As part of our tax design, we develop models that lead to a significant tax advantage. Since these are of course always legal tax models, the tax administration tries to reject these tax structures with the argument of "design abuse". However, an abuse of design according to § 42 AO only exists if an inappropriate tax arrangement is chosen. In addition, the accusation of misuse of design can always be invalidated if our client proves an extra-tax reason for the chosen design.

In the video we explain to you what tax design is and in which cases the BFH draws the line to tax abuse.

1st introduction

The tax administration and the taxpayer always have a different, but more than natural aspiration in terms of tax payments and tax savings. The aim of the taxpayer is to create his employment sphere in such a way that the lowest possible tax result is achieved, whereas the state, represented by the tax administration, tries to counteract this and generate a high tax revenue.

Germany can understand the problem of massive tax avoidance very well, because through preventive tax design a large part of the arising tax debt can be passed by the German Treasury with legal means. This naturally results in tax losses at brilliant heights, which is why the state is limited in its sovereign duties by reduced revenues.

With this problem in mind, the following sections illustrate the limits of tax design in order to achieve the feeling of a legislatively desired tax optimization and tax avoidance. Ultimately, it should emerge that only marginal differences depend between legal tax arrangements and legal arrangements that are inappropriate after economic transactions. [1]

Against this background, common tax design options are taken up from three different legal norms and these are discussed in relation to tax abuse according to § 42 AO. National legislation pays attention to the existence of isolated norms that prevent the abuse of tax situations. The general part briefly touches on the decriminalizing effect of self-disclosure, on which, however, no focus is placed in this work.

2nd Definition of Core Tax Concepts

2.1. Control design

By tax structuring or tax avoidance, one understands the effort of the respective taxable citizen to interpret various taxable situations, which are suitable for implementing an economic objective, in such a way that an occurrence of a burdensome tax event can be avoided in principle or the resulting tax is accordingly kept low. [2] Such an approach is generally not put a stop to, as long as the legislature provides willful or even unintentional legal loopholes, such as evaluation contradictions or not fully thought-out tax laws, as room for manoeuvre. The deliberate exploitation of such a legal gap is also understood as tax planning.

2.2. Tax evasion & tax evasion

The notion of tax evasion includes intentional tax reduction, obtaining non-legitimate tax benefits and abuse of tax-advantaged facts. A tax reduction is understood to mean that taxes are not set at all, not at an accurate level or just too late, which can arise from a deed or omission. In this case, a distinction is thus made between the submission of an incorrect tax declaration and the refusal to submit a tax declaration. A gain of unlegitimate tax benefits is experienced by the tax benefits or tax refunds wrongly withheld by the perpetrator. A term of imprisonment of 5 years or a fine can be prosecuted for tax evasion, whereby in particularly serious cases the term of imprisonment can be extended accordingly to 10 years. [3] However, there is the possibility of the perpetrator to achieve impunity by a complete self-disclosure according to § 371 AO. This is also an option if tax evasion has already been completed.

The term tax evasion means the transfer of one’s company or residence abroad. The choice of a foreign state in which the new residence or even the registered office has been placed creates a tax saving, since the chosen transferring state offers more favorable tax conditions than the initial state of residence. This is a “tax-motivated capital flight”. [4] The abandonment of the unlimited tax liability, which usually results from the departure abroad, is largely accepted by the taxable citizens of the country, because they hope for a lower tax burden through this transfer of seat. As a result, income and assets are accordingly not attacked or rather not attacked in height.

2.3. Tax havens

Countries that have a comparatively lower taxation compared to the country of residence are also colloquially referred to as “tax havens”. Countries such as the Netherlands, for example, have no income tax on private interest income, whereas in Germany withholding tax levies 25% of capital income and a 5.5% solidarity surcharge on the retained 25% as withholding tax. [5] This causes natural persons and even legal persons to transfer their income and assets to a low-tax country. The departure from the original country of residence thus leads to a planned tax saving in the country of departure. Such a departure not only entails advantages, since in such a departure the unlimited tax liability is abandoned, but if domestic German income is retained, the extended limited tax liability according to §§ 2 to 5 AStG takes its place. [6]

Abuse of design according to § 42 AO is not considered if the place of residence or company headquarters is moved to a lower taxing country, but only as soon as no economic or other considerable reasons create conduit constructions, whereby the money is smuggled abroad past the German Treasury. Such a case would exist, for example, if a basic company in the form of a limited liability company were to be interposed in the low-tax country and this intermediate arrangement had no economic or other significant reasons. [7] A little more detail is given to § 42 AO in the following sections.

