Taxation of non-profit organizations

The establishment of an organization (association, trust foundation, independent foundation and non-profit limited liability company) must be strictly distinguished from the recognition of non-profit status by the competent tax office for the organization.

The preliminary examination of the non-profit status should be carried out before the founding of the organization, so that in the end one does not establish an organization which is not allowed to carry out the charitable work.

The revocation of the non-profit status can be the consequence in case of misconduct of the organization.

At least 7 members are required to form the association and the number of members must not fall below 3.

Advantages of the association:

• The registered association is a legal entity, is recorded in the register of associations and can sue in its own name and be sued and be entered in the land register
• The association can be charitable as a corporation (GbR, for example, cannot be).
• The association is a basically democratic form of organization with equal rights and duties for all members.
• The foundation costs are relatively low
• No minimum capital is required

Disadvantages of the association:

The association is not insignificantly restricted in its freedom of action. For example, the following regulations must be considered:

• The association cannot limit its number of members without further ado. In principle, anyone who accepts the statutes must be accepted as a member.
• As a rule, the association cannot have any economic purposes (commercial or profit-making purposes) and may only engage in secondary and subordinate economic activities = special-purpose operation.
• The foundation has certain requirements, such as the creation of a statute and the election of the board of directors.
• The association is managed by the board of directors, but all members are allowed to participate in the decision-making process
• Accumulation of reserves is more difficult

Also known as a fiduciary, non-legally capable, dependent foundation.

The purpose of a trust foundation is to donate assets to a legal entity or natural person with the stipulation that the donated assets are to be used permanently to achieve the purpose determined by the founder.

Characteristics of the trust foundation

• Unincorporated foundation does not have legal capacity
• Participation in legal transactions requires the involvement of a trustee, who must manage the trust assets separately from his other assets. The trustee is the owner of the assets. Rights and duties of the trustee result from the trust agreement and from the foundation charter
• Foundation is possible without the involvement of a foundation supervisor
• No costs of foundation, except for possible consulting costs
• Short time of foundation in relation to an independent foundation
• No state recognition
• Tax and civil law treatment differ fundamentally:

Independent taxable entity in terms of § 1 Sec. 1 no. 5 German Corporation Tax Act

Dependent foundation must independently meet the

requirements of §§ 51 ff. German Tax Code; obligations to

submission of an own tax return

• Activity of the trustee for the dependent foundation is a taxable service (different for foundation funds, no VAT)
• Extended special expenses deduction according to § 10b 1a Income Tax Act (foundation allowance)
• Dependent foundation is suitable for sustainable, long-term foundation commitment; lower establishment and administration costs compared to independent foundation
• Same tax advantages as for an independent foundation
• Can be endowed with a smaller foundation capital
• Can later be “converted” into an independent foundation
• Can accept both endowments and donations
• Can issue donation and contribution receipts

The regulations on independent foundations can be found in §§ 80 ff. German Civil Code and the respective state foundation laws.

• Independent and legal entity under civil law; formation through recognition by the foundation supervisory authority of the respective federal state.
• Establishment requires foundation act and foundation statutes.
• Independent tax entity in the terms of § 1 Sec. 1 no. 4 German Corporation Tax Act – no divergence from dependent foundation.
• Establishment and administration of the foundation is associated with greater expense than in the aforementioned variants; here, too, however, the activity of third parties for the foundation by way of an agency agreement or the activity of banks within the scope of asset management is possible and permissible.
• A separate legal entity whose defining characteristics are assets, purpose and organization (at least board of directors).
• Binding the founder’s will and the foundation’s purpose.
• State foundation oversight monitors compliance with the foundation statutes and the implementation of the founder’s will.
• Financial supervision exclusively for the use of the foundation’s funds for the charitable purpose.
• Foundations are usually established for an indefinite period of time.
• Foundations enjoy a high reputation in society.
• State recognition and foundation oversight ensure legal certainty.
• Tax advantages for charitable and non-profit foundations:
• – no gift tax
• – no inheritance tax
• The foundation capital can be increased.
• The foundation can accept both endowments and donations and issue corresponding certificates.
• The preservation of the founder’s life’s work and personal values can be maintained.

