Oliver Eidel's Blog

Exit Tax: Leave Germany Before Your Business Gets Big

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7 min read

Here’s an interesting take on Germany’s exit tax, which I have written about before:

Leave Germany before your business gets big.

What do I mean by that?

I mean that once you’re a business owner in Germany and your business has reached a certain size, you are essentially barred from ever moving out of the country again.

Crazy, right? I think it’s also pretty crazy that no one really talks about this. This is, quite literally, erecting a “Berlin Wall” around German entrepreneurs, forcing them to stay in the country.

Germany’s Exit Tax

But first things first. What is Germany’s exit tax?

In simple terms, you’re hit by Germany’s exit tax once you hold more than 1% in any limited liability company (foreign companies included!). So if you own 100% of a German GmbH, you’re hit by exit tax. But also if you e.g. own 2% of a US company.

And then your exit tax is calculated by taking the average of the past 3 years of earnings of that company, multiplied by 13.75 (which is crazy), and then taking 60% of that which is taxed at your personal income tax rate (likely 42%; Teileinkünfteverfahren). So:

  • (Average earnings of past 3 years) * 13.75 * 0.6 * 0.42
  • Simplified: (Average earnings of past 3 years) * ~3.5

I’ve simplified the formula for you a bit: It boils down to multiplying the average earnings with ~3.5.

With this calculation in hand, we can do surprisingly interesting things.

We can segment German people into four distinct groups, with greatly varying barriers of ever leaving the country:

Some People Can Leave Germany, Others Can’t

  1. Employees: The simplest case – no shares in any companies. They can just leave the country and are not hit by any exit tax. People say Germany is a good country for being an employee, and this is also true for exit tax.
  2. Business owners of unprofitable companies: Still a reasonably simple case – these people have shares in a business, but its value is calculated as zero, so while they are hit by exit tax, the sum might be zero (caveat: see notes on startups below)
  3. Business owners of profitable companies: The ugliest case – people who own shares in a business which is profitable. Its value, in the eyes of the financial authorities, is likely high, given the factor of 13.75. These people will be hit by significant exit tax; they usually don’t have a crazy amount of savings, and don’t have the resources to engage fancy tax advisors.
  4. Business owners of huge companies: You might think this is worse, but it’s actually not. As soon as your net worth goes beyond ~€2m, you can afford fancy tax advisors which set up a trust in Liechtenstein for you (yes seriously) which allow you to dodge the exit tax. So this group is simpler, for exit tax purposes.

(Note on startups (group 2): If your startup raised investment, the financial authorities might take that last investment-round valuation as actual valuation, even if your company is not profitable. So that puts you into group 3 instead as you will be hit by significant exit tax.)

So, what I’d like to talk about is group 3: Business owners of profitable companies. And let’s zoom in even further, because all businesses start out small.

Let’s look at scenario 3a: You’re a business owner of a profitable business, but it’s not hugely profitable. It might have, say, 50k€ earnings per year (nice job), but you haven’t been paying yourself a salary yet. Instead of taking the 13.75 multiple of the financial authorities you could now task someone with assessing the value of your business (which is a viable strategy, by the way), and they would come up with a result that your “real” business earnings are zero or negative, because the market rate for a CEO would be €100k – €120k / year, and if you’d be paying that to yourself, your business earnings would go below zero.

So, you can realistically assume that your business valuation, in the eyes of the financial authorities, is actually zero, and your exit tax amount will be zero, too.

Okay. But let’s fast-forward a few years and look at the same business again. Maybe it’s still a small business, but now it’s doing slightly better:

Scenario 3b: You’re a business owner of a profitable business which is decently profitable. It has €200k earnings per year and you’re paying yourself a market-rate salary of €120k / year. This now hits you with a brutal exit tax burden because there’s no trivial way of arguing that the value of your business is low. Using our formula above, the exit tax you’re looking at is ~€700k (€200k * 3.5). Crazy!

Here’s a handy table:

Scenario 3aScenario 3b
Earnings / year€50k€200k
Your CEO salary / year€0€120k
Potential exit tax€0€700k

And this is crazy! How crazy? People might point at the business owner of scenario 3b and say “but yeah, €700k exit tax is fine, he owns a hugely profitable business”. But no, it’s not fine, because the same person was working for a salary of €0 just a few years ago and likely has nowhere close to €700k of random savings stashed away for paying some taxes.

