Summary:

I.
§ 19.1 of the Inheritance Tax and Gift Tax Act (hereinafter: The Act) uniformly determines as a tax tariff a percentage of the acquisition for all taxable acquisitions, regardless of the types of asset of which the estate or gift is composed. This tariff is progressive as to the value of the acquisitions, and is sub-divided into three tax brackets based on the degree of relationship with the testator or donor. The taxable acquisitions of assets must be shown as a monetary amount in order to use this tariff to reach a tax amount payable in money. If tax objects are not actual money, their value must be expressed as a monetary value by using a valuation method in order to obtain an assessment basis for the tax owed. The Act determines that the valuation is carried out in line with the provisions of the Valuation Act. The values of the individual assets are thus not determined uniformly, but rather by different methods. According to the Act, the general value is, as a rule, the fair market value. In order to assess the value of domestic property, the rental value method is used concerning important parts of the valuation. The value of the operational part of agricultural and forestry assets is also assessed on the basis of the rental value. In addition, inheritance tax law uses the fiscal balance sheet value for assessing business assets.

The decision of the Federal Constitutional Court was based on a referral by the Federal Finance Court. The referral concerns the question whether the application of the uniform tax tariff to all acquisitions in accordance with § 19.1 of the Act is unconstitutional with regard to the different types of asset because of the unequal determination of the tax assessment base.

II.
The First Senate of the Federal Constitutional Court held that levying inheritance tax pursuant to § 19.1 of the Act is incompatible with the Basic Law as it violates the principle of equality (Article 3.1 of the Basic Law). The legislature is obliged to enact new provisions by 31 December 2008 at the latest. Until the new provisions are enacted, the current ones continue to apply.

The decision is essentially based on the following considerations:

The applicable inheritance tax law is based on the legislature’s decision to impose taxes on the asset increase of the respective recipient in the event of an inheritance. Consistent taxation of taxpayers depends on finding bases for assessment for the individual economic units and assets belonging to an inheritance which realistically reflect the relation of their values. Inheritance taxation meeting this principle can only be ensured if the provisions draw upon the same general value on the valuation level. Only this value adequately reflects the increase in economic capacity and allows for equality-based assessments. The legislature is, in principle, free to choose a valuation method; it must, however, guarantee that all assets are reflected by a value that is approximately the fair market value.
Regarding the further steps taken to determine the tax burden subsequent to valuation, the legislature may draw upon the value of the asset increase determined in that manner and set out steering purposes, for example in the form of targeted tax exemption provisions which satisfy the requirement of legal clarity. By contrast, the level of valuation is unsuitable under constitutional law for pursuing non-fiscal promotion and steering goals in inheritance tax law.
The applicable inheritance tax and gift tax law does not satisfy these constitutional requirements. For major groups of assets the valuation provisions under inheritance tax law do not lead to tax bases that are approximated to the fair market value. They do not allocate the tax burden in a sufficiently equal or consistent manner.
Extensively using the fiscal balance sheet values impedes an approximation to the fair market value with regard to business assets. This leads to taxation which are incompatible with the principle of equality. Pursuant to the statutory provision (§ 109.1 of the Valuation Act), the assets that are part of business assets are indicated at their fiscal balance sheet value. However, this corresponds to the respective current value of the asset (part value) only in exceptional cases. With regard to highly profitable companies, the fiscal balance sheet value is far below the fair market value because the profit is not considered in the valuation. In addition, the preferential treatment is completely uneven, and hence arbitrary. When using the fiscal balance sheet value method, the assessment base of the inheritance tax depends on whether and to what degree the testator or donor took balance-sheet-related accounting measures.
With regard to property, even determining the assessment base under inheritance tax law does not meet the requirements of the principle of equality.
The simplified rental value method that is statutorily required with regard to developed land (§ 146.2.1 of the Valuation Act) fails to result in a valuation at its fair market value. According to the legislative documents, the legislature intended to reach valuations averaging approximately 50% of the purchase price –the fair market value – by the rental value method, and to create an incentive to invest in property by low inheritance taxation, as well as positively impact the construction and housing industry. This implementation of fiscal policy at the valuation level fundamentally conflicts with the constitutional requirements following from the principle of equality.
The valuation of leaseholds and of property subject to leaseholds governed by § 148 of the Valuation Act – in the version applicable until 31 December 2006 – also does not realistically reflect the values as regards their relation to each other. The value of the property subject to leasehold is rigidly determined in schematic terms without taking account of the remaining term of the building lease or further factors. In many cases, this results in valuations, both of the property and of the leasehold, that considerably deviate from the fair market value.
The assessment of the value of undeveloped land (§ 145 of the Valuation Act) does not satisfy the requirement of reflecting the values realistically as regards their relation to each other, either, at least not any more. This is because the statutory law provided that values had to be fixed as on 1 January 1996; this provision was applicable until the end of 2006. Price trends on the property market lead to a situation in which the past-related values do not realistically reflect the values within the group of undeveloped land, as regards their relation to each other, nor do they correspond to the present values of other assets any more. Hence, the value assessment according to the law applicable until 31 December 2006 leads to unconstitutional taxation
The recipients of shares in corporations are subject to inheritance taxation which is set out in a way that is not in compliance with the principle of equality. With unlisted shares which are to be estimated, the statutorily required fiscal balance sheet value method leads to taxation values which are, as a rule, far below the part values. In addition, the transfer of the fiscal balance sheet values – like of business assets – affects shares in corporations in a very different way.
Ultimately, the valuation of agricultural and forestry assets violates the requirements following from the principle of equality. For the operational part, the rental value is defined as the valuation objective. In structural terms this already fails to cover the increased heir’s or donee’s financial capacity arising from the asset increase. Due to the legislative concept on which inheritance tax is based, the increased financial capacity results particularly from the price obtainable on sale under objective conditions, but not solely from the profit obtainable using the asset substance. The valuation of the residential section and of company housing is aligned with the fair market value as a value category. In this respect, said the considerations set out with regard to property apply mutatis mutandis.
Even though the provisions are declared incompatible with the principle of equality, it is necessary to allow, by way of exception, that the current inheritance tax law continues to apply until new provisions are enacted. Under constitutional law, the legislature is obliged to draw on the fair market value at the valuation level as the relevant value objective. If there are sufficient reasons of the common good, the legislature is free to favour the acquisition of certain assets when determining the assessment base in a second step by using exemption provisions. The effects of preferential treatment must be related to specific objectives, and must occur as evenly as possible within the group of beneficiaries. Finally, the legislature can also pursue fiscal policy aims using differentiated tax rates.