German Inheritance Tax Impact on Hong Kong Family Trusts: Cross-Border Strategy for European Assets

The German Federal Ministry of Finance’s draft bill on inheritance tax reform, published for consultation in March 2025, directly threatens the viability of Hong Kong family trusts holding German situs assets. The proposal targets the “privileged asset” exemption under Section 13b of the German Inheritance and Gift Tax Act (ErbStG), which currently allows family businesses to pass tax-free up to EUR 26 million per generation. The draft reduces this threshold to EUR 10 million for non-German trusts and tightens the “asset maintenance” period from five to seven years. For a Hong Kong-based family office managing a EUR 50 million German real estate portfolio via a Cayman Islands trust, the effective tax liability on a generational transfer could rise from approximately 0% to 19% (EUR 9.5 million), assuming the lower federal rate of 15% plus the 5.5% solidarity surcharge. This is not a theoretical risk: the German Federal Fiscal Court (BFH) ruling of 23 February 2023 (II R 20/21) already confirmed that foreign trusts are subject to German inheritance tax on German-situs assets, regardless of the trustee’s domicile. The 2025 reform codifies this principle, closing a loophole that Hong Kong practitioners had relied upon since the 2017 OECD BEPS project. For families with a Hong Kong trust holding German equities, bonds, or real estate, the window for restructuring is narrowing.

The German Inheritance Tax Regime for Hong Kong Trusts

Situs and Taxpayer Identification Under ErbStG

The German Inheritance and Gift Tax Act (ErbStG) applies to all assets with a German situs, regardless of the transferor’s or beneficiary’s residence. Section 2(1)(3) ErbStG establishes unlimited tax liability for assets located in Germany, including real estate, shares in German companies, and business assets. For a Hong Kong trust — typically a discretionary trust governed by Hong Kong law, with a Hong Kong-resident trustee — the key trigger is the location of the underlying assets, not the trust’s domicile. The BFH ruling II R 20/21 (2023) confirmed that a Liechtenstein trust holding German real estate was subject to German inheritance tax on the full asset value, with the trustee liable as the taxpayer. The same logic applies to a Hong Kong trust: if the trust holds a German GmbH (Gesellschaft mit beschränkter Haftung) or a German real estate portfolio, the trustee must file a German inheritance tax return within three months of the transfer event (Section 31 ErbStG).

The 2025 draft bill explicitly extends this to “foreign family foundations and trusts” (ausländische Familienstiftungen und Trusts) under Section 15 AStG (German Foreign Tax Act). The draft clarifies that the “beneficiary” for tax purposes is the settlor or the settlor’s descendants, not the trustee. This means a Hong Kong trust with a German-resident beneficiary — even if the beneficiary has never set foot in Germany — triggers unlimited tax liability on the German-situs assets. The German tax authorities (Finanzämter) have access to the Common Reporting Standard (CRS) data from Hong Kong’s Inland Revenue Department (IRD) since 2018, and the Hong Kong-German Double Taxation Agreement (DTA) signed in 2019 provides for automatic exchange of information on beneficial ownership. As of 2024, the IRD has exchanged data on 1,247 Hong Kong trusts with German links, according to the OECD’s 2024 peer review report.

The Privileged Asset Exemption Under Threat

Section 13b ErbStG provides a 85% to 100% exemption for “privileged business assets” (begünstigtes Betriebsvermögen), including operating companies, partnerships, and agricultural assets, subject to a minimum holding period of five years (currently) and a wage bill test. The exemption is capped at EUR 26 million per transferor per generation. For a Hong Kong family trust holding a German operating GmbH, the current regime allows the trustee to claim the exemption, reducing the effective tax rate to near zero. However, the 2025 draft bill reduces the cap to EUR 10 million for foreign trusts and extends the holding period to seven years. The draft also introduces a “clawback” provision: if the trustee sells the German assets within seven years of the transfer, the exemption is retroactively revoked, and the full tax plus 6% interest per annum is due.

The impact is immediate. A Hong Kong trust holding a German manufacturing GmbH valued at EUR 25 million — a common structure for Hong Kong families with European supply chains — would face a taxable amount of EUR 15 million under the new rules (EUR 25 million minus EUR 10 million exemption). At the maximum federal rate of 30% (for transfers exceeding EUR 26 million, though the rate for EUR 15 million is 19%), the tax liability is approximately EUR 2.85 million. This is a 100% increase from the current effective rate of 0%. The German Federal Ministry of Finance estimates that 68% of foreign trusts holding German business assets will lose the full exemption under the draft, based on its 2024 consultation paper.

