1. Beneficial tax regimes
In Germany, upon application, public-purpose entities may be granted a tax-exempt status, exempting them from German corporate income tax and trade tax. Such tax-exempt status may also result in a VAT-exemption or reduced VAT rate for services provided by such entity, depending, however, on the specific type of service rendered.
Otherwise, if tax exemption is not granted, entities would be subject to a tax burden of roughly 30% on their taxable income. The same tax burden applies in general, if tax-exempt status is granted to the extent that the tax-exempted entity receives income in its taxable “business sphere” income category (discussed further below).
Recently, the German nonprofit tax law regulations have been loosened to also cover cross-border activities.
2. Legal options
The legal options for operating a non-profit organisation in Germany comprise of entities potentially in the scope of German corporate income taxation. Hence, tax-transparent partnerships are excluded.
Common types of non-profit entities in Germany are:
- company (specifically gGmbH )
- foundation (Stiftung) and
- registered association (eingetragener Verein, “e.V”)
Resident or non-resident entities from other EU jurisdictions may also benefit from such tax privileges, provided they meet the requirements stipulated by German tax laws. This new option is due to case law from the European Court of Justice.
3. Costs and timing of establishing a relevant entity
The costs and timing of setting up a relevant entity depends on the legal option to be pursued. The most straightforward approach, in comparison to a foundation (Stiftung) and a registered association (eingetragener Verein) should be using a non-profit limited company (gGmbH). Other than a foundation, a gGmbH is not subject to foundation supervision approval requirements from the respective local supervising authority. Further, provided the gGmbH’s statutes as well as the actual activity pursued by the gGmbH reflect the tax law requirements, company law may be applicable. Hence, a gGmbH structure is more flexible than a foundation or a registered association. A non-profit gGmbH may also use a trade name containing “foundation” or “Stiftung.” In that case, however, the gGmbH should be funded generously in order to achieve registration with the commercial register.
A downside of a gGmbH structure may be that such an entity would have to annually prepare and disclose financial statements.
Overall, following legal changes, the gGmbH has become the most popular type of operating non-profit activities.
A gGmbH can be set up and registered within less than a month and for moderate fees and costs, apart from the statutory share capital. However, this does not reflect the time and costs it takes to achieve a decision on the tax-exemption by the competent tax authority.
4. Tax law requirements
Entities may be granted a tax-exempt status in advance if they pass a review of their founding documents in a specific procedure. One of the benefits of such advance exemption is that entities may start to collect tax-deductible donations. Nonetheless, they remain subject to full audits by tax inspectors.
The entity’s founding documents (statutes, Articles of Association or similar) as well as the actual activity of the entity must reflect the following aspects in order to benefit from a tax-privileged status:
4.1 Purpose of the entity
The entity must directly and exclusively pursue (i) charitable or (ii) public-benefit purposes within the meaning of the chapter “Tax-Privileged Purposes” of the German Fiscal Code. While “charitable purposes” are limited to activities dedicated specifically to poor, dependent or disabled people, “public-benefit purposes” cover a wide range of activities.
Further, it needs to be described how this objective is supposed to be pursued.
4.2 Non-profit character and use of funds
The activities of the entity need to be of an altruistic nature. The entity must not have any economic purposes of its own.
The assets and financial means of the entity may only be used for the purposes as defined in the Statutes. No shareholder may receive any financial benefit from funds of the entity. No person may benefit from expenditures that are not related to the purpose of the entity or through inappropriately high allowances or payments. There may not be legal entitlements to receive benefits from the entity.
4.3 Dissolution of the entity
In case of the dissolution or annulment of the entity or in case tax-exempting purposes cease to apply, the entity’s assets must be transferred to another tax-exempted entity, which has to directly and exclusively use it for charitable or other public-benefit purposes. In these events the shareholders may not receive more than the paid-up capital and the value of the assets contributed by them from the entity.
4.4 Tax treatment of income received by non-profit entity
Even if an entity is recognised as being tax-exempt by the tax authorities that entity may still be taxable with sources of income received.
Funds received by a tax-exempted non-profit entity are attributable to either the:
- “ideal sphere” of the entity (not taxable /e.g. donations)
- asset management (not taxable /e.g. renting out an asset)
- “business sphere” (taxable /e.g. operating a business), or
- “special-purpose business sphere” (not taxable/i.e. a business that serves and is required for the non-profit purpose of the entity)
Hence, even if an entity achieves tax-exemption it may still be partially taxable with its received funds, unless this can be regarded as (i) pure asset management, (ii) special-purpose business (Zweckbetrieb) or (iii) donations and similar contributions provided by donors to serve the ideal purpose of the entity
4.4.1 Tax-exempted asset management?
If existing assets are being used by the tax-exempted entity to derive income, without creating new assets in the process, this may be regarded as non-taxable asset management. This applies mainly on real properties owned and partly rented out by nonprofit entities. However, if an existing intangible asset (IP) is being rented out this may be regarded as asset management as well. In general, the requirements for tax-exempted asset management are strict. For example, ancillary services to renting out an asset may not be provided.
4.4.2 Tax-exempted special-purpose business?
For a tax-exempted special purpose business, it would have to be demonstrated, that (i) this business serves the public-benefit purpose of the entity, (ii) fulfilling the entity’s public-benefit purpose actually requires to exercise this business and (iii) that this business activity does not compete with similar activities of non-privileged taxpayers to a greater extent than necessary.
5. Final remarks
Today’s tax-exemption rules in Germany have been broadened to cover also cross-border public-purpose activities. Hence, an entity may be recognized as tax-exempted (thus being able to issue certificates to donors for tax-deductible donations) even if a charitable purpose or other not-for-profit purpose is being pursued abroad. However, requirements to achieve a tax exemption in these scenarios are strict.
In a specific procedure available for potential not-for-profit entities the German tax authorities review draft documentation and grant/reject tax-exempt status in the process, subject to a retroactive review of the actual activities in the following. In the process, further requirements from a non-profit tax law perspective regarding (i) the exercise of the activity and the monitoring of the use of the funds and (ii) aiming at clearly separating a non-profit entity from any potential genuine business activity pursued by its shareholder would have to be considered.