For many companies, assuming social responsibility and engaging in charitable causes is a matter of course. One of the most widespread forms of engagement is making corporate donations.
Like private donations, corporate donations are also tax deductible - technically. In practice, however, German tax offices and courts often treat corporate donations to "affiliated" NPOs as non-tax-deductible hidden distributions of profits. The result: An unjustified discrimination of corporate donations compared to donations from private individuals, which we criticize from a legal and sociopolitical standpoint.
According to Section 9 (1) Clause 1 No. 2 of the German Corporation Tax Act (Körperschaftsteuergesetz, KStG), corporate donations to nonprofit organizations - regardless of whether the donation is in cash or in kind - are deductible up to a total of 20 percent of income or 4 per thousand of the sum of total sales and wages and salaries spent in the calendar year, provided that the companies can present the appropriate donation receipts to the tax office. These limits correspond to the limits that apply to donations by private individuals pursuant to Section 10b of the German Income Tax Act (Einkommensteuergesetz, EStG).
At first glance, the legal situation seems clear: As soon as a company makes a donation, it can claim it for tax purposes within the statutory donation deduction limits and thus reduce its tax burden. In practice, however, tax offices and courts, instead, often treat corporate donations to "affiliated" charitable institutions as non-tax-deductible hidden distributions of profits:
- What are hidden distributions of profits?
A hidden distribution of profits is a benefit paid by a corporation to its shareholder or an affiliated party that is initiated by the corporate relationship. This means that the donation would not have been granted to a non-shareholder or a person who is not related to the shareholder in question if the due care of a prudent and conscientious manager had been exercised. This type of hidden distribution is not exactly given generously and with the motivation for making a donation.
- Consequences of a hidden distribution
The cash outflows due to the hidden distributions of profits - in this case, the deducted donations - will be added to the company's profit and thus increase its taxable profit. The profits will be attributed to the shareholder as income from capital assets (similar to a standard profit distribution) and taxed accordingly. Depending on the circumstances of the individual case, this may also constitute (attempted) tax evasion.
Tax offices and courts in Germany often justify the existence of hidden distributions of profits with the argument that the corporation only made the donation because there is a special relationship of closeness between its shareholders and the NPO as the donation recipient. According to the case law of the German Federal Fiscal Court (Bundesfinanzhof, BFH), the following criteria indicate a special relationship of closeness:
- Possibilities of influence from the shareholders in the NPO
The shareholders of the donating corporation have established the NPO and/or can significantly influence the management and the use of the NPO's assets through their position as board members/managing directors/chairpersons of the foundation board, etc.
- Donation behavior within the corporation (third-party donation comparison)
According to the third-party donation comparison, hidden distributions of profits exist if, when viewed retrospectively over a period of three to five fiscal years, the specific corporate donation under review exceeds the average of the annual sums of all other donations to third-party NPOs.
- Donation behavior of the shareholders
The private donation activities of the shareholders can also establish a special relationship of closeness. According to the BFH, this is the case, for example, if the shareholders have exhausted their personal maximum amounts pursuant to Section 10b EStG by making donations to the NPO.
The restrictive practice of the tax authorities in reinterpreting corporate donations as hidden distributions and thus denying the donation deduction is, in our opinion, both legally and sociopolitically misguided:
- Nonprofit law
According to the exclusivity requirement as well as the requirement regarding the timely use of funds, the funds of an NPO are bound by nonprofit law and dedicated solely to nonprofit purposes. The NPO itself therefore never fundamentally benefits from a donation, rather it is always the NPO's charitable purposes and, ultimately, the general public which benefit. A corporation cannot then directly contribute to an NPO, with the consequence that it, in turn, cannot be an affiliated party in the sense of a hidden distribution of profits.
- Motivation for corporate donations
An NPO will not receive a donation from a donor without a certain idealistic "relationship of closeness" existing between it and the donor. A donor with an interest in art is more likely to choose to give to the local museum than to the local soccer club. However, this ideational closeness does not justify the assumption of a hidden distribution of profits, as otherwise the tax deduction pursuant to Sec. 9 (1) Clause 1 No. 2 KStG would, in practice, be rendered meaningless for numerous types of contributions.
- Inappropriate watering can principle
The third-party donation comparison is not suitable for distinguishing donations from hidden distributions of profits. Accordingly, a hidden distribution could only be avoided by corporations allocating their donations equally among different NPOs (watering can principle). However, the law presents no basis for the watering can principle: This is because Sec. 9 (1) Clause 1 No. 2 KStG does not provide for an equal distribution of donations among various NPOs, but merely stipulates that donations are to be deductible within the statutory donation deduction limits.
- Indispensable significance of corporate donations
NPOs depend on donations from companies, which often have a higher donation budget than private individuals, to carry out their social duties. A Bertelsmann Foundation study estimates that the annual volume of cash donations by companies amounts to EUR 9.5 billion. The volume of donations from companies is thus larger than the volume from the private donations market which amounts to approximately EUR 8 billion p.a. As a result, corporate donations play a central role in promoting NPOs and therewith the common good. To place them at a disadvantage in terms of taxation - especially considering the observed decline in state support for NPOs over the years - cannot be in the public interest.
In view of the tax risks currently associated with corporate donations, many companies are switching to sponsorship. Sponsorship, however, can be particularly disadvantageous for NPOs as recipients:
- Tax liability: In contrast to a donation, sponsorship is always linked to a return service by the NPO, which - depending on the situation - not only ties up the NPO's resources, but can also lead to a tax liability of the received services: In taxable business operations, both income and sales taxes are incurred; sponsorship payments within the scope of asset management to an NPO are still subject to sales tax.
- Tax back payment: Impeding tax risks in the form of high back tax payments and fiscal court proceedings occur if the sponsorship is incorrectly classified for tax purposes due to difficulties in delimitation.
Donations are not subject to such risks, or only to a significantly lesser extent. It is therefore hardly surprising that affected NPOs only consider sponsorship in a more limited scope and continue to rely on donations as their main means of fundraising. Companies seeking to do good should therefore ensure that their contributions are recognized as donations for tax purposes.
We help companies donate to nonprofit organizations in Germany. Our team of experienced tax advisors and tax lawyers will be happy to help you minimize the risk of a hidden distribution of profit and ensure that your contributions are recognized as donations for tax purposes. Our range of services includes, for example:
- Development of a donation and corporate social responsibility strategy tailored to your company's needs
- Coordination with the tax office and representation with tax authorities, including requests for information by way of an application for binding information
- Advice and representation in communication with the tax authorities in the context of tax audits and appeal proceedings
- Legal representation before the tax courts and the Federal Fiscal Court
- Drafting an Articles of Association
- Tax optimization consulting
- Tax consultancy, such as, e.g., the preparation of annual financial statements and tax returns
- Analysis and optimization of a tax compliance structure to reduce your liability risk
Do you want to ensure that the tax office recognizes your company's contributions as donations for tax purposes? Is the tax office unwilling to recognize your company's contribution as a donation, qualifying it as a hidden distribution of profits instead? Would you like to avoid the consequences of a hidden distribution? Please feel free to contact us.
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