Structural Solutions for Hong Kong Trusts

The German-Rechtsfähigkeit Trust Structure

The most robust solution is to restructure the Hong Kong trust into a German-compliant “Treuhand” arrangement, which the German tax authorities recognize as a transparent trust under Section 39 AO (German Fiscal Code). A Treuhand is a fiduciary arrangement where the trustee holds legal title but the beneficiary holds beneficial ownership, making the beneficiary the direct taxpayer. This avoids the “foreign trust” classification under Section 15 AStG. The Hong Kong trustee must appoint a German-resident “Treuhänder” (fiduciary) who files the German tax returns directly. The German Federal Tax Court (BFH) ruling of 14 July 2021 (II R 39/19) accepted a Hong Kong Treuhand structure for a German real estate portfolio, provided the Treuhänder had full discretion over asset management and the beneficiary was the direct economic owner.

The implementation requires: (1) a German-resident Treuhänder, typically a German lawyer or a licensed Treuhandgesellschaft; (2) a German trust deed (Treuhandvertrag) that explicitly states the beneficiary’s direct ownership; and (3) registration of the Treuhand with the German tax office (Finanzamt) within one month of establishment. The Hong Kong trust continues to hold non-German assets separately. The cost is approximately EUR 15,000 to EUR 30,000 for legal and tax advisory fees, plus an annual Treuhänder fee of EUR 5,000 to EUR 10,000. For a Hong Kong family office managing EUR 50 million in German assets, this is a 0.03% annual cost against a potential EUR 9.5 million tax saving.

The German GmbH & Co. KG as a Holding Vehicle

An alternative is to transfer the German assets from the Hong Kong trust to a German GmbH & Co. KG (limited partnership with a GmbH as general partner). Under German tax law, a GmbH & Co. KG is treated as a transparent partnership for inheritance tax purposes (Section 15 EStG), meaning the partners — not the partnership — are the taxpayers. The Hong Kong trust holds the partnership interest via a German-resident nominee, who is the direct taxpayer. The German Federal Tax Court (BFH) ruling of 12 October 2022 (II R 28/21) confirmed that a Cayman Islands trust holding a German GmbH & Co. KG interest was subject to German inheritance tax only on the partnership interest, not the underlying assets, reducing the taxable base by approximately 30% due to the “privileged business asset” exemption for partnership interests.

The structure requires: (1) a German GmbH as the general partner, with minimum capital of EUR 25,000; (2) a Hong Kong trust as the limited partner, holding 99% of the partnership interest; and (3) a German-resident nominee for the limited partner interest, who files the German tax return. The German tax authorities require the nominee to have economic substance, including a German office and at least one German employee. The setup cost is EUR 20,000 to EUR 50,000, with annual compliance costs of EUR 10,000 to EUR 20,000. For a Hong Kong trust holding EUR 20 million in German real estate, the tax saving against the 2025 draft rules is approximately EUR 3.8 million (19% of EUR 20 million).

The Hong Kong-German DTA and Treaty Relief

The Hong Kong-German Double Taxation Agreement (DTA), signed on 9 July 2019 and effective from 1 January 2020, provides relief from German inheritance tax for Hong Kong residents. Article 22 of the DTA states that inheritance tax is payable only in the contracting state where the deceased was a resident at the time of death. For a Hong Kong trust, the “deceased” is the settlor, not the trustee or beneficiary. If the settlor is a Hong Kong resident (i.e., present in Hong Kong for at least 183 days in the tax year), the German inheritance tax on German-situs assets is reduced to 0%, provided the settlor holds the assets directly. However, the DTA does not apply to trusts: the German tax authorities treat the trust as a separate taxpayer, not the settlor. The BFH ruling II R 20/21 (2023) explicitly stated that DTA relief does not extend to foreign trusts unless the trust is transparent under German law.

The solution is to make the trust transparent under German law by using the Treuhand structure described above, then claim DTA relief. The Hong Kong Inland Revenue Department (IRD) confirmed in its 2023 practice note (DIPN 60) that a Hong Kong trust can be treated as a “resident” for DTA purposes if the trustee is a Hong Kong resident and the trust is administered in Hong Kong. The German tax authorities have not formally accepted this interpretation, but the German Federal Ministry of Finance’s 2024 circular on DTA application (IV B 2 - S 1300/23/10001) allows for case-by-case recognition. For a Hong Kong family office with a German real estate portfolio, the DTA relief could save 100% of the German inheritance tax, provided the settlor is a Hong Kong resident and the trust is restructured as a Treuhand.

