Applicable Law of Succession

Since the entry into force of the European Succession Regulation (“ESR”) on 17 August 2015, the question of which law of succession applies to an estate has been harmonised within the European Union (the principle of unity of the estate). From a German perspective, unlike the previous legal position, the law of succession applicable is now generally the law of the state in which the deceased had his or her last habitual residence (Article 21(1) ESR). As a rule, the nationality of the deceased is therefore no longer decisive.

If, for example, a German national spent the last years of his life living on the French Côte d’Azur, French succession law will generally apply. In such a case, even real estate located in Germany would be inherited under French law. If the deceased had drawn up a will in the belief that German succession law would apply, the will—drafted in German—would, in case of doubt, have to be interpreted in accordance with French law. Ambiguities, a heightened risk of disputes and, consequently, increased costs of estate administration are then virtually inevitable.

If a domestic resident wishes to ensure in such circumstances that the (economic) objectives set out in the will are actually achieved, he or she may choose the law of succession of the state whose nationality he or she possesses either at the time of making the choice of law or at the time of death (Article 22(1) ESR). In the example above, this would be German law. Persons holding multiple nationalities may choose between the respective laws of succession.

Special issues may arise where the international element extends beyond the scope of the ESR. If, from the perspective of the ESR contracting states, the deceased had his or her last habitual residence in a third country, this may result in different succession laws applying to different parts of the estate, depending on where the assets are located (so-called fragmentation of the estate). This particularly affects common law jurisdictions such as the United Kingdom, the United States or South Africa, but also countries such as Thailand or Brazil.

A so-called de facto fragmentation of the estate may also occur where the deceased owned assets in a third country whose courts apply their own succession law, as they do not consider themselves bound by the principle of unity of the estate established by the ESR. In such cases, it is essential to take both legal systems into account when drafting the will. There are often significant differences, for example with regard to forced heirship or mandatory inheritance rights.

From a German perspective, it must be taken into account that the German compulsory share (Pflichtteil), which guarantees a minimum participation in the estate regardless of need, constitutes an indispensable right of compulsory heirs and forms part of German public policy (“ordre public”). German courts would therefore apply German compulsory share rules even where a foreign succession law applies that does not provide for an equivalent right. Depending on the circumstances, this may require a will that interlinks the different succession laws, or the drafting of several coordinated but separate wills—one for each fragmented estate.

Applicable Inheritance Tax Law

The inheritance tax consequences must be assessed entirely independently of the question of which substantive succession law applies. From a German tax perspective, the decisive factors are initially the tax residence of the deceased and of the heirs or legatees.

If the deceased and/or the heirs or legatees are resident in Germany—by virtue of having their domicile or habitual residence there—German inheritance tax generally applies to the entire acquisition of assets by reason of death (“unlimited tax liability”). If only one of several beneficiaries is resident in Germany for tax purposes, German tax liability is limited to the share of the estate acquired by that beneficiary. For German nationals who move abroad, an “extended” unlimited tax liability continues for five years after departure; in the case of relocation to the United States, this period extends to ten years.

German inheritance tax liability may also arise where neither the deceased nor the beneficiaries are resident in Germany, but the estate includes so-called domestic assets (“limited tax liability”). These may include, for example, real estate located in Germany or shareholdings of at least ten percent in German corporations. A broader form of limited tax liability may also arise where German nationals relocate to low-tax jurisdictions for up to almost eleven years following departure, provided that the individual was subject to unlimited tax liability in Germany for at least five of the ten years prior to departure and retains economic interests in Germany thereafter (“extended limited tax liability”).

To avoid potential double taxation of an acquisition upon death by multiple states, German inheritance tax law provides, upon application, for a credit mechanism—subject to the existence of unlimited German tax liability (“unilateral credit”). In principle, foreign taxes assessed and paid on so-called foreign assets may be credited. Depending on whether the deceased was tax resident in Germany or not, more or fewer assets qualify as foreign assets. However, a credit is always excluded to the extent that the foreign tax attributable to the relevant part of the acquisition exceeds the German inheritance tax.

In addition to unilateral relief under German inheritance tax law, Germany has concluded inheritance tax double taxation treaties (“DTTs”) with a limited number of countries, providing bilateral measures to avoid double taxation. These treaties either allocate taxing rights between the contracting states (“exemption method”) or also provide for a credit mechanism, in which case the state levying the higher tax effectively determines the tax burden for the relevant assets (“credit method”). Due to numerous specific features, each DTT must be carefully examined on a case-by-case basis.

When drafting wills in cases involving an international element, tax burdens should always be taken into account in order to avoid particularly disadvantageous outcomes, especially double taxation. In some cases, it may suffice to allocate estate assets differently among the beneficiaries than originally intended. In other cases, inheritance tax analysis may provide sensible incentives to restructure or reallocate assets during the testator’s lifetime.

International Estate Administration

For heirs and legatees, the decisive factor in estate administration is generally their ability to prove their status as such. From a German perspective, this is typically done by means of a certificate of inheritance (Erbschein). When administering foreign assets—for example, registering a change of ownership of real estate in a public register—the German certificate of inheritance is often not accepted.

The European Certificate of Succession provides assistance where such foreign assets are located in a member state of the ESR. Where the foreign assets are located in a third country, however, the applicable local evidentiary requirements must be considered and, if necessary, appropriate precautions must be taken in advance.

Conclusion

The possible constellations of international connections of a (German) testator are extraordinarily diverse and depend on the countries involved. For testamentary planning in such cases, a sober analysis of the status quo from the perspectives of succession law, inheritance tax law and procedural law is essential. Where third countries are involved from the perspective of the ESR, obtaining foreign legal advice is unavoidable in order to achieve a complete assessment.

Following this analysis, the relevant levers must be identified to achieve the individual objectives of succession planning. It should be emphasised that international elements add further complexity to testamentary planning, which may already be considerable due to particular family or asset structures. In relatively straightforward international cases, a choice of law may allow the use of German succession law instruments to implement the testator’s core objectives. In more complex cases, it may be necessary to additionally execute further wills under foreign law and to undertake lifetime asset restructurings.