Hidden profit distribution (vGA) update!

Shareholder-managers should know this now. With a checklist!

Frankfurt am Main

December 18, 2024

---

VGA Checklist: Important current decisions on hidden profit distributions (vGA)

The upcoming turn of the year requires existing agreements between the GmbH and its shareholders or shareholder-managers to be reviewed with regard to risks of asset-linked securities.

In particular, the following tax court decisions, most of which were announced in 2024, should be taken into account. In addition, agreements between the GmbH and shareholders should also be regularly reviewed for their appropriateness, which is advisable at the turn of the year. The economic developments of the company and the business environment should also be taken into account.

If changes to the agreements are to be made in 2025, these must be initiated by controlling shareholders in 2024 to avoid a violation of the prohibition on back payments and to comply with the requirement of clarity. The review of the agreements could be structured in the form of a checklist , focusing on the following key points:

• General questions

• Pension commitments/retirement benefits (in particular earnability and financeability)

• Assumption of expenses by the GmbH or reductions in the assets of the GmbH

General questions

Tax recognition of incongruent profit distributions:

In its judgment of September 28, 2022 (case no. VIII R 20/20), the Federal Fiscal Court had already ruled against the tax authorities' view that a resolution on an incongruent advance distribution of a GmbH that partially violates the articles of association and which was passed unanimously by the shareholders' meeting and cannot be challenged by any shareholder is to be treated as a distribution resolution valid under civil law and is to be used as the basis for taxation.

The Federal Ministry of Finance (BMF) has now responded to this with a letter dated September 4, 2024. According to this letter, incongruent profit distributions are generally recognized for tax purposes only if they have been validly effected under civil law. Contrary to the previous opinion of the tax authorities, a general review of tax structuring abuse is not carried out.

TaxPro Note:

This Federal Ministry of Finance (BMF) circular applies to all outstanding cases. This opens up a wide range of options for structuring profit distributions. However, the prerequisite for tax recognition is always the effectiveness under civil law, which must be ensured.

Within this framework, incongruent profit distributions that deviate from the shareholding ratios for tax purposes as well as incongruent payments that affect the time of receipt for tax purposes, i.e. payments that accrue only to individual shareholders and are subject to tax and are booked to personal reserve accounts of the other shareholders, can be implemented.

Erroneous donation and inducement through the corporate relationship:

In its judgment of November 22, 2023 (case no. I R 9/20), the Federal Fiscal Court ruled on the requirements for a transfer of assets that, when examining whether a transfer of assets from a corporation to a shareholder is caused by the corporate relationship, the question of whether a possible lack of intention to make a donation due to an error on the part of the shareholder-managing director is not based on whether a properly and conscientiously acting managing director would also have made the same error. Rather, the sole determining factor is whether the specific shareholder-managing director was subject to such an error.

As a rule, neither the intention to distribute profits secretly nor a corresponding awareness of the distribution is required. However, if the intention to make a donation, which is required to assume a distribution, is lacking, then a distribution is ruled out because there is no specific reason in the corporate relationship.

TaxPro Note:

With this decision, the Federal Fiscal Court has confirmed its case law, according to which subjective elements can exceptionally be of importance in the context of a vGA – namely if there is no final intention to transfer assets to the detriment of the company and to the benefit of the shareholder (given, for example, in the case of accounting errors by a tax advisor).

Pension commitments/retirement benefits (in particular earnability and financeability)

VGA if the recognition requirements for a pension provision are not met:

In its judgment of 28 February 2024 (case no. I R 29/21), the Federal Fiscal Court, in continuation of its case law on the recognition requirements for a pension provision, took a position on the question of the existence of a vGA in the event that the pension promise does not contain clear information on the requirements for early retirement and the corporation actually makes payments to the shareholders entitled to the pension before they reach the normal retirement age.

In this respect, the Federal Fiscal Court has ruled that the recognition of a pension provision is permissible "if and to the extent" the requirements set out in Section 6a (1) of the Income Tax Act are met. For this to happen, the written promise must contain clear information on the type, form, requirements, and amount of the future benefits promised. Therefore, if the requirements for receiving an old-age pension upon reaching the standard retirement age are clearly defined, then a pension provision must be created for this purpose, even if the pension promise does not contain clear information on the requirements for early retirement. However, if pension payments are made before the standard retirement age in such a case, this does not prevent the creation of a pension provision for the clearly issued pension promise in the event of the standard retirement age. However, the early pension payments are to be classified as a non-profit-making arrangement due to the lack of arm's length practice.

TaxPro Note:

With this decision, the Federal Fiscal Court also underlined that pension payments actually made on the basis of an unclear agreement are not to be regarded as arm's length – and consequently lead to the assumption of a vGA.

Assumption of expenses by the GmbH or reductions in the assets of the GmbH

Determination of the cost rent in the case of a vGA due to the transfer of a property to the majority shareholder:

In its non-final judgment of April 24, 2024 (case no. 7 K 113/21), the Düsseldorf Finance Court ruled that a limited-liability lease (VGA) may be assumed if the rent agreed between the company and the majority shareholder is below the cost rent plus a reasonable profit margin. The so-called cost rent, rather than the market rent, should be applied.

TaxPro Note:

According to the decision of the Düsseldorf Finance Court, the cost rent is calculated from the elements of debt capital costs, equity capital costs, building depreciation with the regular tax depreciation (also includes any depreciation of the kitchen and outdoor facilities), administration and maintenance costs, rent default risk and 5% profit margin.

Non-deductibility of the costs of a consulting company for a Ferrari Dino and for a Sky subscription:

In its final judgment of September 25, 2023 (case no. 6 K 6188/19), the Berlin-Brandenburg Finance Court ruled that the expenses of a consulting GmbH for a Ferrari Dino, which is used to acquire customers at classic car events, are non-deductible business expenses according to Section 4 (5) Sentence 1 No. 4 of the Income Tax Act and that the GmbH's costs for a Sky subscription, which the shareholder can also use on a mobile basis, are to be recorded as a non-deductible business expense.

TaxPro Note:

This decision confirms the highest court rulings (both regarding the "causation by the corporate relationship" criterion and the "arm's length" criterion). Therefore, the tax deduction of expenses for the use of exclusive vintage cars is likely to continue to be a source of dispute with the tax authorities until the highest German tax court must once again address this important issue.