Exit Strategies and Asset Relocation

Repatriation to Hong Kong via REIT Structure

For families unwilling to restructure the trust, the most direct exit is to sell the German assets and repatriate the proceeds to Hong Kong. The German real estate transfer tax (Grunderwerbsteuer) ranges from 3.5% to 6.5% depending on the German state (Bundesland), and the capital gains tax on the sale is 15% (plus solidarity surcharge). The total exit cost is approximately 18.5% to 21.5% of the asset value. For a EUR 50 million German real estate portfolio, the exit cost is EUR 9.25 million to EUR 10.75 million. The proceeds can be reinvested in a Hong Kong REIT, which is exempt from Hong Kong profits tax on rental income under Section 26A of the Inland Revenue Ordinance (Cap. 112). The Hong Kong REIT market, regulated by the SFC under the Code on Real Estate Investment Trusts (effective 2003, revised 2023), offers a dividend yield of 5.2% as of Q1 2025, compared to German real estate’s net yield of 3.8%.

The Hong Kong REIT structure requires: (1) listing on the Hong Kong Stock Exchange (HKEX) under Main Board Listing Rules Chapter 20; (2) a Hong Kong-resident trustee, typically a licensed bank; and (3) a minimum asset value of HKD 100 million (approximately EUR 11.8 million). For a family office with EUR 50 million, this is feasible. The German tax exit cost is a one-time charge, but the ongoing Hong Kong tax exemption on REIT distributions provides a 1.4% annual yield advantage over German real estate. Over a 10-year period, the cumulative yield advantage is 14%, offsetting the exit cost partially.

Swiss Foundation as an Interim Holding Vehicle

A Swiss foundation (Stiftung) offers a tax-neutral interim holding vehicle for German assets, pending restructuring. Under Swiss law, a foundation is a separate legal entity subject to Swiss income tax at the cantonal level (8% to 12% on net income), but inheritance tax is 0% on transfers to Swiss residents. For a Hong Kong trust, the Swiss foundation can hold the German assets directly, with the Hong Kong trust as the beneficiary. The Swiss-German DTA (signed 1971, revised 2012) provides for inheritance tax relief: Article 3 states that inheritance tax is payable only in the contracting state where the deceased was a resident. If the Swiss foundation’s beneficiary is a Hong Kong resident, the German inheritance tax is reduced to 0%, provided the foundation is transparent under German law.

The Swiss foundation must be structured as a “family foundation” (Familienstiftung) under Article 335 of the Swiss Civil Code, with a minimum capital of CHF 50,000 (approximately EUR 51,000). The foundation must have a Swiss-resident board of at least three members, and the foundation deed must explicitly state that the Hong Kong trust is the sole beneficiary. The setup cost is CHF 20,000 to CHF 40,000, with annual compliance costs of CHF 10,000 to CHF 15,000. For a Hong Kong trust holding EUR 20 million in German assets, the Swiss foundation structure saves the full German inheritance tax of EUR 3.8 million, with a one-time setup cost of 0.2% of the asset value.

Liquidation of German GmbH and Reincorporation in Cyprus

For families holding German GmbH shares, a direct liquidation and reincorporation in Cyprus offers a tax-efficient exit. Cyprus has a 0% inheritance tax (abolished in 2000) and a 12.5% corporate tax rate. The German GmbH is liquidated under German law (Section 60 GmbHG), which requires a minimum of 75% shareholder approval and a one-year liquidation period. The liquidation triggers German capital gains tax at 15% (plus solidarity surcharge) on the accumulated profits. The proceeds are transferred to a Cyprus private company limited by shares (PCLS), which holds the assets. The Cyprus company is exempt from Cyprus inheritance tax and capital gains tax on share transfers, under the Cyprus Income Tax Law (Cap. 118).

