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11. November 2018 | Save the loss carry forwards at the GmbH: the new § 8d KStG helps!

17. February 2019 | Buy loss carryforwards from GmbH: 6 new strategies for the use of losses

Lovemaking means activities that are not carried out with the intention of making profits in the future. This lacks an income-generating intention. If the tax office assumes that a taxpayer carries out an activity only out of hobby, this can have a positive effect on the one hand, but on the other hand it can also have negative tax consequences. Specifically, profits, insofar as they arise at all, do not have to be taxed. But what is more important is that existing losses are not taken into account. This article deals with how to avoid this and we discuss whether there are cases in which a loss offset could still be possible.

The question of whether a taxpayer is pursuing an activity only out of hobby is essentially about the existence of the profit intention. Intent to make a profit is given if someone carries out an activity with the intention of generating a surplus of income over the expenditure (§ 15 (2) EStG). Only when this intention is present, income is taxable. The problem here is that the profit intention is an inner subjective characteristic. The tax authority cannot read the thoughts of the taxpayer and therefore cannot determine for sure whether he actually wants to make a profit from the activity. Furthermore, the tax office must predict to what extent the activity is suitable at all to generate a profit in the long term. Consequently, on the basis of external objective circumstances, the Authority must assume whether the income is taxable. In this way, the authority makes an assumption that can prove to be wrong over time.

Lovemaking refers to an activity that is carried out only out of private devotion or inclination and thus belongs to the sphere of private living. For the time being, hobbyism comes into consideration if an activity is pursued that can be considered more as a hobby. A prime example of this is horse breeding. But even professionals who earn self-employed or commercial income can suffer the consequences, although their activities may be seen less as a hobby. This is the case if a longer loss period leads to the realization that the activity is unsuitable for achieving a total profit when considered objectively. Especially with initial losses, this prognosis is difficult to make. The measure is the objective suitability of the company as a source of income.

If the activity is correctly recognized as a hobby, the question arises as to what tax consequences are to be linked to it. There is no taxable income in the case of activities carried out by hobbyists. Therefore, negative income is not taken into account. This means that neither loss compensation nor loss recovery may take place. This means that the losses cannot be offset against the positive income within the tax period of the calendar year or against those of other calendar years.

Furthermore, no positive taxable income can be assumed. This means that any profits incurred may not be taxed. Care must be taken here that the taxpayer cannot simply rely on the fact that he carries out the activity only out of hobby. The fact that profits are made gives the impression that there is also a profit intention. This appearance is then rather to be shattered with contrary evidence.

In order to avoid the negative consequences, i.e. the exclusion of the loss deduction, it is crucial that a hobby is excluded.

For occupational activities, it is necessary to examine additional evidence suggesting that a taxpayer accepts losses only from a personal inclination. In particular, the reasons which led to the commencement of the activity are decisive. Especially in occupational activities, the reasons for admission should probably speak against the acceptance of hobby.

If private interests are nevertheless decisive, it is indispensable when starting a company to create a coherent operating concept that explains why you can expect a total profit. Furthermore, appropriate restructuring measures should be taken over a period of up to five years. In particular, losses incurred for the duration of a company-specific start-up phase must then be taken into account for tax purposes.

The start-up phase depends on the object and the type of operation. During this period, restructuring is by no means mandatory for tax purposes, since it is of course possible to wait for the company to develop further during the start-up phase. Therefore, one cannot yet speak of an evidence against the existence of the profit intention. The period is quantified differently. The lowest limit is currently three years. Within this time, only in small exceptional cases can the losses be denied tax recognition.

If there is certainly an activity out of hobby, this has no tax consequences and therefore generally does not have to be specified in the tax declaration. The situation is different if it is not yet certain whether hobby is present. Here the income and the losses should be absolutely explained. Above all, initial losses are initially considered. Pending the final declaration, the tax may be provisionally fixed and then, if necessary, amended.

If an activity was initially assessed as a hobby, but in the further course it turns out that there is a profit intention, the activity should also be declared mandatory. It must be made credible here that in future the activity will be carried out for the reason of generating a surplus of income over expenditure. This, of course, requires the appropriate evidence. For example, restructuring measures or advertising measures can be cited as evidence.

The assessment of profit intent may change over time.

An activity originally yielded many profits, but towards the end only leads to losses. Here, the following situation is conceivable: a doctor continues his originally profitable activity despite incurred losses without taking restructuring measures and then ceases operations. In this case, the doctor has a profit intention at the beginning of the professional activity. Towards the end, according to current jurisprudence, however, he should in any case exercise his profession only out of private inclination, regardless of the reasons for which the doctor continues the operation. The private inclination should be assumed by the non-prevention of losses. Thus, as a result of this decision pro futuro, he would basically only act out of hobby.

This argument can be viewed critically. It is possible that the professional operator continues to work for professional reasons and does not take action against the losses, since he wants to and will soon stop anyway. At the end of the professional activity, the period during which the profit-making intention is to be assessed necessarily includes only the remaining years until the end of the professional activity. In these remaining years, only losses are generated. However, the total profit is regularly positive despite losses in the end in the result.

From this point of view, one can well assume that the professional activity was carried out with a profit intention for the entire period. This would also have to lead to the loss that is not exclusively based on private interests being taken into account. The fact that the taxpayer stops pursuing his profession at a time when the total profit is still positive shows precisely that he hopes for overall profits from the activity. Nothing prevents him from practicing the profession even longer and thus getting into the minus.

In the professional task, you can also see a successful restructuring measure here, as it is guaranteed that a total profit remains and thus the livelihood can be financed. If the losses which are not exclusively based on private interests are no longer taken into account, the overall positive total profit is simply disregarded. Under these aspects, high demands must be made in the event of losses at the end and the question of whether there is hobby, and the circumstances of the individual case must be particularly appreciated.

But it is important to mention that jurisprudence does not follow this argument. It should be decisive that from the specific time in future only losses will be achieved and no countermeasures will be taken while continuing the operation. Previous, possibly high profits should therefore not be considered. It remains to be seen whether the jurisprudence sees the arguments outlined above. At least one should critically question the jurisprudence especially with regard to this topic, because only in this way a further development of the law is possible.