Incongruent Profit Distributions: Current Developments and Tax Implications

February 17, 2025

The Federal Ministry of Finance (Bundesministerium der Finanzen, BMF) clarified in its circular dated 4 September 2024 (BMF-Schreiben vom 4. September 2024) that it is recognizing and applying the ruling of the German Federal Fiscal Court of 28 September 2022, pursuant to which the Federal Fiscal Court (Bundesfinanzhof, BFH) contradicted the administrative opinion on the treatment of incongruent profit distributions as set out in the circular of the Federal Ministry of Finance dated 17 December 2013. Recognising the ruling of the BFH has significant practical implications for companies in the legal form of a limited liability company (GmbH) domiciled in Germany.

Key Takeaways:

  • Pursuant to sec. 29 para. 3 German Limited Liability Companies Act (GmbH-Gesetz, GmbHG), profit distributions of a GmbH are to be made pro rata to the shares held by each shareholder. The articles of association may, however, provide for a different distribution ratio (incongruent profit distribution).
  • To be recognized for tax purposes, an incongruent distribution of profits thus required a legal basis in the articles of association of a limited liability company, either by providing directly for the deviating distribution ratio or by incorporating an opening clause in the articles of association.
  • German legal literature controversially discussed in the past whether an incongruent dividend distribution without an explicit provision on the articles of association would also be effective from a civil law perspective and to be recognised for tax purposes.
  • The BFH ruling of 28 September 2022 and the related circular issued by the German BMF on 4 September 2024 facilitate the recognition of incongruent profit distributions for tax purposes and provide for legal certainty and clarity on this previously controversially discussed topic. As a result, incongruent profit distributions based on one-off, unanimous shareholder resolutions that deviate from the articles of association are to be recognized for tax purposes, if effective from a civil law perspective.

General Background

An incongruent profit distribution represents a special form of profit distribution within a limited liability company. This approach is characterized by differing distributions of individual profits to certain shareholders, even if it deviates from the provisions of the articles of association. While incongruent profit distributions were previously recognized for tax purposes only under strict conditions, a new ruling by the BFH and an updated circular by the BMF have significantly changed and simplified these conditions.

Previous Legal Situation

According to a BMF circular dated 17 December 2013, the tax recognition of an incongruent profit distribution was linked to the condition that the profit deviation was effectively stipulated in the articles of association. Two different approaches were possible:

  1. Articles of Association: A specific different distribution standard (deviating from the general rule that profits are to be distributed pro rata to the shareholding in the limited liability company) is specified in the articles of association in accordance with section 29 para. 3 sentence 2 GmbHG.
  2. Opening Clause: The articles of association contain an opening clause, i.e. a clause according to which the shareholders, with the consent of the affected shareholders, can decide on a profit distribution that deviates from the general rule (pro rata distribution) or a deviating rule provided in the articles of association of the limited liability company. If a respective resolution, making use of an opening clause in the articles of association, is passed with the majority specified in the articles of association (including, in any case, with the consent of the affected shareholders), the related incongruent profit distribution is recognized for tax purposes. An unanimous decision of the shareholders is not required in this case (but remains possible, of course).

    In turn, without at least an opening clause provided in the articles of association of the limited liability company, a shareholder resolution that selectively breached the articles of association by resolving upon an incongruent profit distribution with the approval of all shareholders, was not recognised by the tax authorities as sufficient and its effect on treatment and recognition for tax purposes was controversially debated in German legal (particularly, tax law) literature.

    Current Legal Situation

    This situation was clarified by the ruling of the BFH of 28 September 2022, which the BMF finally decided to accept and apply by its circular of 4 September 2024.

    According to the ruling of the BFH of 28 September 2022, a shareholder resolution resolving upon an incongruent profit distribution that selectively breaches the articles of association (as a result of a lacking opening clause) is to be used as the basis for taxation as a distribution resolution that is effective under civil law, provided that the resolution has been adopted by the shareholders' meeting with the votes of all shareholders and cannot be challenged by any shareholder. Further, the resolution must have been adopted as an individual act (e.g. to provide for a specific incongruent profit distribution deviating from the general pro rata-rule for a single fiscal year of the limited liability company) not aiming to set the scene also for future profit distributions (i.e. resulting in a one-time / case-by-case violation of the articles of association, but not intending to amend the articles with effect for the future).

    The updated BMF circular dated 4 September 2024 states that, in accordance with the ruling of the BFH of 28 September 2022, incongruent profit distributions shall generally be recognized under tax law if they are effective under civil law. By this statement, the BMF confirms the BFH-ruling of 28 September 2022.

    Consequently, incongruent profit distributions that are effective under civil law are to be treated in the same way as regular pro rata profit distributions for tax purposes, regardless of whether the incongruent profit distribution is based on a respective provision in the articles of association or on a unanimous shareholder resolution overriding the articles of association for a single case.

    Conclusion

    The BMF circular provides for significant clarity and legal certainty for the treatment of incongruent dividend distributions for German limited liability companies and their shareholders. A unanimous, unchallengeable resolution by the shareholders' meeting is recognized for tax purposes even without an opening clause in the articles of association, offering limited liability companies a more flexible option for structuring the distribution of their profits.
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