And it’s not like these people are crazy criminals fleeing to Dubai to evade taxes – most of them, presumably, have very legitimate reasons of moving to another country, e.g. moving together with their partner, moving back to family, or simply moving to expand their business (the irony, I know).

Instead, Germany erects something of a “Berlin Wall of exit tax” around any entrepreneur who builds a business in this country, prohibiting them from ever leaving. When thinking of “countries which prohibit their citizens from leaving”, certain countries come to mind, but hardly anyone thinks of Germany.

So yeah. That’s what this post is about. The moral of the story is: If you find yourself in scenario 3a, where you own a decent business which is not super-profitable yet but has a certain chance of growing, and if you think the probability of you ever moving countries is more than zero, then it might be a good idea to leave – now.

There are, of course, a bunch of notes here:

  • Scenario 3b assumes the worst-case scenario that you take the high valuation of the financial authorities (factor 13.75) as base valuation for your exit tax. Instead, you could also find someone to assess the real value of your company, which is likely lower, like we did in scenario 3a. However, your exit tax would probably still be in the six figures.
  • If you’re in scenario 3b, you could, of course, just “stick it out” and grow your business and net worth by so much that you move up into scenario 4, i.e. that you have enough money to pay fancy tax advisors to set up a Liechtenstein trust for you, which would enable you to leave the country without paying exit tax again. But this feels both shady and wrong. Besides, are you happy to be locked into the country you might no longer want to live in while you’re building your business?
  • The message of this article also applies to startup founders: Leave Germany before your startup raises investment, because the financial authorities will likely take your (bloated) investment valuation as base amount when calculating your exit tax.
  • You could, of course, sell or wind down your company, which would solve all problems outlined here. But this is not an option for most entrepreneurs.
  • Theoretically, if you plan to come back within 11 (I think) years, Germany can opt to not collect the exit tax from you. But this doesn’t change the fact that your exit tax gets levied and you’re, in theory, liable to pay it.

15 responses

  1. Anon Avatar
    Anon

    There is nothing crazy about this tax. Most companies are able to grow to to massive proportions through exploitation whether legal or not alongside using the countries infrastructure and so on, paid by the tax payers. Leaving the country is effectively a tax dodging exercise for companies as operations and profit taking will continue in the country of origin. This article smacks of entitlement and a “everyone has the ability to pull themselves up by the bootstraps” mentality.

    Reply
    1. Anon Avatar
      Anon

      No, anon, the tax is absolutely crazy.

      Reply
    2. Oliver Eidel Avatar
      Oliver Eidel

      This was also raised in the Hacker News discussion, so I’ll respond similarly here:

      While I can understand the high-level gist of your point, it seems like no one can substantiate these claims in a somewhat rational manner. Sure, for a hardware business, I can imagine that the country’s infrastructure plays a significant role, e.g. worker’s unions, safety, accident insurance, roads, railways, etc.. But for software companies? The main requirements for a software company are electricity, stable internet, good mobile phone coverage, efficient bureaucracy, a bank account in which the cash doesn’t disappear, rule of law, etc. Maybe education, too? But that’s a slippery slope.

      The company does indeed pay for this infrastructure, specifically with the 30% corporate tax on earnings (which turns out to be one of the highest corporate tax rates in OECD countries). Even more so, the company continues to pay this corporate tax, even after the shareholder has left the country. So the only “drawback” the country has here is that the shareholder no longer pays (personal) income tax, and that a potential sale of the business would not be taxed in the country (more on that below); most importantly however, the business continues to operate in Germany, to employ people, and to pay corporate taxes. It seems ironic to levy an exit tax based on business shareholdings, while the actual “lost” tax concerns personal income tax and a future sale of the business.

      Anyway, the bigger question might be: How much of any software company’s success can be attributed to the country’s infrastructure? This is a valid question, and an interesting discussion. Probably worthy of a separate blog post 🙂 but as a thought experiment, consider a one-person software company founded by someone who got their education elsewhere. Further, assume this company is a remote company and doesn’t have any employees in Germany. How much is this company, in your words, “exploiting” German infrastructure? Here, it’s feels merely like a coincidence that the founder was in Germany at the time of incorporation. And now that person is financially locked in to not being able to leave the country.

      I think a good point can be made for exit tax regarding the sale of the company. Indeed, what the German exit tax boils down to is simulating a virtual “sale” of the company once the shareholder leaves the country. The implementation, unfortunately, is rather terrible, because the taxes on this virtual “sale” have to be paid immediately, and the default valuation of the company is incredibly high (13.75x). Other countries have implemented a much saner approach, where the “exit tax” is only charged once the company actually gets sold in the future. I think that would be a fair implementation here.

