Appointing the GmbH as General Partner (Komplementär):

  • In a GmbH & Co. KG, the GmbH becomes the general partner, taking on the legal and management responsibilities.
  • The shareholder(s) transition from shareholders of a corporation to limited partners in a partnership, which changes the tax implications.

Approval by Shareholders:

  • Shareholders must formally agree to the conversion, generally through a shareholder resolution.

Registration with the Commercial Register:

  • The transformation is not fully effective until it’s registered in the Commercial Register (Handelsregister), which establishes the new partnership officially.

Legal and Tax Review:

  • A comprehensive legal and tax review is recommended to ensure the conversion is conducted according to regulatory standards and is tax-effective.

Advantages of Conversion to a GmbH & Co. KG

Avoidance of Exit Tax:

  • By transforming the GmbH into a partnership structure, the shares are no longer subject to the exit tax. This is because the exit tax applies specifically to shares in corporations, not partnerships.

Flexibility in Profit Distribution:

  • GmbH & Co. KGs offer greater flexibility in profit distribution, allowing for tailored agreements that may benefit tax efficiency or reinvestment strategies.

Limited Liability for Limited Partners:

  • As a limited partner, your liability is confined to your capital contribution, similar to being a shareholder, while the GmbH retains unlimited liability as the general partner.

Maintaining Control:

  • The conversion allows original GmbH shareholders to retain substantial control through the GmbH’s role as the general partner.

Disadvantages of Conversion to a GmbH & Co. KG

Complex and Costly Process:

  • The transformation from a GmbH to a GmbH & Co. KG involves significant legal, administrative, and registration costs. Proper legal and tax consultancy is essential to avoid compliance issues, which can be costly and time-intensive.

Potential Tax Liabilities on Retained Earnings:

  • Converting a GmbH to a GmbH & Co. KG may trigger tax liabilities on retained earnings or reserves accumulated in the GmbH before conversion, as these may be treated as distributed profits.

Increased Administrative Burden:

  • Operating a GmbH & Co. KG requires meeting partnership tax filing and accounting requirements, which are more complex than those for a GmbH alone.

Risk of German Business Tax (Gewerbesteuer):

  • If substantial business operations remain in Germany, the GmbH & Co. KG could still be subject to German trade tax, depending on the scope of business activity.

Summary

Converting a GmbH to a GmbH & Co. KG can offer a viable solution to avoid exit tax when relocating, allowing continued control and limited liability. However, the complex nature of this transformation and the potential tax on retained earnings necessitate careful planning with experienced legal and tax advisors.

Option 2: Conversion to an Atypical Silent Partnership

In Germany, the exit tax (Wegzugsbesteuerung) is levied on unrealized capital gains when individuals holding significant shares in corporations relocate their tax residency abroad. This tax aims to prevent the avoidance of capital gains taxation through emigration. However, restructuring a German limited liability company (GmbH) into an atypical silent partnership (atypisch stille Gesellschaft) can offer a strategic approach to mitigate this tax burden.

Understanding the Atypical Silent Partnership

An atypical silent partnership is a unique German business structure where a silent partner contributes capital to a company and, unlike in typical silent partnerships, gains co-entrepreneurial rights. This includes participation in profits, losses, and decision-making processes, effectively treating the silent partner as a co-entrepreneur. For tax purposes, such partnerships are classified as partnerships rather than corporations, leading to different tax implications.

Restructuring a GmbH into an Atypical Silent Partnership

To transition a GmbH into an atypical silent partnership, the following steps are typically undertaken:

  1. Formation of the Partnership Agreement: The GmbH enters into a partnership agreement with the silent partner, detailing the capital contribution, profit and loss sharing ratios, and the extent of co-entrepreneurial rights.
  2. Contribution of Capital: The silent partner provides a capital contribution to the GmbH, which is recorded as equity.
  3. Operational Integration: The silent partner becomes involved in the company’s operations to the extent defined in the agreement, thereby acquiring co-entrepreneurial status.

Tax Implications and Mitigation of Exit Tax

By restructuring into an atypical silent partnership, the entity is reclassified as a partnership for tax purposes. In Germany, partnerships are generally tax-transparent, meaning that income is taxed at the partner level rather than at the entity level. This reclassification can influence the applicability of the exit tax in the following ways:

  • Change in Tax Subject: Since the entity is now considered a partnership, the individual’s shareholding in a corporation is effectively transformed into a partnership interest. This change may alter the conditions under which the exit tax is applied, potentially reducing or eliminating the tax liability.
  • Deferral Opportunities: German tax law provides deferral options for exit tax liabilities under certain conditions, particularly when relocating within the European Union or European Economic Area. Restructuring into a partnership may facilitate access to these deferral provisions.

