German Inheritance Tax Valuation Rules Incompatible With Free

Movement of Capital, ECJ Says

by Tom O'Shea

The European Court of Justice on January 17 issued its judgment in

Theodor Jäger v. Finanzamt Kusel-Landstuhl (C-256/06), ruling that
Germany's inheritance tax valuation rules are incompatible with the EC
Treaty principle of free movement of capital.

Date: Feb. 5, 2008

The European Court of Justice on January 17 issued its judgment in Theodor

Jäger v. Finanzamt Kusel-Landstuhl (C-256/06), ruling that Germany's
inheritance tax valuation rules are incompatible with the EC Treaty principle of
free movement of capital.

In Jäger, Germany calculated the inheritance tax payable on agricultural and

forestry assets situated in Germany more favorably than for similar assets
located in France. The appellant challenged those tax rules on the ground that
they breach his right to the free movement of capital as guaranteed by the EC
Treaty. The matter was appealed to the German Federal Finance Court
(Bundesfinanzhof), which took the view that the matter should be referred to
the ECJ under the preliminary ruling procedure.

The European Court of Justice on January 17 issued its judgment in Theodor

Jäger v. Finanzamt Kusel-Landstuhl (C-256/06), ruling that Germany's
inheritance tax valuation rules are incompatible with the EC Treaty principle of
free movement of capital. (For the judgment, see Doc 2008-1144 [PDF] or
2008 WTD 14-17 .)

In Jäger, Germany calculated the inheritance tax payable on agricultural and

forestry assets situated in Germany more favorably than for similar assets
located in France. The appellant challenged those tax rules on the ground that
they breach his right to the free movement of capital as guaranteed by the EC
Treaty. The matter was appealed to the German Federal Finance Court
(Bundesfinanzhof), which took the view that the matter should be referred to
the ECJ under the preliminary ruling procedure.

Facts of the Case

The German inheritance tax rules impose taxation on the entire estate of a
person who died while domiciled in Germany. Assets situated outside
Germany are also subject to the tax, with a credit granted for foreign
inheritance tax payable on those foreign assets in the absence of treaty
provisions relating to inheritance tax.

Under the German rules, property consisting of agricultural land and forestry
assets situated outside Germany is valued according to its fair market value.
Different valuation rules are used if the agricultural land and forestry assets
are situated in Germany, reducing the taxable valuation to around 10 percent
of the current market value.

Moreover, the German tax rules provide for an additional tax-free amount of
DEM 500,000 in the case of acquisition by inheritance of agricultural land and
forestry assets situated in Germany, and only 60 percent of the remaining
value of the property (after deduction of the tax-free amounts) is taken into
account for inheritance tax purposes. The tax-free amount and the valuation
at the reduced rate do not apply to agricultural land and forestry assets
situated outside Germany.

Jäger, a French resident, was the sole heir of his mother, who died in
Germany. Her estate contained assets in Germany and some agricultural land
and forestry assets situated in France. Jäger was denied the tax advantages
granted under the German tax rules because the agricultural land and forestry
assets are not located in Germany.

Free Movement of Capital

The ECJ noted that while the EC Treaty does not define the term "movement
of capital," Annex I of Directive 88/361 retains the same indicative value for
the purposes of defining capital movements. Accordingly, because the
transfer of assets of a deceased falls within the heading of personal capital
movements, an inheritance is a movement of capital "except in cases where
its constituent elements are confined within a single Member State," the ECJ
said. That purely domestic situation did not apply to the Jäger case because
there was a cross-border dimension: A resident of Germany had left to
another person resident in France assets situated in Germany and France.
Therefore, the free movement of capital applied.

Restriction on the Free Movement of Capital

The ECJ noted that inheritance tax rules such as those in Germany could:

• discourage the purchase of agricultural land and forestry assets in EU

member states other than Germany;
• deter the transfer of the financial ownership in such assets to persons
resident in other member states; and
• reduce the value of an inheritance of a resident of a member state
other than that in which the property was situated.

The ECJ determined that "the national provisions . . . insofar as they result in
an inheritance consisting of agricultural land and forestry situated in another
Member State being subject, in Germany, to inheritance tax that is higher than
that which would be payable if the assets inherited were situated exclusively
[in Germany] . . . have the effect of restricting the movement of capital by
reducing the value of an inheritance consisting of such an asset situated
outside Germany." The ECJ went on to reject the arguments of the German
government justifying such inheritance tax rules.

Justification

The ECJ rejected the notion that the effect of the German legislation was the
unavoidable consequence of the coexistence of national tax systems, stating
that the "reduction in the value of the estate flows solely from the application
of the German legislation."

