Summary
If a property is not held directly but through a corporation, the shareholders should pay an appropriate rent to the corporation for their private use of “their” property. Otherwise, the private use of the property may be considered a taxable hidden profit distribution for the shareholder. The German Federal Fiscal Court (Bundesfinanzhof, BFH) reconfirmed this in a decision dated October 1, 2024. At the same time, however, the Court clarified that the mere possibility of using the property is not subject to tax.
Reasons for a corporate structure
There are many reasons why a holiday home might be held through a corporation. In many cases, a decisive factor is the (supposed) tax advantages in the state in which the property is located. This includes, in particular, inheritance and gift tax, wealth tax and taxes due on a later sale. However, there are also a number of non-fiscal reasons, such as the preservation of anonymity and protection against unlimited liability.
Private use of the property constitutes a taxable hidden profit Distribution
Already in 2013, the BFH ruled that the use of a holiday home by a corporation’s shareholders, either free of charge or at a reduced rate, generally constitutes a taxable hidden profit distribution. This has been expressly confirmed by the BFH in a recent ruling of 1 October 2024 (VIII R 4/21).
The hidden profit distribution is subject to income tax for the shareholders in Germany. According to the BFH, the amount of the hidden profit distribution is dependent on the extent to which the property is used privately:
- In the case of a permanent right of use for the property for private purposes, the hidden profit distribution should be determined on the basis of a so-called cost rent, including an appropriate return on capital and plus an appropriate profit margin.
- On the other hand, in the case of an actual private use of the property by the shareholders only on a daily basis, the arm’s length price of a short-term rental including an appropriate profit margin should generally be decisive for determining the hidden profit distribution.
It remains unclear, however, at what point a use is no longer only on a daily basis, but already permanent.
The mere possibility of use is not taxable
The mere factual possibility for the shareholder of the corporation to use the property also privately does not by itself lead to a hidden profit distribution for the shareholder. This was clearly stated by the BFH in its ruling from 1 October 2024. In conclusion, a hidden profit distribution can therefore only be assumed if
- the corporation has provided the property to its shareholder free of charge or at a reduced rate (also) for private use, or
- the shareholder is using the property privately without a usage agreement or contrary to a usage prohibition.
Therefore, the tax office has to positively determine the actual use or provision of use of the property to the shareholders. The shareholders have an increased duty of cooperation in this regard. For this reason, it should be carefully documented when the property was actually used by whom, what condition the property is in (size, location, facilities and habitability) and whether efforts are being made to sell or rent it to third parties. Appropriate evidence, such as photos, flight tickets, invoices and consumption values for electricity, water, etc., should also be stored as a precaution.
To avoid the assumption of a hidden profit distribution, it is important to ensure that for each private use of the property by a shareholder, a rental agreement between the company and the shareholder is concluded and that a rental fee that is comparable to third-party conditions is actually paid.
What else should be considered?
In addition to the risk of a hidden profit distribution, there are a lot of other points to be considered when buying and holding a property for private use in a corporation. These include e.g. the following:
- Compared to direct ownership of a property, ownership through a corporation often involves a higher administrative burden and associated costs.
- If the shareholders themselves bear expenses in relation to the property, this generally constitutes a so-called hidden contribution. The hidden contribution is the counterpart to the hidden profit distribution.
- If the corporation makes a profit based on the arm’s length rent, this is subject to income tax at the level of the corporation. If this profit is intended to be paid back to the shareholders later, a taxable profit distribution is also necessary.
- If the shareholders of the corporation provide financial resources in the form of a loan, for example for the purchase or renovation of the property, it is important to ensure that the loan agreement is concluded and executed in an arm’s length manner.
- If shareholders resident in Germany are appointed to the management of a foreign corporation, it is important to ensure that the corporation does not “accidentally” transfer its place of management to Germany and thereby become fully liable to tax in Germany.
- If a shareholder resident in Germany relinquishes his or her residence and habitual abode in Germany, he or she is generally subject to the exit tax on his or her shares in the corporation. On the other hand, directly held properties are not subject to the exit tax.
Conclusion
Holding a property for personal use through a corporation involves a number of tax pitfalls for shareholders resident in Germany. Therefore, existing structures should be reviewed. A restructuring may be recommendable.
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