I. Introduction

In principle, (open) profit distributions are made according to the capital shareholding quota. This means that dividends are allocated to the shareholders in proportion to their respective share in the share capital. This results, for example, for limited liability companies from § 29 para. 3 sentence 1 Limited Liability Companies Act (Gesetz betreffend die Gesellschaften mit beschränkter Haftung – GmbHG). However, incongruent (disproportionate) distributions may also be made in deviation from this. It is still hotly disputed whether these can be recognized for tax purposes. The case law has affirmed such recognition in almost all cases decided to date. Nevertheless, the tax authorities very often refuse to recognize disproportionate profit distributions with reference to § 42 AO as an abuse of the tax system. This is also shown by the case below, which the Münster Fiscal Court had to decide last year (Münster Fiscal Court, ruling of 30 June 2021, ref. no. 13 K 272/19 G, F, final and binding).

II. Facts of the case

The claimant in the main proceedings was a limited partnership which held 91% of the shares in N-GmbH in the year in dispute 2013. The remaining shares were held by the claimant’s partners. These included, in particular, G-GmbH, which acted as the claimant’s general partner, which held a 25% share in the claimant’s assets and to which 2.33% of the shares in N-GmbH were directly attributable. In addition, G-GmbH was the controlling company of its own group of companies, which was not included in the claimant’s consolidated financial statements.
G-GmbH generated a loss in the amount of millions in the year in dispute. In order to avoid insolvency of the company and to improve the creditworthiness of G-GmbH, the shareholders’ meeting of N-GmbH therefore decided in the same year on a disproportionate distribution in favor of G-GmbH to compensate for the loss of G-GmbH.
The corresponding resolution on the appropriation of profits was adopted subject to the condition precedent of an effective amendment to the Articles of Association of N-GmbH, by which a so-called opening clause with regard to the distribution of profits was to be included in the Articles of Association. Furthermore, it was intended to implement a liquidation preference to the effect that the remaining shareholders would be compensated in advance to offset the incongruent distribution made in favor of G-GmbH upon dissolution of the company.
By shareholders’ resolution dated 17 March 2014, N-GmbH amended its Articles of Association in the aforementioned sense. In particular, the possibility of concluding a deviating profit distribution agreement permissible under company law pursuant to § 29 para. 3 sentence 2 GmbHG was anchored in the Articles of Association. The amendment to the Articles of Association was entered in the commercial register in April 2014. G-GmbH then recognized the distribution as a receivable in its 2013 financial statements and applied the tax exemption of § 8b German Corporate Income Tax Act (Körperschaftsteuergesetz – KStG) to the income. This resulted in an exemption of the disproportionate distribution in the amount of 95%.
In the course of the external tax audit, the deviating profit distribution was classified as an abuse of structure. The auditor argued that the improvement of the creditworthiness or the avoidance of an imminent insolvency of G-GmbH could also have been achieved by the normal case of a proportional profit distribution with subsequent contribution of the amounts by the shareholders of the claimant who held shares in G-GmbH. The chosen arrangement therefore served the sole purpose of obtaining a tax advantage not provided for by law. For this reason, it was not to be recognized pursuant to § 42 AO.
The tax assessment office concurred with this assessment and determined the claimant’s income as it would have been in the event of a congruent distribution. This subsequently led to a partial elimination of the tax exemption under § 8b KStG and to the application of the partial income procedure for the other shareholders of the KG. At the same time, it was assumed that the amounts were contributed to G-GmbH. After the appeal proceedings remained unsuccessful, legal action was filed.