Moreover, the ECJ rejected the German government's argument that it was
entitled to reserve the tax advantages at issue to assets situated within its
territory, noting that such rules could be compatible with the free movement of
capital provided that they applied to situations that were not objectively
comparable, but that the national provisions must not constitute a means of
arbitrary discrimination or a disguised restriction on the free movement of
capital.

Also, "the difference in treatment between the agricultural land and forestry
assets situated in Germany and those situated in the other Member States
must not go beyond what is necessary to achieve the objective pursued by
the legislation at issue," the ECJ said. Therefore, to be considered compatible
with the free movement of capital, the difference in treatment must concern
situations that are not objectively comparable or must be justified by
overriding reasons in the general interest, it said.

Comparability

In this case, the calculation of the inheritance tax was "directly linked to the
value of the assets included in the estate, with the result that there is
objectively no difference to justify unequal tax treatment," the ECJ said. In
other words, the situation involving agricultural land and forestry assets
located in France was comparable to that of any other heir whose inheritance
consists only of agricultural land and forestry situated in Germany bequeathed
by a person domiciled in that state, according to the Court.

Overriding Reasons in the General Interest

Next, the ECJ examined the German government's argument that its
legislation was justified because it was designed to "compensate for the
specific costs involved in maintaining the social role fulfilled by agricultural
land and forestry holdings . . . [which] makes it possible to prevent . . . the heir
. . . from being forced to sell or relinquish it in order to be able to pay the
inheritance tax and . . . [to prevent] the break-up of agricultural land and
forestry holdings guaranteeing productivity and jobs." The government argued
that there was a direct link between the specific obligations resulting from the
subordination of those holdings to the general interest and the particular kind
of valuation applied to those holdings in inheritance tax matters.

While the Court accepted that there may be situations in which rules related to
agricultural and forestry holdings and the preservation of jobs connected to
such holdings might concern objectives in the public interest capable of
justifying a restriction on the free movement of capital, in the circumstances of
this case, the Court found that the government had not demonstrated "a need
to refuse the benefit of a favourable assessment and other tax advantages to
any heir who acquires by inheritance an agricultural or forestry holding which
is not situated within German territory." The ECJ found that there was no
evidence to support a finding that the holdings established in other member
states are not in a comparable situation to that of holdings established in
Germany.

Practical Difficulties

The Court also examined the government's argument that its tax rules were
justified because of the practical difficulties of valuing agricultural land and
forestry assets situated in other member states. The assessment and
valuation procedure used by the German tax authorities was based on
"statistical documents compiled by the German authorities," the Court
observed. "Similar data [were] not available in respect of agricultural land and
forestry assets situated in other Member States."

However, the Court rejected that justification, commenting that while it may
prove difficult to apply the national assessment procedure to agricultural and
forestry assets situated in another member state, "that difficulty cannot justify
a categorical refusal to grant the tax advantage in question since the
taxpayers concerned could be asked themselves to supply the authorities with
the data which they consider necessary to ensure application of that
procedure in such a way that it is adapted to holdings in other Member
States." The Court observed that "any disadvantages encountered in
determining the value of assets situated in the territory of another Member
State under a special national procedure cannot, in any event, be sufficient to
justify restrictions on the free movement of capital such as those arising under
the legislation at issue."

The Court's Conclusion

The ECJ therefore concluded that the German inheritance tax rules at issue
were incompatible with the free movement of capital and that it had not been
established that the tax rules at issue were justified by overriding reasons in
the general interest.

Analysis
The Jäger decision is the latest in a line of ECJ judgments concerning the
inheritance tax rules of EU member states. The variety of inheritance tax rules
that have come before the Court has restricted tax concessions to property
located in the national territory (Jäger) or to persons who resided and died in
the national territory (Barbier C-364/01).

In Geurts and Vogten (C-464/05), Belgium's inheritance tax exemption rules

came under scrutiny because they restricted a tax exemption relating to the
assets of a family undertaking to situations in which at least five full-time
workers were employed in the Flemish region of Belgium in the three years
preceding the death of the deceased. The exemption was not granted if the
family undertaking employed the requisite number of workers in another EU
member state. (For the ECJ judgment in Geurts and Vogten (C-464/05), see
Doc 2007-23781 [PDF]or 2007 WTD 208-13 ; for related coverage, see Doc
2007-24638 [PDF] or 2007 WTD 216-2 .)

