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Tax planning by means of a usufruct in favour of children

The transfer of a source of income to (under-age) children via the establishment of a gratuitous usufruct has to be recognised for tax purposes if no further tax advantage arises for the provider of this benefit apart from the transfer of taxable income. This was the decision of the Federal Fiscal Court (Bundesfinanzhof, BFH), in its ruling of 20.6.2023 (case reference: IX R 8/22) and, in this respect, it has opened up structuring options for tax optimisation within a family. There are however a number of pitfalls that you need to watch out for here.

Issue – Transferring income to children

The parents were the owners of a property rented out to third parties and, for a limited period, they granted both of their under-age children a usufruct related to the property (usufruct of a benefit). This meant that, for the duration of the usufruct, the children would assume the position of the landlord, be entitled to the rental income and it would also be allocated to them for tax purposes. In the case in question, as the children did not have any other income, after applying the basic personal tax allowances, no tax arose on the rental income, whereas this income would have been subject to a high rate of tax if it had been allocated to the parents. The local tax office however viewed the arrangements as an abuse of structuring options and refused to recognise the transfer of the income to the children.

Transferring a source of income by way of the usufruct of a benefit does not constitute an abuse of the law

The BFH however took a different view of the arrangements. In the context of an overall assessment, the transfer of a source of income that results in a tax advantage will be the consequence of a situation that has to be recognised for tax purposes and, in this respect, it is ‘provided for’ under the law and, therefore, will not constitute an abuse of the law. This would only be different if further tax advantages accrued that it would otherwise not have been possible to use. This would have been the case, for example, if the parents had leased back the property from the children for commercial purposes and would thus have been able to deduct the rent as a business expense – something that would otherwise not have been possible.

By contrast, the court did not view the transfer of a source of income that likewise serves the purpose of fulfilling a maintenance obligation as being detrimental from a tax point of view. Parents may decide whether they provide support for their children in the form of cash or by (temporarily) giving them a source of income. 

Helpful information on tax depreciation and gift tax

(1) Tax depreciation – It should be noted that in the case of a gratuitous usufruct of a benefit related to a property it would no longer be possible to make use of the depreciation of the building for tax purposes. The owners (parents) would no longer generate any income from the property and the children would not have to bear any depreciation in value. The arrangement would therefore be considered mainly for properties that have already been fully depreciated.

(2) Avoiding gift tax – The granting of a gratuitous usufruct is subject to gift tax. However, in this case, a tax-exempt amount of €400k is available to each parent and child; moreover, this exempt amount can be claimed once every 10 years. That is why, in the case in question, the usufruct was accordingly granted for a limited period of time in order to keep the value of the gift within the tax-exempt parameters.

Please note: As always with close relatives, in order for the agreements that are made to be recognised for tax purposes they have to be legally effective in terms of civil law, seriously intended and actually implemented as agreed. In the case of property, the usufruct agreement including the entry in the land register has to be certified by a notary. In the case of children who are still under age, it will additionally be necessary to appoint a supplementary guardian.

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