I. Risk of hidden profit distributions
If real estate is held via corporations and used by a shareholder or by persons close to the shareholder (e.g. family members), the resulting benefit is to be remunerated at arm’s length in the sense of a rent. If such remuneration is not paid, there are generally hidden profit distributions at the level of the company in the amount of a fictitious rent and, in principle, taxable dividends at the level of the shareholder. Against this backdrop, corresponding structures in Germany and abroad should be tax-checked and the necessary steps derived from the result and implemented.
Case law of the BFH
In its ruling of June 12, 2013 (Case No. I R 109-111/10), the German Federal Fiscal Court (Bundesfinanzhof, BFH) ruled that a Spanish corporation holding a privately used vacation property in Spain is subject to hidden profit distributions in the form of saved rental expenses to the shareholders. The BFH has confirmed this ruling in three further rulings, each dated July 27, 2016 (Ref. I R 8/15, I R 12/15 and I R 71/15) and further specified the resulting effects.
Until the aforementioned BFH ruling in 2013, it was largely assumed that the private use of a vacation property held abroad via a corporation established specifically for this purpose constituted a so-called hobby business “not relevant” under tax law, since a foreign corporation does not necessarily have to generate commercial income (cf. in this regard FG Düsseldorf, ruling of 29.10.2010, 3 K 1239/09 E, EFG 2011, 556).
Vacation properties affected in particular
Since in many places in Europe and outside Europe there were and in some cases still are acquisition restrictions for foreigners, one often made do with the interposition of a corporation, which acquired the desired vacation domicile as a legal entity. Economically as well as fiscally, the intermediary company was usually, at least partially, ignored in such cases.
Tax and criminal law consequences
If the tax authorities take up a case in which hidden profit distributions have occurred as described above, the “local rent” is added as a minimum value to the company’s taxable income and at the same time added to the shareholder’s income as a fundamentally taxable dividend. As far as the annual costs of the property plus of a reasonable profit mark-up are higher, this amount is to be recognized as fictitious rent according to the case law of the BFH. The annual taxable benefit of use can thus even exceed the actual local rent.
Moreover, to the extent that the place of management of the real estate company incorporated abroad is actually in Germany, Germany may tax the notional income from the rental at the level of the company. Otherwise, it must be examined to what extent a fictitious rent abroad is taxable for the company.
If the taxpayer has not reported such a matter to the competent tax office, this may result in criminal tax consequences or a fine in addition to an additional tax payment.
II. Investigations by the tax authorities
So far, vacation homes in Spain and Italy in particular have come under the scrutiny of the German tax authorities. Due to developments in the area of automatic exchange of information between the tax authorities of different countries and the extended disclosure obligations for taxpayers, there is an ever-increasing flow of information for the tax authorities. Along with this, the volume of matters picked up by tax offices is also increasing and expanding to other countries participating in the exchange of information.
Automatic exchange of information (AEOI) concerning tax data
The now global OECD standard of automatic exchange of tax information on financial accounts will be implemented in most countries worldwide in 2018. Some countries, such as Spain, Italy, France, Greece, but also the British Virgin Islands, have committed themselves as so-called “early adopters” to implement the automatic exchange of information already in 2017 (notification for the first time on September 30, 2017 regarding data from 2016).
For example, the AEOI standard requires financial institutions (e.g., banks) in participating countries to identify all customers who are residents of another participating country. In certain constellations, this also applies to the controlling persons of legal entities (companies/trusts/foundations). As soon as a reportable person is identified, the tax authorities in the country of residence of the reportable person receive the corresponding data on a collective basis.
Reporting obligations pursuant to the German Anti-Tax Avoidance Act (StUmgBG)
Following the publication of the so-called “Panama Papers” in April 2016, the disclosure of the beneficiaries behind domiciliary companies (so-called letterbox companies) has increasingly become the focus of public and political attention. In the course of this, the legislator wants to improve the possibilities of the tax authorities to determine corresponding facts with a new law (Gesetz zur Bekämpfung der Steuerumgehung – StUmgBG). The StUmgBG is intended to achieve this by creating transparency regarding “controlling” business relationships of domestic taxpayers. In this context, tax banking secrecy is also to be lifted. Overall, the extension of notification, reporting and information obligations subject to fines is intended to further strengthen the exchange of data for the tax authorities in Germany.
In addition, tax evasion through covert business relations with third-country companies controlled by the taxpayer is to be included in the list of particularly serious tax evasion.
In principle, a particularly serious case would also exist if real estate were held via a company abroad and taxes were evaded as a result.
Further information on this topic can be found in the Client Info June 2017 “Strengthened disclosure requirements – strengthened sanctions”.
Against the background of current developments, it may make sense from a tax point of view to consider dissolving so-called real estate companies and winding up such a structure. In any case, a sufficiently detailed notification of the facts to the competent tax office is required. This also applies in the event of the dissolution of so-called real estate companies.
In many member states of the European Union and also in some third countries, the private use by shareholders of real estate held via corporations is also regarded as a hidden distribution of profits. In these cases, there is also an urgent need for action abroad.
Of course, we will be happy to answer any questions you may have on this topic and provide support as needed. Our international KPMG network is also available for this purpose.
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Head of Criminal Tax Law
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