In van Hilten (C-513/03), the Netherlands taxed the estates of Dutch nationals
who died within 10 years of ceasing to reside in the Netherlands as if they had
continued to reside in the Netherlands (with credit for any inheritance taxes
paid in the country to which the deceased transferred his or her residence).
(For the ECJ judgment in van Hilten, see Doc 2006-3763 [PDF] or 2006 WTD
39-7 .) The ECJ's jurisprudence in the area of inheritance taxes indicates
that this is an area that the member states need to reconsider to ensure that
their inheritance tax rules fully comply with EU law and do not restrict the
fundamental freedoms guaranteed by the EC Treaty.

The Concept of Restriction

The Jäger case provides a nice contrast to the van Hilten decision, in which
the ECJ held that the Dutch inheritance tax rules did not constitute a
restriction on the free movement of capital because they treated the estates of
Dutch nationals who had transferred their residence abroad in a similar way to
the estates of Dutch nationals that remained in the Netherlands (the
migrant/nonmigrant test). The Court noted that "such legislation cannot
discourage the former from making investments in that Member State . . . nor
the latter from doing so in another Member State . . . nor can it diminish the
value of the estate of a national who has transferred his residence abroad."

"Since it applies only to nationals of the Member State concerned, it cannot

constitute a restriction on the movement of capital of nationals of the other
Member States," the ECJ concluded.

By contrast, in Jäger, the Court found that the German inheritance tax rules
did restrict the free movement of capital. The reduction in the value of the
estate flowed solely from the German legislation, and the inheritance tax on
the agricultural property and forestry assets situated in France was higher
than the inheritance tax that would be payable if the assets had been situated
in Germany. That tax "disadvantage" had "the effect of restricting the free
movement of capital by reducing the value of an inheritance consisting of
such an asset situated outside Germany," the Court said.

The distinction between van Hilten and Jäger is important because in the
former, there was no restriction on the free movement of capital. Moreover,
van Hilten demonstrates that reverse discrimination is possible in an EU
setting because a member state is entitled to treat its own nationals less
favorably from a taxation point of view than the nationals of other member
states who exercise their EU law rights in relation to its territory. In van Hilten,
the Dutch inheritance tax rules applied only to nationals who moved abroad;
the rules did not apply to nationals of other member states who had resided in
the Netherlands and then moved abroad. Consequently, this is an example of
a situation in which a member state taxes its own nationals who move abroad
but not the nationals of other member states who leave the Netherlands after
residing there.

Practical Obstacles

In Jäger, the ECJ dismissed the German government's arguments about the
practical difficulties involved in valuing agricultural land and forestry assets
situated in other member states as a justification for the less favorable tax
treatment of the French agricultural property. This was in line with its earlier
case law regarding the freedom of establishment (Geurts and Vogten) and the
free movement of workers and the freedom to provide services (Commission
v. Belgium, C-300/90). Moreover, in Manninen (C-319/02), the Court noted
that difficulties in determining the tax actually paid cannot justify an obstacle
to the free movement of capital. (For the ECJ judgment in Manninen, see Doc
2004-17814 [PDF] or 2004 WTD 174-17 .)

In Jäger, the Court emphasized that any "practical difficulties" cannot justify a
"categorical refusal to grant the tax advantage in question since the taxpayers
concerned could be asked themselves to supply the authorities with the data
they consider necessary." The Court had already made similar statements in
Commission v. Belgium, Commission v. France (C-334/02), and ELISA (C-
451/05). (For the ECJ judgment in European Commission v. France, see Doc
2004-5316 [PDF] or 2004 WTD 50-19 . For the ECJ judgment in ELISA (C-
451/05), see Doc 2007-23006 [PDF] or 2007 WTD 199-16 .)

Tax Consequences of Inheritance Tax

The Jäger case is also interesting because of the Court's comments on the
effects that inheritance tax rules have on the free movement of capital. These
rules can discourage the purchase of immovable property in other member
states and reduce the value of an inheritance of a resident of a member state
other than that in which the property is situated, the Court said. The rules
were, therefore, protectionist in nature and restrictive of the free movement of
capital.

The Court delivered a similar response in Barbier, noting that "the tax
consequences in respect of inheritance rights are among the considerations
which a national of a Member State could reasonably take into account when
deciding whether or not to make use of the freedom of movement provided for
in the Treaty." This echoed its reasoning regarding the freedom of
establishment in Halliburton (C-1/93), in which the ECJ determined that a
"payment of tax on the sale of immovable property constitutes a burden which
renders the conditions of sale of the property more onerous and thus has
repercussions on the position of the transferor." The inheritance tax rules of
the EU member states can therefore have an impact on any of the
fundamental freedoms, and any different treatment of EU nationals under
such rules must be justified.

Tom O'Shea, lecturer in tax law, Centre for Commercial Law Studies, Queen
Mary, University of London