I. Facts

The claimant, a natural person, held 50 % of the shares in each of A-, B- and C-GmbH. The claimant granted usufruct of its shares in C-GmbH free of charge with a quota of 80 % in favor of A-GmbH (so-called quota beneficial usufruct (Zuwendungsnießbrauch)). However, the management rights associated with the shares in C-GmbH, in particular the voting rights, remained with the claimant. In the further course of time, the claimant contributed its shares in C-GmbH, which were encumbered with usufruct, to B-GmbH in the course of an increase in share capital. Profit distributions of C-GmbH were paid out to A-GmbH and recognized as hidden contributions by the latter.
The Federal Fiscal Court (Bundesfinanzhof) ruled that profit distributions from GmbH shares subject to usufruct (in this case: in C-GmbH) do not accrue to the person entitled to usufruct as the beneficiary (in this case: A-GmbH), but to the shareholder as the holder of the assets (in this case: B-GmbH or, in the last instance, the claimant) for income tax purposes,

• if the shares only grant an entitlement to a share in profits,
• without at the same time enabling the exercise of significant management rights (such as voting rights) precisely in the event of a conflict and thus there is no equality of the usufructuary with the shareholder under civil law.

A hidden profit distribution exists if a GmbH grants its shareholder an advantage outside of the distribution of profits under company law and this benefit results from the company relationship. A hidden profit distribution can also be realized without an actual inflow to the shareholder (in this case: B-GmbH or, in the final instance, the claimant) if the advantage is indirectly granted to the shareholder as a result of the corporate relationship in such a way that a person close to him (in this case: A-GmbH) benefits from the transfer of assets (so-called indirect hidden profit distribution (mittelbare verdeckte Gewinnausschüttung)). This means that in this case, in which the shareholder of the usufructuary GmbH share is a corporation (in this case: B-GmbH) and the direct payment of the distributions is made to the beneficiary of the usufruct (in this case: A-GmbH), there is an indirect hidden profit distribution for the claimant, as the latter has established a “close relationship” on the basis of its 50 % shareholding in each case. In order to avoid such unintended tax consequences, the usufruct must be precisely structured so that the desired income and inheritance or gift tax consequences occur.

II. Objectives and models of structuring the usufruct

If an entrepreneur plans to transfer his business or shares in a company to the next generation, various objectives can be achieved with usufruct arrangements. The motive of any usufruct arrangement is regularly the flexible allocation of the asset substance on the one hand and the current company income flowing from it on the other hand. In this context, different entrepreneurial, economic, legal and tax objectives can be achieved:

• Introducing younger generations to the company at an early stage (if necessary, reserving the right to influence the company management);
• Securing earnings for non-shareholders (e.g. retiring entrepreneur or his relatives);
• Income tax and inheritance or gift tax benefits (in particular the (multiple) exhaustion of progression benefits and tax allowances).

The usufruct can take different forms:

• The most common variant in practice is the conditional usufruct (Vorbehaltsnießbrauch). Classically, the entrepreneur transfers the company stock or a shareholding and thus ceases to be a shareholder, but retains the use of the business share, in particular in the form of the right to draw profits. If not all of the company’s earnings are required to cover the private living expenses of the transferor and if the successors are also to participate in the profits to a certain extent right from the start, a so-called quota usufruct (Quotennießbrauch) can be considered.
• If the focus is on the provision and financial security of other family members, such as spouses, children or grandchildren, who are not to have a direct share in the company’s assets, the beneficial usufruct (Zuwendungsnießbrauch) may be considered. As a rule, the company’s assets remain with the previous entrepreneur, vice versa to the conditional usufruct (Vorbehaltsnießbrauch), while the company’s earnings flow (possibly on a quota basis) to a third party.

Depending on the structure of the usufruct, there are different income tax and inheritance or gift tax consequences as well as pitfalls which must be taken into account and which are outlined in the following.

III. Income tax consequences

In principle, the transfer free of charge of shares in a business subject to usufruct is possible with no effect on income tax. In the case of shares in a partnership, however, the scope of the company’s assets must be examined in detail so that a transfer of shares that is not subject to income tax is not jeopardized. If, for example, assets essential to the business that are solely owned by an entrepreneur (so-called special business assets) are not also transferred, this can lead to the disclosure of hidden reserves and a massive income tax and thus also liquidity burden.
With regard to current corporate income (dividends and withdrawable profits), the question arises as to whom these profits are attributable for income tax purposes:

• In the case of a conditional usufruct (Vorbehaltsnießbrauch) of business shares, the income will generally continue to be attributed to the transferring entrepreneur and current usufructuary for income tax purposes (on a quota basis, if applicable). Only the sale of such shares may result in income tax consequences for the new shareholder. The same applies to the legacy usufruct (Vermächtnisnießbrauch) granted by testamentary disposition.
• In the event that a beneficial usufruct for a benefit (Zuwendungsnießbrauch) is granted, the current income is generally still attributable to the entrepreneur and the person granting the usufruct. As the German Federal Fiscal Court principles outlined above make clear, a shift in income only occurs in exceptional cases if the usufructuary also becomes the beneficial owner of the business shares. In this respect, the contractual form of the usufructuary right is decisive.
• In all cases, it is generally advisable to obtain binding information, especially if special rights and obligations in connection with the usufruct of the shares are to be regulated.

IV. Inheritance and gift tax consequences

Under certain conditions, the gratuitous transfer of business assets is subject to both gift and inheritance tax exemptions (§ 13a and § 13b German Inheritance Tax Act (Erbschaftsteuergesetz – ErbStG)). The partial or full tax exemption is not affected by the granting of usufruct, provided that the asset actually transferred, despite the usufruct, meets the requirements of the preferential tax rules:

• If it is structured “correctly”, the conditional usufruct (Vorbehaltsnießbrauch) reduces the gift tax payable by the successor on the substance of the business in the amount of its capital value. It should be noted that the subsequent relinquishment of a possibly no longer required usufruct leads to a renewed gift to the successor of the company.
• Both the beneficial usufruct (Zuwendungsnießbrauch) and the legacy usufruct (Vermächtnisnießbrauch) are subject to gift or inheritance tax in the amount of their capital value for the usufructuary. The capital value corresponds to a multiple of the annual use of the business share in the form of company profits that are likely to accrue and are therefore difficult to forecast.

V. Conclusion

As the above explanations make clear, there are a number of tax obstacles to be overcome in the case of usufruct arrangements. Alternatively, the desired succession objective may be better achieved with other arrangements, such as trust constellations, sub-participations, (atypical) silent partnerships, asset transfers in return for pension benefits, disproportionate profit participation rights, foundation solutions, etc.