Exit taxation is a key component of German tax law. It applies to individuals who transfer their tax residence abroad while holding certain shareholdings. The rules are primarily governed by Section 6 of the German Foreign Tax Act (Außensteuergesetz – AStG) and Section 17 of the German Income Tax Act (Einkommensteuergesetz – EStG). Their purpose is to tax the increase in value of these shareholdings—commonly referred to as hidden reserves—before Germany loses its taxing rights. As of 1 January 2025, the new Section 19(3) of the German Investment Tax Act (Investmentsteuergesetz – InvStG) also extends exit taxation to certain investment fund units.

Below you will find an overview of the most important provisions.

What Is Exit Taxation?

Exit taxation applies to unrealised increases in the value of shareholdings when an individual leaves Germany and, as a result, Germany loses its right to tax the future capital gain. The tax is based on a deemed disposal, meaning that a fictitious capital gain is calculated even though no actual sale has taken place. The objective is to ensure that the hidden reserves accrued during the period of German tax residence are taxed before the taxpayer relocates abroad.

Legal Basis

- Section 6(1) AStG: Provides that giving up a tax residence or habitual abode is treated as a deemed disposal of the shares.

- Section 17(1), first sentence, EStG: Applies to individuals holding at least a 1% interest in a corporation.

- Section 19(3) InvStG: Extends exit taxation to certain investment fund units held outside business assets.

Who Is Affected?

Exit taxation applies to individuals who:

1. Hold a substantial interest in a corporation, meaning at least 1% of the company's shares; or

2. Hold investment fund units outside business assets, provided that:

- They have held at least 1% of the units in an investment fund at any time during the previous five years; or

- The acquisition cost of the investment fund units is at least €500,000.

3. Have been subject to unlimited tax liability in Germany for at least seven of the previous twelve years (Section 6(2) AStG).

4. Permanently transfer their tax residence or habitual abode abroad.

The rules do not apply to taxpayers who leave Germany only temporarily and can credibly demonstrate their intention to return within seven years (extendable to twelve years upon application) pursuant to Section 6(3) AStG.

How Is the Tax Calculated?

The tax is calculated on the basis of a deemed sale of the shares. For this purpose, the German tax authorities estimate the increase in value that has accrued since the shares were acquired. The following simplified example illustrates the calculation:

1. Determination of the company's value:

Average annual profit of the last three years × factor of 13.75.

2. Calculation of the capital gain:

The acquisition cost of the shares is deducted from the estimated company value.

3. Taxation under the partial income method (Section 3 No. 40 EStG):

Only 60% of the gain is subject to the taxpayer's personal income tax rate (up to 45%).

Example:

Annual profit: €100,000 → Company value: €1,375,000.

Acquisition cost of the shares: €375,000.

Capital gain: €1,000,000.

Tax liability: €270,000 (60% of €1,000,000 × 45%).

With regard to investment fund units, the relevant value is their fair market value, i.e. the price that would be achieved in a hypothetical arm's-length sale.

 

Criticism and Legal Challenges

The recent tightening of the German exit tax rules has raised doubts as to its compatibility with European Union law. Articles 21 and 45 of the Treaty on the Functioning of the European Union (TFEU) guarantee the free movement of EU citizens within the European Union. As previous versions of the German exit tax rules have already been challenged before the Court of Justice of the European Union (CJEU), it cannot be ruled out that the current amendments—particularly the extension of the rules to investment fund units—may also be found to infringe EU law. Under the principle of supremacy of EU law, European law takes precedence over national legislation, including constitutional provisions.

It remains to be seen whether the current legislation, and in particular the extension to investment fund units, will withstand judicial scrutiny.

How Can Exit Taxation Be Avoided under the Current Legal Framework?

Complete avoidance of German exit taxation is generally only possible in the following situations:

1. Sale of the shares before leaving Germany. In this case, however, the capital gain will normally be subject to German income tax under the ordinary taxation rules.

2. Transfer of the shares, for example as part of a business succession or by way of a gift. Depending on the circumstances, gift tax or other tax consequences may arise.

3. Conversion of the corporation into a partnership.

Conclusion

German exit taxation represents a significant challenge for taxpayers intending to leave Germany on a permanent basis. The legislative amendments applicable from 2025 further increase the potential tax burden while reducing the opportunities for tax planning.

Taxpayers affected by these rules should seek professional advice at an early stage in order to assess the available options and minimise potential tax risks. As the legal framework continues to evolve, it is advisable to monitor future legislative developments and court decisions closely.

Our law firm will be pleased to analyse your individual circumstances, carry out the necessary administrative procedures on your behalf and assist you with the preparation and filing of the relevant tax returns. Should you require further information or have any questions regarding this subject, please do not hesitate to contact us by email or telephone.

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