III. Decision

The Münster Fiscal Court ruled in favor of the claimant. It ruled that the distribution resolved in the year in dispute was attributable solely to G-GmbH for tax purposes. The condition precedent agreed in the resolution came into effect when the amendment to the Articles of Association was entered in the commercial register in 2014, which led to the effectiveness of the resolution. The mere fact that a distribution was made which deviated from the shareholding ratios does not justify an abuse of the tax system. In this respect, the court refers to the previous case law of the Federal Fiscal Court, according to which the effect of § 42 AO is overstretched if the amounts in question are deemed to have fictitiously accrued to another shareholder.
In addition, in the case in dispute, a fictitious pro rata distribution would lead to overcompensation of the remaining shareholders. This is because they would have agreed with G-GmbH to compensate for the current disproportionate distribution in the future by being compensated via a proceeds waterfall (Erlöswasserfall) in the liquidation.
Furthermore, there is no general legal principle according to which incongruent profit distributions are abusive. On the contrary, corporate law explicitly recognizes such distributions as permissible under § 29 para. 3 GmbHG. Therefore, there are no basic objections to following this principle from a tax point of view. It must also be taken into account that almost every hidden profit distribution also represents a disproportionate distribution. For tax purposes, however, these are indisputably attributed to only one and not all shareholders in accordance with the quota. In this respect, there are no reasons to treat open and hidden profit distributions differently.
Finally, and without it being important, the court comments on the non-tax reasons put forward by the claimant for the chosen structure. It grants the taxpayer freedom of decision in the choice of the implementation of capital measures. Thus, the shareholder is not forced to make such additions in a certain way, i.e. by means of a pro rata distribution and subsequent contribution, if this is associated with a higher tax burden.
The court did not allow an appeal to the Federal Finance Court (Bundesfinanzhof), as it considered the legal situation in this respect to be clarified.

IV. Consequences for the practice

The ruling of the Münster Fiscal Court once again makes it clear that, at least in case law, deviating profit distribution agreements are not classified as tax abuse per se.
Unfortunately, the tax authorities continue to be very restrictive. It requires that a profit distribution agreement deviating from the share in the capital stock or share capital must be sufficiently defined (letter of the Federal Ministry of Finance dated 17 December 2013, Federal Tax Gazette I 2014, 63). In the case of GmbHs (limited liability companies), this is the case if a different standard is stipulated in the Articles of Association pursuant to § 29 para. 3 sentence 2 GmbHG or if the Articles of Association contain an opening clause and the corresponding resolution on the appropriation of profits was adopted with the majority stipulated in the agreement. Furthermore, in the opinion of the tax authorities, the principles of abuse of legal structuring possibilities (§ 42 AO) must be examined in all cases of disproportionate distribution. Thus, an abuse shall (only) not exist if considerable economically reasonable non-tax reasons are proven for the distribution deviating from the statutory profit distribution key.
For consulting practice, this means the following:
First of all, it must be ensured that the deviating profit distribution is regulated either explicitly or by means of an opening clause in the Articles of Association. In our opinion, the literature correctly points out that resolutions that break through the Articles of Association are also possible and permissible under civil law, which speaks in favor of consideration for tax purposes. However, according to their own statement, the tax authorities do not recognize this. We can therefore look forward to pending proceedings at the Federal Fiscal Court (case no. VIII R 20/20), in which the court will take a position on this. The lower court, also the Münster Fiscal Court, had in any case affirmed recognition.
In addition, non-tax reasons, if any, which should be the rule for a deviation from the statutory distribution, should be clearly documented in order to be prepared in the event of a tax audit. If there are no non-tax reasons for an incongruent distribution, or if these can at least no longer be clearly understood, it is nevertheless worth taking legal action against the corresponding notices. This is because, as already explained, the Federal Fiscal Court considers the effect of § 42 AO to be overstretched if amounts are fictitiously attributed to another shareholder.
This applies all the more, and this is also made very clear by the ruling of the Münster Fiscal Court discussed above, if the shareholder benefiting from the distribution has to compensate the co-shareholders in some form in the future. Liquidation preferences are therefore a secure means of avoiding, on the one hand, the favoring of a shareholder (which may be subject to gift tax) and, on the other hand, an unintended attribution of the income to the co-partners.