      All in all, I feel like the discussions regarding “hey you used this country’s services, now pay your share, exit tax is fair!” miss the point I’m trying to make here: Exit tax, in principle, seems fair if charged only when the business is actually sold. The current implementation, however, actively prohibits founders from leaving the country, and this puts them at a gigantic disadvantage in contrast to employees.

      Reply
      1. Merovius Avatar
        Merovius

        > The main requirements for a software company are electricity, stable internet, good mobile phone coverage, efficient bureaucracy, a bank account in which the cash doesn’t disappear, rule of law, etc. Maybe education, too? But that’s a slippery slope.

        Nothing slippery about that slope. A company needs literate workers and literate customers. That’s why we generally fund it through taxes: there are high positive externalities to education, that can’t be captured by private businesses. Only the state can capture this value – via the resulting increase in taxes. Exactly *because* it is an externality, because the value *every* company active in Germany gains from it is so abstract, it is tax-funded. Nothing slippery about that, just simple economics.

        You also shouldn’t forget social insurance, unemployment insurance, health insurance (how much would you like it, if your employees come to work sick, infecting everybody else?)… Because security makes people more willing to take risk, take up extra education and ultimately, be more productive.

        Let me ask you this: if the location and infrastructure matters so little, why not set up your business in the Bahamas? Rent some office space, ask your coders to relocate there. Makes no difference, after all. Right?

        > Exit tax, in principle, seems fair if charged only when the business is actually sold.

        No, that seems to be the exact opposite of when it is fair. The point of an exit tax is to discourage capital flight. If you sell the company, the Capital stays in the country.

        Reply
        1. Oliver Eidel Avatar
          Oliver Eidel

          Understandable points! As commented in another thread, I’d challenge this assumption with the thought experiment of a one-person software business which only hires remote employees, and which (by coincidence or not) only ends up with having employees outside of Germany. In that case, all of your assumptions (literate workers, social insurance, unemployment insurance, health insurance) become irrelevant, at least in the context of Germany (= the country of incorporation).

          > Let me ask you this: if the location and infrastructure matters so little, why not set up your business in the Bahamas?

          This is indeed happening, however only for two small sub-groups who are free to choose their country of incorporation: Digital nomads and large enterprises. Digital nomads tend to set up a US LLC or an Estonian OÜ, and large enterprises have enough resources to come up with all sorts of other fancy constructs, most famously the “double irish with a dutch sandwich” by Google in Bermuda.

          All other “normal” humans however are restricted by the law to set up a company in their country of residence. So, in other words, as a German resident, you have to set up a German company, even if you don’t like the German infrastructure.

          > The point of an exit tax is to discourage capital flight.

          No. If this were the intent, they would tax capital (including private capital, i.e. ETFs etc.), not company shares in a “virtual sale”. Currently, capital is mostly not taxed (at least funds below 500k€ purchase value). Or, put more concretely, a wealthy person who’s “only” an employee in Germany will likely not face exit tax, so you can’t really make the statement that the purpose of Germany’s exit tax is to discourage capital flight.

          Reply
          1. Anon Avatar
            Anon

            Regarding the hypothetical thought experiment you constructed to avoid every point raised, what percentage of German businesses match that situation?

            Every single law has hypothetical thought-experiment situations where the law appears unjust.

          2. Oliver Eidel Avatar
            Oliver Eidel

            Personally, I know of multiple people with such businesses – mostly freelance software developers who chose to found a UG in Germany due to liability protection (with or without employees). They didn’t grow up / get their education in Germany. They are now facing the exit tax situation.

            So yeah, this hypothetical thought experiment scenario exists in reality, chuckle.. but, of course, I agree that this is a small percentage of businesses, and of course I have the bias of being in the Berlin startup bubble here.

            > Every single law has hypothetical thought-experiment situations where the law appears unjust.

            While not sure whether I’d agree with that statement, I’d argue the perceived unjustness of the German exit tax is significantly higher than for most other laws.

    3. AV Avatar
      AV

      Most businesses are just SMBs that do useful things and get paid for it. this tax would even apply to a freelancer who has a small UG making 100k a year (equivalent to a salary). it even applies to assets you had before you came to Germany. It basically treats every legit person like the exploiting tax dodging crook that youve set up as the straw man

      Reply
      1. Oliver Eidel Avatar
        Oliver Eidel

        100% agreed. It’s fair to chase down tax evasion with due process, but it’s not fair to assume that every entrepreneur leaving the country does so due to tax evasion.

