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A gift to a closely related person does not constitute a donation

The Federal Fiscal Court (Bundesfinanzhof, BFH) recently ruled on the connection between the deduction of donations against tax and gifts given to closely related persons. In view of the fact that the latter are not regarded as donations it is possible that constructive dividends could arise.

In its ruling of 13.7.2021 (case reference: I R 16/18), the BFH had to make a decision about the arrangements of a married couple devoted to art. They had founded a charitable trust and were the sole founders. The aim of the trust was to maintain artworks and, among other things, make them available on permanent loan to municipal galleries and museums. In this way, the objective of promoting art and culture was supposed to be accomplished.

In order for the trust to be able to fulfil its mission, the married couple donated a number of valuable works of art to their organisation and claimed a deduction for these as donations in their personal income tax returns. Besides the trust, both spouses also had a (non-charitable) corporation that, in turn, itself was the owner of the works of art. The married couple also arranged for this company, a GmbH [German limited liability company], to transfer its artworks to the trust in the form of a donation. To this end, the trust issued the appropriate donation receipts so that the GmbH would be able to deduct the donations in its corporation tax return. 

However, a tax auditor for the GmbH took a different view of the situation. These gifts were not donations in the conventional sense, but rather constructive dividends for the married couple. The case against this was unsuccessful both before the competent Cologne tax court as well as the BFH. In the opinion of the judges, a constructive dividend can also arise if the pecuniary benefit goes not to the shareholders or partners themselves but, instead, to such closely related (even legal) persons. In this case, the trust could undoubtedly be identified as a closely related person.

Outcome: A constructive dividend arose here because this was the only way that the trust could pursue its actual objective and, moreover, not just small amounts of money – as unrelated third parties would likewise give – were donated.

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