Advice on equalisation of gains

The final balance of family assets

Anyone who marries in Germany without a prenuptial agreement is legally subject to the statutory property regime of the community of accrued gains. This means that

during the marriage both spouses have separate assets, just as they would under the regime of separation of property. Each spouse manages its assets independently.
Only at the end of the marital time, whether through the death of one of the spouses, through contractual termination, through a legally binding divorce or through the premature cancellation of the property regime, is the increase in assets gained by each of the spouses during the marriage equalised.

In the event of a divorce, the spouse who gained more assets during the marriage than the other one owes the other spouse cash compensation. This compensation is called the equalisation of gains.

This is the mechanism in a divorce through which in general most money flows from one spouse to the other.

This makes it all the more important to familiarise yourself early on with the principles of equalisation of gains. If you want to avoid high equalisation payments at the end of your marriage, you can conclude a marriage agreement with your spouse when you get married or at a later date, in which the equalisation of gains is excluded or modified. Before and during the marriage, such agreements are required to be notarised. After the divorce has become final, you can conclude such an agreement without a notary.

In any case, seek legal advice before concluding a matrimonial property agreement.

How is equalisation of gains calculated?

In order to determine the claim for equalisation of gains in the event of divorce, the first step is to determine the value of the total assets of each of the spouses on the following two dates:

on the day of the (civil) marriage. These assets are referred to as the initial assets.
on the day the petition for divorce is served (lis pendens). These assets are referred to as the final assets.

The difference between the initial and final assets of each spouse represents the respective spouse´s gain. The difference between the respective gains of the spouses, in turn, is netted out by law at the time of divorce in that the spouse with the greater gain has to compensate the other spouse in cash for half of the difference in gains.

A simple calculation example:
During the marriage, the husband has made a gain of €500,000.00. The wife has made a gain of €100,000.00. The difference is €400,000.00. Therefore, when the divorce becomes final, the husband has to pay the wife a compensation amount of €200,000.00. In this way, both spouses leave the marriage with a gain of €300,000.

The legal system of equalisation of gains is therefore also governed by the principle of half-division. Strategically, each spouse has an interest in having their initial assets valued as high as possible and their final assets as low as possible, since then their gain is smallest possible.

According to the current legal situation, initial assets can also be negative. This means that anyone who enters into marriage with debts and works their way out of debt during the marriage, or at least reduces the amount of debt, must allow the entire reduction of the debt to be credited as a gain. Otherwise, the spouse who entered into marriage without debt, achieved a gain and must allow this to be fully credited, would be at a disadvantage.

Calculation example:
The husband had debts of €100,000.00 when he married. At the end of the marriage, he no longer had any debts, but he also had no further assets. The wife had no initial assets and had assets of €100,000 at the end of the marriage.

According to the applicable law, both the husband and the wife have each achieved a gain of €100,000.00. No equalisation of accrued gains is therefore due.

Under the law applicable until 1 September 2009, however, the initial assets could not be negative. In the example case, the husband would therefore not have made any gains, and the wife would have had to pay him €50,000.00 as compensation, even though both had made an identical gain in assets. This was felt to be unfair.

The gain itself, on the other hand, can never be negative. This means that if you have reduced your initial assets during the course of the marriage or even have negative final assets, you cannot use this method to recover the costs from your spouse.

How are the initial and final assets determined?

To determine the initial and final assets of both spouses, balance sheets must be prepared as of the record dates, in which the assets available to each spouse are compared with the liabilities of the spouses. Foreign assets, e.g. foreign real estate or securities accounts, must also be taken into account.

The most important assets are:

Real estate and shares in, or rights of use to, real estate
Accounts and deposits, securities, fund holdings
Companies or shareholdings
Private practices
Vehicles
Tax refund claims
Works of art and jewellery
Outstanding claims, e.g. rental deposits
Endowment life insurance policies
Household items acquired after the separation

The most important liabilities are usually:

Loan liabilities
Tax liabilities

Joint household items and pension claims are not subject to equalisation of gains. They are divided between the spouses in the special procedures for the division of household effects and pension splitting.

It is important to make the correct allocation for each item of property: if the joint house is co-owned at the end of the marriage, half of it is to be recorded on the assets side of each spouse’s final balance sheet. The same applies to joint debts: half of these are to be recorded on the liabilities side of each spouse´s final balance sheet. If, on the other hand, the house belongs to only one spouse, its value is to be recorded only for that spouse. Special care must also be given to the question of whether accounts or securities accounts are individually or jointly held.

