The tax design abuse in Germany

The tax design abuse in Germany

The German tax office is very quick to assume that there has been an abuse of tax planning within the meaning of Section 42 of the German Fiscal Code, although in many cases this assertion turns out to be unfounded (in court).

When is there an abuse of tax planning?

As a rule, there is an abuse of design if a legal design was only chosen in order to obtain an unforeseen tax advantage.

In such cases, the arrangement is therefore inappropriate. Such arrangements are usually also complicated, opaque, absurd and purposeless (with regard to an extra-tax reason).

For example, the “interposition” of a child is in most cases an inappropriate arrangement, because in most cases there will be no meaningful economic reason for this (other than wanting to save taxes).

When is there no abuse of design?

There is no abuse of tax planning if the legal arrangement was chosen for non-tax reasons, according to Section 42 (2) sentence 2 AO:

This does not apply if the taxpayer proves non-tax reasons for the chosen legal arrangement, which are relevant according to the overall picture of the circumstances.

Section 42 (2) sentence 2 of the Tax Code

The tax saving in such cases is therefore to be seen only as a positive side effect. Such an appropriate arrangement primarily attempts to solve an extra-tax problem – in the simplest and most expedient way.

For example, the sale of business shares at a loss – among several shareholders – resulted in significant tax savings. In this case, the BFH came to the conclusion that there was no abuse of the tax structure (BFH ruling of 07.12.2010 – IX R 40/09 BStBl 2011 II p. 427), because ultimately the loss had actually been incurred.

Neither the choice of legal form nor a change of legal form can be seen as an abuse of legal form, because every entrepreneur is basically free to choose the legal form.

Even in the case of a swing in the matrimonial property regime and in the case of chain gifts, there is generally no abuse of the tax regime.

In the case of the latter, however, only if each person within the chain could also keep the money themselves. Put simply, there must be no contract or agreement between person A and B (or) C that person C would receive the money from person A via person B.

With the so-called “Güterstandsschaukel” it is possible to change from the legal matrimonial property regime of “Zugewinngemeinschaft” to the matrimonial property regime of “Gütertrennung”, then to transfer the surplus part to the (lower-earning) spouse and then to change back to the matrimonial property regime of “Zugewinngemeinschaft”. This procedure means that the transfer of the surplus portion is no longer subject to gift tax. Even if the property regime swing is fully executed on only one day, there is no abuse of the arrangement.

Caution: Individual tax laws

Section 42 (1) sentence 2 AO states that individual tax laws may contain provisions to prevent tax avoidance. It must therefore always be checked whether the relevant tax law also contains such a provision. If this is the case, not § 42 AO is applied, but the other provision (including the legal consequences).

Section 42 (1) sentence 2 AO thus displaces Section 42 (2) AO – in simple terms: even if there is an extra-tax reason, there could still be tax avoidance under another provision. This could be the case, for example, with regard to Sec. 50d (3) EStG.

Section 42 (1) sentence 2 AO is fortunately limited to cases where the law is intended to be evaded. In the case of an appropriate design, the objective of “saving taxes” should therefore be in line with the respective purpose of the law for the designed facts.

How does the tax office deal with such cases?

As described above, the German tax office assumes at a very early stage that there has been an abuse of tax structuring

However, the tax office must prove that such an inappropriate legal arrangement – which leads to unforeseen tax advantages – actually exists.

What is the risk for the taxpayer?

As mentioned above, the burden of proof and presentation initially lies with the tax office. Should the tax office be able to sufficiently substantiate an abuse of the arrangement, non-tax reasons for the chosen arrangement can still be put forward.

If such non-tax reasons exist, this leads to the fact that there is no abuse of the arrangement.

Such reasons can be the protection of business interests, liability risks and many other economic and legal motives.

If, however, an abuse of the arrangement is established, only the tax burden that would have been incurred in the case of an appropriate arrangement is to be paid, plus the corresponding interest on arrears.

Accordingly, the risk lies mainly in the costs for the implementation of the arrangement itself (formation costs, tax consultancy costs, etc.) and any default interest incurred.

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