Considerations and Professional Guidance

While restructuring into an atypical silent partnership can offer tax advantages, it is essential to consider the following:

  • Legal and Tax Compliance: The restructuring must comply with German commercial and tax laws to be effective.
  • Economic Substance: The partnership arrangement should reflect genuine economic activity and not solely serve as a tax avoidance mechanism.
  • Consultation with Experts: Engaging with tax professionals and legal advisors is crucial to navigate the complexities of such restructuring and to ensure that it aligns with the individual’s broader financial and relocation plans.

In summary, converting a GmbH into an atypical silent partnership can be a viable strategy to mitigate the impact of Germany’s exit tax. However, this approach requires careful planning, adherence to legal requirements, and professional guidance to ensure its effectiveness and compliance.

Option 3: Establishing a Family Foundation in Liechtenstein

Setting up a family foundation in Liechtenstein can be a potential way for German residents to mitigate the exit tax when relocating to Dubai. The exit tax in Germany targets unrealized capital gains on shares when an individual relocates outside Germany. By transferring these shares to a foundation, the owner effectively removes them from personal ownership, potentially alleviating the exit tax. However, transferring shares to a Liechtenstein foundation may itself trigger German tax liabilities at the time of transfer.

Understanding the Liechtenstein Family Foundation

A family foundation in Liechtenstein is a private legal entity designed to manage and preserve family assets. It operates as an independent entity with its own legal rights, distinct from the founder and other family members. The foundation manages assets and distributes benefits to family members according to specific rules, supporting wealth preservation across generations.

Steps to Establishing a Liechtenstein Family Foundation

  1. Foundation Charter and By-laws: Define the foundation’s purpose, beneficiaries, and asset management rules.
  2. Notarization and Registration: Official notarization and registration in the Liechtenstein Commercial Register establish the foundation’s legal status.
  3. Transfer of Assets: Shares or other assets are transferred to the foundation, which now holds them independently, helping to avoid direct personal ownership.
  4. Recognition by Liechtenstein Authorities: The foundation’s structure must comply with Liechtenstein’s regulatory framework to ensure full recognition.

German Tax Implications upon Transfer

While transferring shares to a Liechtenstein foundation may ultimately reduce personal ownership, it’s important to consider immediate German tax implications:

  • Capital Gains Tax upon Transfer: The transfer may be treated as a taxable sale or disposition under German tax law, triggering capital gains tax based on the market value of the shares at the time of transfer. This “deemed sale” results in tax on the difference between the original purchase price and the market value.
  • Gift Tax Considerations: If family members are beneficiaries, the transfer might be seen as a gift, subject to German gift tax, especially if beneficiaries are close family members.
  • Controlled Foreign Corporation (CFC) Rules: Liechtenstein is not part of the EU or EEA, meaning the family foundation might still be subject to German Controlled Foreign Corporation rules (CFC) if assets or income remain linked to Germany.

Advantages of a Liechtenstein Family Foundation

  • Long-term Wealth Preservation: Foundations offer secure ways to hold family wealth, providing protections not available with direct ownership.
  • Tax Optimization in Certain Jurisdictions: Liechtenstein has favorable tax policies, which may benefit foundation-held assets under local law.
  • Generational Wealth Transfer: The foundation structure supports planned succession, ensuring that family wealth is passed down efficiently.

Disadvantages and Considerations

  • Immediate Tax Liabilities: German capital gains tax may be triggered on the market value of the shares upon transfer, potentially leading to significant initial tax expenses.
  • Ongoing Compliance and Complexity: Family foundations are complex to establish and manage, with ongoing requirements for legal and tax compliance.
  • Reduced Flexibility: Assets transferred to a foundation are typically locked into the foundation’s structure, reducing personal control over them.

Summary

Setting up a Liechtenstein family foundation can be an effective strategy to avoid exit tax if executed correctly, but it may trigger other German tax liabilities at the time of transfer. Given the complexity and potential tax costs, professional guidance is essential to assess whether this approach aligns with your long-term goals and to ensure compliance with both German and Liechtenstein regulations.