While checking account or securities account balances, as well as credit liabilities, can generally be easily determined on a specific date, the valuation of real estate, business interests, professional practices, works of art, etc. is usually hardly possible without obtaining an expert opinion. It is not uncommon for a divorce to prove almost as complicated as a small company acquisition depending on the financial circumstances of the parties.

Ascertaining the initial assets is often problematic if no inventory of assets was drawn up at the time of marriage and no bank records from that period are available. If a marriage lasted more than 10 years, the banks are also generally no longer able to provide information, as the statutory retention periods have expired and the documents have been destroyed. Determining the value of real estate at a certain point in the distant past is also often difficult and requires a great deal of research.

Inheritances and gifts during the marriage

Inheritances and gifts that one of the spouses receives from a third party during the marriage are treated differently. According to the intention of the legislator, these should not be subject to equalisation of gains. The other spouse should not benefit from this in the event of a divorce, as it can be assumed that the testator or donor would not have wanted this. Such assets are referred to as privileged assets.

According to the law, the privileged treatment also applies to assets that a spouse acquires after entering into the matrimonial property regime with a view to a future inheritance or as a dowry. It is not possible to transfer the privileged treatment to similar situations, such as winning the lottery, receiving a severance payment from an employer or receiving compensation for pain and suffering. These are subject to the equalisation of gains.

The privileged treatment is achieved by adding the privileged assets to the initial assets of the spouse who has such assets, at the value on the record date of the acquisition of such assets. The privileged assets are also referred to as initial assets II, in contrast to the initial assets I existing at the time of the parties were married.

Strategically, each spouse thus has an interest in arguing that gifts and inheritances were received during the marriage to the greatest possible extent in order to minimise their own gains.

However, not every monetary payment received from third parties during the marriage constitutes privileged property. If monetary payments were used to cover the beneficiary’s current living expenses, i.e. they were intended for consumption, such as a monetary payment from parents for an annual holiday, a large celebration or to buy a new washing machine, then these are not privileged under the law. As a rule, such assets no longer exist in the final estate. On the other hand, monetary contributions for the purchase of real estate or donations of securities are privileged assets, since they were intended to serve the accumulation of wealth according to the will of the donor.

Furthermore, unless otherwise stipulated in the prenuptial agreement, the law requires that increases in the value of the privileged assets up to the final record date be taken into account in the equalisation of gains. Particularly in the case of real estate or securities accounts that a spouse received from family members at an early stage in the marriage, the development of the value alone can result in very substantial amounts being subject to the equalisation of gains. Thus, the family home inherited 25 years ago or the holiday home on the North Sea island may ultimately end up being sold in the event of divorce, even though it originally constituted privileged assets.

If you want to avoid this, you should urgently seek legal assistance to draw up a marriage agreement in which the consideration of increases in the value of the privileged assets in the equalisation of gains is excluded.

Indexing and deferred income taxes

When drawing up the balance sheets for the two relevant points in time, two points that reduce the gain must be regularly taken into account:

To compensate for the loss of purchase price over the years, the initial assets must be indexed. This applies both to the total assets at the time of marriage (initial assets I) and to the assets at the time of inheritance or gift (initial assets II). The indexation is calculated using a mathematical formula in which the consumer price index from the respective starting year is compared with the current consumer price index. Anyone who bought a house 25 years ago had to pay significantly less for it than they do today. Particularly in the case of long marriages, the value of the initial assets often increasess quite considerably as a result of indexation, and the gains of this spouse are reduced again significantly.

A second point concerns so-called notional income taxes, which, according to the case law of the Federal Court of Justice, are to be used to reduce all assets in the balance sheet for which such taxes would be incurred in the event of a notional sale on the reporting date. This applies above all to real estate (speculation tax) and securities (capital gains tax). If such adjustments are to be made to the final assets of the respective spouse, they reduce their gain.

Manipulation of assets during the separation phase

Some spouses, when separating, come up with the idea of reducing their assets before filing for divorce in order to have to give less in the equalisation of accrued gains or to receive more from the other spouse. The law provides various protective mechanisms against this tendency to deliberately impoverish oneself:

It is not without reason that the record date for calculating the final assets is the date of service of the divorce petition (lis pendens) and not the date on which the divorce becomes legally binding thus terminating the property regime. The amount of the claim for equalisation of accrued gains is also limited to the assets available at the time of the lis pendens and not to the assets available at the time of the termination of the property regime. Disposals made after the petition for divorce has been served no longer have any influence on the amount of the equalisation of gains.