2.4.

Self-disclosure reveals tax evasion to tax authorities. Under the statutory requirements of § 371 AO, the legislature provides for tax-exempt effects. The possibility of making a self-declaration exists in principle in the case of attempted or completed tax evasion, it being noted that the act has not yet been discovered up to the time of making the self-declaration. A possible case in this regard would be if the tax administration has already announced an audit order to the tax evader. [] 8]

In principle, anyone, whether alone or accomplice, can file self-declaration with his or her tax office, which is responsible for the matter and for the area. Since a self-declaration can only be considered useful if it also leads to impunity, you have to make sure that all tax situations are clarified in it, which are not already statute-barred. This is the case in particularly serious cases of tax evasion according to § 376 (1) AO after 10 years. In the form of self-declaration, according to the legislature, there is generally no specific formal provision, but it should be put in writing for your own security, as only in this way any kind of tax transactions for the relevant periods can be recorded and thus supplemented. [9]

After receiving the self-report, the public prosecutor checks whether there is a lawful self-report, so that a possible tax penalty for the tax evader could exist. If this occurs, the procedure is discontinued.

A tax design is also understood as the term tax optimization. The result of these two concepts is to reduce the tax burden of the taxpayer concerned accordingly. Similarly, it is understood that a minimum tax burden is planned through tax accounting policies and thus the track record in the tax account is designed in such a way that profits are postponed into the future or, accordingly, into lower-yield marketing years. [10] One speaks of the granting of an interest-free loan from the tax office.

The choice of specific legal forms or the choice of company headquarters also offer options for certain planning possibilities. The latter can be quite lucrative in terms of the trade tax burden of certain municipalities. In extreme cases, the location of the company to be taxed is even moved to a low-tax country.

Election rights arising from tax policy affect directly or indirectly the tax liability incurred. This is done by changing the tax base, the tax rate or even both mentioned variables. [] 11]

It should be noted that such tax policy decisions are usually controversial, as a result of which a fact already realized by the tax office or even a fact to be taken into account in the future is fraught with great uncertainty. This also explains why there will be constant changes in legislation in national and international tax law.

3.2. Limitations of tax structure in the Conversion Tax Act

When a company is restructured, usually in conjunction with a change of legal form, the abuse of tax arrangements is often assumed. After such a restructuring, the tax consequences for the respective new taxation situation generally come into force. This is made clear precisely by § 38 AO, which codifies the principle of the proportionality of taxation. If the tax administration now wishes to differ from the tax consequences observed by the taxpayer to the detriment of the taxpayer, correct basis for authorisation is therefore necessary.

In the context of the above-mentioned restructuring, it may therefore happen that the taxpayer, by changing the civil legal form, creates unjustified tax advantages which can be considered abusive. For this reason, the individual tax laws have specific abuse prevention regulations. As usual, the principle of the primacy of individual laws over the general law applies. Thus, the individual tax law takes precedence.[12] According to the wording of the tax administration, ‘it must first be examined whether the individual tax law applicable in the individual case contains for the present situation a regulation which serves to prevent tax avoidance’. ‘ [] 13]

As an example, § 22 of the UmwStG serves for such an abuse prevention regulation. A provision which, with regard to §§ 20, 21 UmwStG, is intended to prevent that in the case of a tax-neutral transfer of assets without the discovery of hidden reserves, this brings the advantage to the taxpayer, the partial income procedure according to § 3 no. 40 in conjunction with § 3c para. 2 EStG. Other conceivable advantages would be the restriction of the German taxation law in relation to the corresponding double taxation agreements or a tax exemption according to § 8b KStG. The effect, which constitutes § 22 UmwStG with an abuse-avoiding character, is, however, carried out within seven years, so that the design abuse intention melts down by one seventh each year. Accordingly, it can be inferred from the legislator that an abuse character is lower the more time between conversion and the subsequent process to be implemented abusively.

With regard to § 42 AO, the examination ends after an offence of an abuse prevention provision afflicted by the Individual Tax Act has been fulfilled. The resulting legal consequences are therefore based on the standards of the Special Tax Act. Now it is necessary to clarify how something is to be judged if, for example, the UmwStG with its § 22 knows an abuse prevention provision, but because of a lack of a prerequisite does not apply effectively. In such cases, § 42 AO is generally used. A subsidiary effect is thus achieved. The tax liability thus arises under this provision to the extent that it would arise in economic transactions with an adequate legal structure. [] 14]

The proportionality between general law and special law abuse prevention regulations has long been controversial in this regard. [15] For this reason, one finds standardized in § 42 Abs. 1 sentence 2 AO that an event which applies to a situation formulated in the Individual Tax Act is determined in accordance with this standard. This clarifies the “relationship” between § 42 AO and other individual legislation aimed at combating tax avoidance. ‘[16] In contrast to the financial administration, the BFH sees it in several jurisdictions that even if special law provisions on the prevention of abuse are not met, recourse to § 42 AO does not necessarily apply. [17] If other legally abusive tax benefits are involved in measures, the field of application of § 42 AO is not restricted[18], but this seems to be of minor importance, since abuse prevention provisions of the individual tax laws address precisely these facts of § 42 AO.