        Reply
  2. Anon Avatar
    Anon

    What does infrastructure mean for you? It’s certainly more than roads and factories. Even a solo software entrepreneur benefits from it. Free education? Even if the founder is not educated in Germany, how about German contractors, freelances, and other professionals they might interact with? How about healthcare? Even when paying some premium as it seems to be the case, the system is bound by state regulation, public hospitals and subsidies. And what about being country with limited corruption and rule of law for IP protection, NDAs, and client contracts? Stable banking, fraud protection? All this exists because of tight regulation. Utilities? Transport and logistic? Public safety? Social services? Taxes are not money waste. They are being used for social good. And how about potential earning lost after the company leaves?

    Reply
    1. Oliver Eidel Avatar
      Oliver Eidel

      I do see your point, and I replied elsewhere already on this topic, feel free to take a look 🙂

      More in detail:

      • German contractors, freelances, and other professionals they might interact with: Does founding a business in Germany give you magical access to German contractors, freelancers and other professionals? Or, on the contrary, does founding a business outside of Germany bar you from interacting with these people?
      • How about healthcare: Healthcare is paid for separately, e.g. ~€1.1k / month for public insurance for high salaries. Once the person leaves Germany, they stop being covered by German health insurance, and they stop paying for German healthcare. Statistically speaking, as a young person with a high salary, you’re already paying way more than what you’re likely receiving. Still, of course the point can be made that the German healthcare system is pretty good (for now) and essentially feels like full coverage, with can give peace of mind. But all those things aside.. to my knowledge, the German healthcare system is not significantly subsidized by taxes, so I don’t really see the connection to exit tax here.
      • limited corruption and rule of law for IP protection, NDAs, and client contracts, Stable banking, fraud protection? Valid points – those are indeed things which you receive in Germany.
      • Utilities? You pay for utilities separately (e.g. water and electricity).

      One additional point to note:

      > And how about potential earning lost after the company leaves?

      In the exit tax scenario outlined in this post, the company (e.g. a GmbH) remains in Germany and continues to pay 30% tax on earnings, one of the highest tax rates in OECD countries. So, in the short to mid term, the German state doesn’t “lose” any tax earnings.

      You could, of course, make the point that individual tax earnings are lost, i.e. income tax of the person who left the country. But then why the hell would you levy an exit tax based on company holdings? If that were the intent, the exit tax should be calculated based on individual wealth, with all its (additional) drawbacks and potential “benefits”.

      The current implementation and calculation of the exit tax seems to mostly aim towards taxing a potential future sale of the company, as that would no longer be taxed in Germany (simplified), because the shareholder now resides outside of Germany. That’s why the exit tax assumes a “virtual” company sale and taxes that.

      Reply
  3. Chris Avatar
    Chris

    You can still shut down your company. That’s exactly my plan for my GmbH if taxes continue to rise and I decide to leave Germany.

    Reply
    1. Oliver Eidel Avatar
      Oliver Eidel

      True! This might be the “local optimum” solution for most one-person GmbHs.

      However, it might get tricky once the GmbH is actually larger and can’t be trivially shut down, e.g. with employees on the payroll, clients on retainer, etc. And moving that to a foreign company also doesn’t help much because the German exit tax also covers shareholdings in foreign companies. And I guess this is where the rather shady tax advisor industry begins to exist with all sorts of weird constructs, e.g. “selling” your business to a friend, setting up a trust in Liechtenstein, etc.

      Reply
  4. Anon Avatar
    Anon

    Something that may surprise some people and makes this tax unfair in other cases, is that the exit tax applies to any company you own, independently of where it is located. So if you had a company before moving to Germany and you want to emigrate after a few years, that will also be subject to an exit tax (the calculation is a little bit different in that case). Same applies if you establish a company outside of Germany while being a resident.

    Reply
    1. Oliver Eidel Avatar
      Oliver Eidel

      Yeah, good point!

      This is also interesting in the context of people trying to avoid the exit tax – a knee-jerk reaction I often hear is “well, I’ll just move my company assets to a foreign company before I leave Germany”. That doesn’t work for the same reason, because exit tax applies to all your shareholdings where you own >1% of a company, foreign companies included.

      Reply

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