In its letter dated September 4, 2024, the Federal Ministry of Finance defines a legally certain scope of application for the structuring of disproportionate or mismatched profit distributions.
Content of the Regulation
In its letter dated September 4, 2024, the Federal Ministry of Finance defines a legally certain scope of application for the structuring of disproportionate or mismatched profit distributions.
The non-proportional or “incongruent” distribution of profits among partners in a partnership has long been firmly established in contractual practice and is generally referred to as compensation for services, an advance on profits, or a preferential withdrawal. However, even in the context of corporations, shareholders may, in certain situations, wish to distribute the profits of their GmbH among the shareholders in a manner that deviates from their respective ownership interests. In its recent case law, the Federal Fiscal Court has expressly recognized the tax validity of such disproportionate or inconsistent profit distributions under certain conditions; the tax authorities have now adopted this position as well with the new BMF letter dated September 4, 2024 (Ref.: IV C 2 - S 2742/19/10004 :003).
A prerequisite for the tax recognition of non-pro rata profit distributions is the inclusion in the articles of association of a GmbH of a provision that is legally valid under civil law for either (a) a specific modified profit distribution or (b) a so-called “opening clause” for annual resolutions on the appropriation of earnings involving non-pro rata profit distributions (Section 29(3), second sentence, of the German Limited Liability Companies Act (GmbHG)) . In the latter case, the shareholders who are disadvantaged by the non-proportional distribution must, in particular, give their consent.
The scope of application has now been expanded so that so-called “statute-derogating” shareholder resolutions regarding one-time, non-pro rata profit distributions (as individual acts) can be carried out in a legally effective manner and recognized for tax purposes (BMF, para. 4). A permanent distribution of profits on a pro rata basis is not permitted by means of shareholder resolutions that deviate from the articles of association; for this, a notarized amendment to the articles of association must be made.
In the case of a stock corporation, the scope for flexibility is more limited, and the principle of strict adherence to the articles of incorporation remains in full force. Accordingly, inconsistent profit distributions based on an opening clause in the articles of incorporation or a resolution of the general meeting that deviates from the articles of incorporation are not permitted; only a sufficiently specific, permanent modification of the profit distribution in the articles of incorporation of a stock corporation (Section 60(3) of the German Stock Corporation Act (AktG)) is permissible and recognized for tax purposes (Federal Ministry of Finance, para. 8).
In this context, one should also consider the newly created option not only to distribute profits to all shareholders on a pro rata basis, but rather to distribute profits exclusively to certain shareholders of a GmbH without having to distribute them to all shareholders. Such an approach is referred to as a split appropriation of profits or a temporally incongruent distribution of profits (BMF, para. 6) . Shareholders who do not wish to participate in the distribution on a pro rata basis may therefore retain their proportionate entitlement to the distribution and transfer it to a shareholder-specific capital reserve. A notional inflow of such retained profits, which would result in taxation of the income pursuant to Sections 20(1)(1), 11(1) of the Income Tax Act (EStG), and a subsequent notional (re)contribution of this distribution to the company cannot be assumed in these cases (see Federal Fiscal Court (BFH), judgment of September 28, 2021—Case No. VIII R 25/19).
In the previous BMF letter dated December 17, 2013 (Ref.: IV C 2-S 2750-a/11/10001, BStBl. I 2014, p. 63), which has been completely repealed and replaced by the new BMF letter, the tax authorities addressed the possibility of tax planning abuse in this context (Section 42 of the German Fiscal Code (AO)). Although the new BMF letter no longer contains these passages, tax planning abuse may still occur in certain exceptional cases. However, the number of potential cases of abuse is expected to be extremely limited.
Conclusion
The new BMF letter on disproportionate or inconsistent profit distributions provides significant legal certainty for tax-planning contract practices. When establishing new companies or comprehensively restructuring articles of association, it is generally recommended to include flexibility clauses for disproportionate profit distributions in the articles of association in advance to accommodate specific situational needs, and to establish the legal basis for shareholder-related capital reserves. The latter may also prove helpful from a gift tax perspective in cases of mismatched capital contributions in family-owned businesses or holding companies.