If, before the petition for divorce is served, you give your assets to a third party without being morally obliged to do so, or squander your assets or take action with the intention of disadvantaging the other spouse (so-called disloyal dispositions), you must accept that the missing assets will be added back to your final assets.

The law also provides the spouses with a mutual right to information, not only with regard to their respective initial and final assets, but also with regard to their assets at the time of separation (see below). If it later turns out that the final assets of one spouse are less than their assets at the time of separation, that spouse must prove that the reduction in assets did not occur in an unfair manner, but was justifiable. Otherwise, the amount of the reduction in assets will be added to his or her final assets. This constitutes a relaxation of the burden of proof for the disadvantaged spouse.

Finally, each spouse has the option of initiating summary proceedings in court for premature equalisation of gains in order to protect their future claim for equalisation of gains from disloyal manipulation by the other spouse, provided that there is a specific ground for assuming that such manipulation may take place and that the fulfilment of the claim for equalisation is thereby significantly jeopardised.

Therefore, if you notice your spouse manipulating their assets in a way that could jeopardise your claim to equalisation of gains, you should consult a lawyer immediately.

Disclosure and documentation obligations

In order to enable the spouses to make the appropriate calculations, the law provides for mutual disclosure obligations. Each spouse must, upon request, provide the other with complete and truthful information about their initial and final assets, as well as the assets at the time of separation.

This information must also be supported by suitable documentation. For account and deposit balances, bank statements as of the relevant record date are to be submitted. The value of the assets does not otherwise have to be stated. It is sufficient to state the factors that determine the value, such as the make and model of a car, the year of manufacture and the mileage.

If the spouses’ initial assets at the time of marriage were not specifically documented, it is often almost impossible to reconstruct this retrospectively. As a rule, banks no longer provide information for record dates that fall outside the retention periods applicable to them. If initial assets cannot be proven, the law provides that they be set at zero.

As a rule, divorce lawyers take on the task of obtaining this information and subsequently calculate and negotiate claims for equalisation of accrued gains.

The equalisation claim

As a rule the equalisation claim is to be settled in cash in the full amount. It falls due when the divorce becomes final and interest accrues from that point on. It is not uncommon for real estate or other valuables to have to be sold in order to fulfil the equalisation claim.

If the other spouse agrees, other assets, in particular real estate assets, can be transferred to him or her instead of a cash payment.

The law also allows the equalisation claim to be deferred (with interest) if it would ‘occur at an inopportune time’. In this case, the interests of the person who owes the equalisation, e.g. an interest to avoid tax liability when selling a property, must be reconciled with the interests of the other party in immediately receiving the equalisation amount.

Equalisation of accrued gains before divorce

In exceptional cases, a claim for equalisation of accrued gains may be asserted before divorce. The law allows this in the following cases:

The spouses have been separated for three years.
There is reason to fear disloyal reductions in assets, which could pose a significant threat to the claim for equalisation of accrued gains.
The other spouse has culpably not fulfilled their economic obligations arising from the marital relationship over a long period of time (example: violation of maintenance obligations).
The other spouse persistently refuses, without reason, to provide information about its assets.

In these cases, the calculation date is brought forward. The relevant record date is then the date of application.

Tax aspects

The settlement of the statutory equalisation claim is tax-free for the spouses. In particular, it does not trigger any gift tax.

However, waiving equalisation of accrued gains can very well constitute a taxable gift. This must always be taken into account when drafting a marriage agreement.

A fairly popular and permissible form of arrangement that allows assets to be transferred to the other spouse tax-free during the marriage is the so-called ‘Güterstandsschaukel’ (swinging of matrimonial property regimes).

In this case, the spouses amicably terminate the statutory matrimonial property regime through a marriage contract, equalise the accrued gains free of gift tax and then re-establish the statutory matrimonial property regime. However, tax exemption only applies if the matrimonial property regime has actually been terminated. In addition to a specialist lawyer in family law, a tax expert should always be consulted for such arrangements.

Please feel free to contact me if you require advice on matrimonial property issues.

Contact

If you have any questions regarding the equalisation of gains, you can contact me by phone at any time during my office hours, or by email outside office hours. I will get back to you as soon as possible.

Mon-Fri: 9.00 – 13.00 and 14.00 – 18.00
T: 06174 – 935 75 70
E: marx@familienrecht-marx.de

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