The UmwStG only provides for abuse prevention provisions for certain restructurings, which means that restructuring as such generally does not have an abusive character. Much more is offered to the taxpayer relief for restructuring.

In the event that there are no restrictions whatsoever concerning any restructuring measures, it is necessary to clarify whether the positive tax effects arising follow the desired “overall planning jurisdiction” of BFH or are withdrawn in the absence thereof. By means of a failure of intermediate steps when using an overall planning jurisdiction, it is possible that a different and thus perhaps worse tax result can be assumed by the tax administration. This would result in the deprivation of tax-generated benefits.

In a large number of its judgments, the Bundesfinanzhof confirms that the legal appearance of the so-called “overall plan” is a typical application of § 42 AO.[19] Others are of the opinion that the overarching plan is not based on the norm of § 42 AO, but on an “overall economic consideration of several legal transactions”. ‘ [] 20]

In order to prevent commercial property trading, it is common to place a corporation between. This is rejected in the eyes of the BFH under the aspect of general planning jurisdiction. Another aspect that is considered with a critical eye is the relocation of essential operating bases in advance of a conversion in accordance with the initially mentioned §§ 20, 24 UmwStG. However, if this process is targeted for a longer period of time, this is considered harmless.[21] The aspect of the passage of time thus plays a relatively decisive role.

The aspect of inadequacy also plays a decisive role. If the tax arrangement leads to unintended tax advantages for the taxpayer, an inadequacy is usually assumed. Complicated and impracticable tax legal structure is therefore perceived as inappropriate, as the BFH also confirmed.[22] In the event of a change of legal form without any further factors occurring, the path of § 42 AO is in principle never taken, since such a restructuring measure is considered to be a thoroughly appropriate set of circumstances. This is different, however, if in a far-reaching restructuring individual intermediate steps are considered more closely and these can be rejected as unreasonable. Similarly, if a tax advantage is drawn by conversion, it is possible that inadequacy is maintained for the taxpayer. However, § 22 UmwStG provides for a blocking of § 42 AO, since § 22 UmwStG itself already codifies an abuse prevention provision. If § 22 UmwStG did not exist so restrictively, § 42 AO would come into effect.

The interposition of domestic corporations also does not give rise to any tax abuse if the intermediary corporation draws any tax consequences. This is different for foreign corporations. Inappropriateness is conceivable here if the “economic and considerable reasons” mentioned in § 42 AO are absent. [] 23]

The most important decision criterion is therefore definitely the component of durability, since with increasingly elapsed time it can be assumed that the occurring tax consequences were intended for a longer period of time.

3.3 Limitations of tax structure in commercial real estate trade

Even in a commercial real estate trade, there can be confrontations between legal tax design and misuse of design according to § 42 AO. As already mentioned in the previous section, an intermediary of a GmbH in commercial real estate trading is in principle not to be regarded as abusive if this intermediary GmbH carries out an active activity in order to generate revenue. [24] However, if the acquiring company was created solely for the purpose of buying and selling, even a previously not considered abusive intermediation of such a GmbH can be regarded as an abuse of design. If there are special circumstances relating to the forthcoming divestment transactions, such as the procurement of funds for the payment of the purchase price from the taxpayer’s private source, this is also accused of misuse of design. [] 25]

Even in the case of an intermediary, a company controlled by the taxpayer would be conceivable to realize an abuse of design in a single sales process, whereas the intermediary company generates only small profits in the commercialization of the land. [26] The inoperability of the intermediate company is of course a prerequisite here. In the present active activity of Zwischen-GmbH, this is in principle not considered to be functional, as a result of which misuse of design can primarily be excluded. This is the case, for example, if the limited company carries out the work of developing the acquired land. The freedom of choice of the legal form thus prevents a presumption of misuse of design according to § 42 AO. The choice of the legal form of the GmbH constitutes a limitation of liability due to the active activity of the intermediary company. Preventing personal liability of the partners is therefore only a logical reason.

