04.03.2015BFH rules on incongruent dividend distributions
The BFH has held that an incongruent dividend distribution of a corporation in the course of a partial change in shareholders does not represent an abuse of law.
Germany’s Federal Tax Court (BFH) issued a decision dated September 2, 2014 in which it addressed the controversial topic of the treatment of “incongruent dividend distributions,” i.e. whether such distributions should be recognized for tax purposes or whether they represent an abuse of law. An incongruent dividend distribution generally is a dividend distribution where a shareholder’s portion of a dividend is disproportionate to his / her shareholding in the company.
The case involved a situation where an individual (A) made a gratuitous transfer of his 40% shareholding in a German GmbH to the other 60% shareholder (B). Immediately before the transfer of the shares, A and B resolved to distribute to A the GmbH’s retained earnings to the extent attributable to A. The portion of the retained earnings attributable to B was not distributed.
The tax authorities took the position that the gratuitous transfer of the shares, together with the distribution of retained earnings, was a disguised sale of the shares and they partially re-qualified the dividends received by A as a purchase price for the shares.
The BFH, however, held that the incongruent dividend distribution must be recognized for tax purposes and that there was no abuse of law. The court stated that any legally valid incongruent dividend distribution generally should be recognized for tax purposes and rejected the abuse of law argument since shareholder B did not intend to withdraw more funds than necessary from the GmbH. While the BFH agreed that the parties could have achieved the same result if in a first step a congruent dividend distribution was executed followed by a sale of the shares, it confirmed that the parties generally are free to adopt a more tax-efficient alternative.
The BFH decision provides some added certainty and flexibility on the use of incongruent dividend distributions.
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