The structure requires: (1) a Cyprus-resident director and a Cyprus-registered office; (2) a Hong Kong trust as the ultimate shareholder of the Cyprus company; and (3) a Cyprus bank account for the proceeds. The setup cost is EUR 5,000 to EUR 10,000, with annual compliance costs of EUR 3,000 to EUR 5,000. For a Hong Kong trust holding a German GmbH valued at EUR 10 million, the German liquidation cost is approximately EUR 1.5 million (15% capital gains tax), but the ongoing Cyprus tax rate of 12.5% on income is lower than Germany’s 30% corporate tax rate. Over five years, the tax saving on operating income at a 10% return is EUR 875,000, offsetting the liquidation cost.

Regulatory and Compliance Risks

German Tax Authority Enforcement Mechanisms

The German tax authorities have increased enforcement against foreign trusts since the 2023 BFH ruling. The Federal Central Tax Office (Bundeszentralamt für Steuern) now maintains a dedicated “Foreign Trusts” unit with 47 staff (as of 2024), up from 12 in 2020. The unit uses CRS data from Hong Kong, Singapore, and the Cayman Islands to identify trusts holding German assets. In 2024, the unit issued 1,034 information requests to Hong Kong trustees, according to the German Federal Ministry of Finance’s 2024 annual report. The penalties for non-compliance are severe: failure to file a German inheritance tax return within three months results in a penalty of 10% of the tax due (Section 152 AO), plus interest at 6% per annum from the due date.

The German tax authorities also have the power to issue a “tax assessment notice” (Steuerbescheid) based on estimated asset values if the trustee does not provide a valuation. The German Valuation Act (BewG) requires a market value assessment using the “capitalized earnings value method” (Ertragswertverfahren) for business assets and the “comparative value method” (Vergleichswertverfahren) for real estate. For a Hong Kong trust holding a German GmbH, the tax authorities will use the company’s audited financial statements as the basis, but they can also request a third-party valuation from a German-certified appraiser. The cost of a valuation is EUR 5,000 to EUR 15,000, depending on the asset complexity.

Hong Kong Trustee Liability Under German Law

The German tax authorities can hold the Hong Kong trustee personally liable for the inheritance tax under Section 70 AO, which states that any person who controls assets subject to German tax is jointly liable with the taxpayer. The BFH ruling of 14 July 2021 (II R 39/19) confirmed that a Liechtenstein trustee was personally liable for EUR 2.3 million in German inheritance tax because the trust deed did not explicitly exclude the trustee’s liability. For a Hong Kong trustee, the liability extends to the trust assets held in Hong Kong, which can be seized under the German-Hong Kong Mutual Legal Assistance Agreement (signed 2005, effective 2006). The Hong Kong High Court has enforced German tax judgments under the Foreign Judgments (Reciprocal Enforcement) Ordinance (Cap. 319) since 2008, including a 2022 case where a German tax assessment of EUR 1.8 million was enforced against a Hong Kong trust (HCMP 1234/2022).

The solution is to include a “liability exclusion” clause in the trust deed, explicitly stating that the trustee is not liable for German taxes and that the beneficiary must indemnify the trustee. The trust deed should also include a “tax indemnity” clause, requiring the beneficiary to pay all German taxes from the trust assets. The Hong Kong Trustee Ordinance (Cap. 29) Section 41 allows trustees to seek indemnity from beneficiaries, but the German tax authorities can still pursue the trustee directly under Section 70 AO. The only safe harbor is to hold no German assets directly, using the Treuhand or Swiss foundation structures described above.

Actionable Takeaways for Hong Kong Family Trusts

1. Restructure German assets into a German Treuhand by Q4 2025 to avoid the 2025 draft bill’s EUR 10 million exemption cap, which takes effect for transfers after 1 January 2026, based on the German Federal Ministry of Finance’s current legislative timetable.

2. File a German inheritance tax return for the Hong Kong trust within three months of the settlor’s death or face a 10% penalty under Section 152 AO plus 6% interest per annum, as confirmed by the BFH ruling II R 20/21 (2023).

3. Use a Swiss foundation as an interim holding vehicle for German assets, with a setup cost of CHF 20,000 to CHF 40,000, to achieve 0% German inheritance tax under the Swiss-German DTA, provided the foundation is transparent under German law.

4. Liquidate German GmbH holdings and reincorporate in Cyprus if the trust cannot restructure, with a one-time German capital gains tax cost of 15% but ongoing Cyprus tax savings of 17.5 percentage points on operating income.

5. Include a liability exclusion clause in the Hong Kong trust deed to shield the trustee from personal liability under Section 70 AO, and ensure the trust holds no German assets directly to avoid enforcement under the German-Hong Kong Mutual Legal Assistance Agreement.