Income from capital assets – Split and incongruent appropriations of profits

The appropriation of profits resolution and the profit distribution resolution

A profit distribution resolution will determine whether shareholders are entitled to the profit to be distributed on the basis of their shareholdings or in deviation from their shareholding percentages. An appropriation of profits resolution provides the basis for shareholders to decide on a dividend distribution, the allocation to revenue reserves, or retained earnings to be carried forward to the following year.

Effectiveness under civil law is always required 

Effectiveness under civil law is always crucial for the recognition of agreements for tax purposes. This specifically requires relevant provisions, in the corporation’s articles of association, on the distribution of profits and the appropriation of profits as well as a shareholders’ resolution that is permissible under corporate law.

If these requirements have been fulfilled then, for tax purposes, there should be no objection to a split/ incongruent appropriation of profits.

Income from capital assets and its transfer

The BFH, in its ruling of 28.9.2021 (case reference: VIII R 25/19), had had to decide on the date of the cash inflow of profit shares arising from shareholdings in a GmbH [a German limited liability company] and, thus, on the date when this income would need to be taxed as income from capital assets. In the specific case, the profit shares were distributed to the minority shareholders and, by contrast, the share of the profits that was attributable to the majority shareholder – which was based on the size of their shareholding – was allocated to a shareholder-related revenue reserve. A shareholders’ resolution had been passed that was effective under civil law.

The profit shares (dividends) and other payments arising from participations in the GmbH constitute income from capital assets for the shareholders. Access by the shareholder to their profit share is crucial for determining the date for the imposition of tax, i.e. a specific due claim to the profits. 

According to the BFH, in the event that the profit is allocated to a personal revenue reserve then the date of the cash inflow would not yet be clear. This reserve was recorded as a revenue reserve under the company’s equity. It did not result in an inflow of capital gains for the controlling majority shareholder, according to the BFH. This is because this reserve is not freely available to the shareholder. In fact, a separate resolution would have to be passed for a dividend distribution to be made out this reserve.

Moreover, the BFH clarified that such an appropriation of profits resolution does not constitute abusive structuring. This is because it is based on economic reasons that should be recognised and is neither atypical nor inappropriate.

Conclusion

This BFH ruling will be of interest, in particular, for corporations where the shareholder structure is heterogeneous. In accordance with the different interests of the shareholders, it will thus be possible to tax the profit shares either on the date of the dividend distribution or else postpone taxation to a later date by crediting the profit shares to personal reserve accounts.

This may however also entail risks. Given that the accumulated profits have to be recorded as part of equity, in the event of a loss a dividend distribution would not be possible.

Please note: Furthermore, this most recent BFH ruling is of far reaching significance for partnership organisations and professional partnerships (Personenhandelsgesellschaften, a German type of professional corporation) that opt for corporation tax in accordance with Section 1a of the German Corporation Tax Act. Shareholder accounts that existed prior to the opting to be taxed as a corporation will, when the option is exercised for the first time, be consolidated into one single contribution account for tax purposes for the corporation without establishing an allocation between the individual shareholders. From now on, it will be possible to set up personal reserve accounts out of current profits – analogously to the shareholder equity accounts that existed prior to the simulated change of legal form. It will subsequently be possible to make shareholder-related dividend distributions out of these new accounts by passing a separate resolution or via an option to revert back to being taxed as a partnership.