Foundation Act

Form of the foundation transaction

Inter vivos:

• Written form
• Notarial certification in the case of property transfers
• Freely revocable until the foundation is recognized (§ 81 (2) 1 German Civil Code)

On account of death:

• Forms of will or contract of inheritance
• Attached articles of association must also satisfy formal requirement
• Heir can revoke foundation transaction unless founder/decedent has already applied for recognition (§ 81 Sec. 2 (3) German Civil Code)
• Supplementary authority of the foundation supervisory authority (§ 83 (2) German Civil Code)
• Foundation cannot be pre-inheritor (disputed) due to lack of permanent asset commitment
• Prior clarification of eligibility for recognition with the foundation authorities recommended (better: gradual formation)
• Formation with recognition, but pre-effect according to § 84 German Civil Code
• Problem of the lack of tax recognition of pre-effect (BFH BStBl. II 1996, 99 on the inheritance tax recognition of value increases between inheritance and recognition, BFH ZEV 2004, 85 on corporate income tax)
• Legal nature of the foundation between death of the founder and recognition (pre-foundation) is highly controversial!
• Coupling with execution of will required (to obtain recognition of foundation, to amend articles of foundation, etc.)

Foundation strukture

• Board of Directors = body authorized to represent the foundation externally
• Board of Trustees/Supervisory Board = Monitoring and supervisory body
• Advisory Board = Advisory body (e.g. scientific advisory board)
• Secretary General/Managing Director = Operationally responsible with authority to act

Recognition procedure

(independent foundation)

Only independent/legally capable foundations under civil law are subject to recognition.

Responsibility

Local

= Seat of the foundation

• Can be freely chosen by the founder
• Actual seat of administration
• Abuse control (str.) – “Forum Shopping

Competence

• Type of foundation (civil law – ecclesiastical – municipal – public law)
• Foundations in terms of §§ 80 ff. German Civil Code: Foundation authority

Legal nature of the recognition

= administrative act shaping private law

• Renamed by law on the modernization of the foundation system: formerly “approval”
• Founder’s legal entitlement to recognition, § 80 Sec. 2 German Civil Code

(=subjective public law)

• Legal protection: action for obligation to grant recognition as favorable administrative act
• Foundation only comes into existence as a legal entity upon notification of recognition to applicant or executive board.
• „Pre-foundation” with its own legal personality; however, according to prevailing opinion, donations to pre-foundation are permissible.

Procedure of the recognition process

• Consultation
• Preliminary examination of articles of association and foundation business
• Parallel: Clarification of the formal compatibility of the articles of association with the requirements of the tax code (in the case of non-profit status) with the tax authorities; these issue a provisional certificate (protection of confidence, cf. BMF letter dated 17.11.2004 – IV C4 -SO 171-120/04)
• Application
• Recognition and announcement to the board
• Announcement of recognition
• Entry in the register of founders (entry has no guarantee of correctness/protection of good faith).

The non-profit corporation (UG=entrepreneurial company, GmbH=limited liability company or AG=stock company) is not a special form, but it is a normal GmbH, which fulfills non-profit purposes due to the German Tax Code and the articles of association.

The certainly most important reason is the tax concession granted to the company due to its non-profit status (by the tax office).

• Profits must be used for the charitable purpose and the shareholders do not receive any profit distributions.
• Relatively low initial capital: 1,000 euros, 25,000.00 euros or 50,000 euros.
• The corporation is entitled to accept donations and issue donation receipts. The company may also accept donations in kind and issue donation receipts.
• The non-profit corporation is not subject to any supervisory authority like the foundation
• A charitable foundation or association can be a shareholder of a charitable corporation. However, they are two independent legal entities with their own rights and obligations
• The corporation can offer both taxable services (such as fee-based seminars) and tax-exempt services as fulfillment of its purpose
• The purpose can be changed
• The company can be dissolved
• May issue donation and charitable contribution receipts
• May include the name “Foundation” as part of the corporation name

A family foundation is a foundation that is essentially established in the interests of a family or certain families (§1 Sec. 1 No. 4 Inheritance Tax Act).

The Federal Fiscal Court (judgement of 10.12.1997, ZEV 1998, 122) points out that “according to the articles of association and, if applicable, the foundation transaction, its essence is to enable families to use the foundation assets, insofar as they are available for private use, and to draw the foundation income to themselves. The extent to which this is actually used is not decisive.”

The tax authorities (Inheritance Tax Act R 2 Sec. 1-3) assume a family foundation if:

• The founder, his relatives and his descendants are entitled to receive and accrue more than half or
• more than one quarter of the beneficiaries are entitled to receive and accrue benefits and additional characteristics prove a family interest, e.g. significant influence on the management of the company.

In addition to the entitlement to draw, significant family interests consist in the use of foundation assets at a discount or free of charge (e.g. real estate, personnel, art holdings).