The main focus for the delineation of an abuse of design or a tax arrangement within the framework of the tax laws regarding the interposition of a company for the purpose of a commercial real estate trade therefore lies rather in a functionality of the intermediary company. If this is functionless, if there is a misuse of design, if this carries out an active activity, one moves within the framework of a legal tax arrangement. The choice of legal form plays no major role here, as there is freedom of choice in Germany in this regard.

Technical advice for preventing design abuse

3.4. Limitations of tax structure in the Inheritance Tax Act and Gift Tax Act

In order to realize the event of an inheritance tax relevant donation, according to § 7 para. 1 No. 1 ErbStG the condition of enrichment by a free grant to the covered person be fulfilled. Such an enrichment is actually given when the enriched person can dispose of what he has devoted to him concretely and in relation to the person who provides it.[27] Whether an enrichment actually exists is a civil question.

If a property is now transferred to a person by donation and this person also hands this property to another third party, it is necessary to clarify whether the transferring intermediary has his own decision-making power with regard to the use of the property. [28] However, if something is turned to a transit or middle person, which he will give one hundred percent to a third person because of an already existing obligation, there is from a gift tax point of view only a donation of the donor to the latter third party.[29] The direct transfer of the donation absolutely excludes an enrichment of the middle person, which does not have any consequences for gift tax purposes.

From the point of view of § 42 AO, such a “chain gifting” is fulfilled as a circumvention if, for example, the gifted children of the donor are obliged to forward the gift mass immediately and unabated. As already mentioned in the two previous sections, the aspect of the temporal relationship is also of great importance. The direct transfer to a third party is considered here as an indication of a detour and thus constitutes an abuse of design. The gift would therefore go to the third party in full, whereby the burden of the gift tax would also be charged one hundred percent to the third party. Due to the omission of the allowance to which the transit person, here the children, would be entitled, this can lead to a much higher tax burden.

However, there are constellations which also fulfill the temporal aspect of the immediate transfer of the donation, but are designed with the transfer of the gift mass accordingly that the realization of an abuse of design according to the BFH decision does not apply.

In the case of donation of a condominium of the mother to her son by a notarial contract and transfer of the half of the condominium with a separate deed of donation of the son to his wife, who has also entered into the obligations linked to the original donation to the son, there is, according to the tax administration, an offence according to § 42 AO. From the BFH’s point of view, there is usually no misuse of design here. The son was enriched on half of the condominium, because he can actually and legally freely dispose of the turned, namely half of the condominium. According to BFH, tax considerations, such as the economic approach, have no bearing relevance.

From various judgments of the BFH it is clear that for the assessment of a so-called “chain gifting” the temporal context and the passing on of the gift mass is always used. If one of these aspects is not given, it is more likely to circumvent design abuse.

4th concluding remark

4.1. summary

In the main part of this seminar work it became clear that the boundaries between design abuse according to § 42 AO and legal tax design are relatively close together. In order to avoid an illegal tax structure, there are certain abuse prevention provisions in the respective individual tax laws in order to deny a tax refund that may be wrongly received from the outset. Such an abuse prevention provision can be found in § 22 UmwStG as an example. If there is a lack of a special legal standard to avoid an economic advantage, the general standard is used, namely § 42 AO.

Due to the tax code, significantly more issues are taken up, which restricts the tax structure immensely. The commercial real estate trade as well as the facts of chain or detour gifting are not standardized by law, which makes use of judicial case law.

If an intermediary company is used in a commercial real estate trade, it is only considered an abuse of design if it can be accused of functionlessness. However, if it carries out active activities, such as the construction of the building to be built and resold, an abuse of design is accordingly far away.

One focus of gift tax law is the transfer of the gift mass. If the transferred goods are given immediately and 100% to a third party, the transit person is not considered enriched. The temporal aspect should also not be overlooked here, since an abuse of design is also only assumed if the forwarding occurs with a separate document, but at the same time.

4.2. Summary

Due to the idea of saving money and thus taxes, there is an equally drastic legal change. By embedding various abuse prevention regulations, which are explicitly tailored to a certain fact, it can be seen that these cases are not necessarily far-fetched. In order to ensure that disputed cases, which have not been standardised to date, are also the focus of misuse of design, the general norm of § 42 AO is always used and it is decided by means of a supreme court decision that an illegal tax arrangement has occurred. Since an increasing complexity of tax law is perceptible, it can be assumed that there will be further abuse prevention regulations, which therefore creates a shielding effect compared to the General Law, because there is no concrete application of § 42 AO.