Provision of residential property to managing directors

Shareholding managing directors of a limited liability company are frequently faced with the question of whether they should cover their own housing needs with private funds or if their limited liability company should construct the residential property and leave it to them for use. The advantage of such arrangements can especially be found in the area of VAT. To benefit from those advantages, certain conditions must be fulfilled.

Overview

A managing director with a substantial shareholding (> 25 %) can also satisfy the housing needs by having residential property constructed by his or her own limited liability company and having the limited liability company grant the right to use the building. If there is no substantial shareholding, other principles apply and managing directors are subject to wage tax.

Under certain conditions, the full input tax deduction (up to 20 %) can be claimed for the building or acquisition of the residential property, while the income from renting out the property is taxed at the reduced tax rate of 10 %. This is a significant advantage of this arrangement.

The question in which cases the input tax deduction is possible has repeatedly occupied the fiscal and administrative courts in recent years. In particular, the most recent decisions aimed to provide clear criteria for this question. It was specifically clarified under what circumstances the input tax deduction for the corporation which build the apartment for their managing director is to be denied.

Refusal of the input tax deduction

In the following circumstances, the corporation which construct the apartment is not entitled to an input tax deduction:

1. Mere transfer of use to the shareholder:
   If a limited liability company grants the use of a residential property to a person close to the firm to provide a benefit to the person and not to generate income, there is no economic activity and thus no right to deduct input tax. In this regard, the overall picture of the circumstances must be considered and a comparison must be made with the situation under which a rental activity is usually carried out.
   
   
2. Hidden distributions at its core:
   A hidden distribution is assumed when the building is intended for the private use of the shareholders, meaning it is a particularly representative residential building. In this case, the input tax deduction is denied if the actual rent does not reach close to the current market rental rates.
   
   
3. “Classic” hidden distribution:
   This case concerns the renting of buildings that can be ordinarily used in business operations. If the agreed and paid rent deviates significantly from the rent that is considered reasonable, the input tax deduction will be rejected. This is the case if the agreed rent is less than 50 % of the rent that is considered to be reasonable. If a rental market exists in that area, then the current market rate of rent can be used as a comparative value. Otherwise, the return on the investment, which according to case law must be approximately 3 - 5 %, is used as a comparative value.

A further case of hidden distribution can occur if the apartment becomes available as a further reward for the activity as managing director (ie no rent is paid for it, but the flat represents a benefit in kind). The first step is to check the amount of the total remuneration of the managing director is in an arm's length comparison (ie in comparison to a managing director who is not shareholder of the limited liability company). The total remuneration consists of the cash salary and the value of the use of the flat (plus any other remuneration). If the value of the use of the apartment is set at the market price, the ordinance on non-cash remuneration for employees cannot be applied.

If the total remuneration proves to be excessive, this constitutes a hidden distribution of profits. If in this case at least half of the market price for the use of the flat is not covered by an arm's length remuneration for the managing director, this is predominantly a hidden profit distribution, and no input tax deduction is available.

Possibility of input tax deduction

Conversely to these negative criteria, input tax deduction is generally possible in the following cases:

1. Living space is provided to the managing director for a consideration and the consideration is sufficiently high. This judgement is based on the current market rent or yield rent. The consideration for renting the accommodation is subject to a VAT rate of 10 %.
   
   
2. The residential property can be used for business purposes (therefore the property is not exclusively designed for the personal needs of the managing director) and
   • the rent agreed and paid is higher than half of a market rent (or a yield rent), or
   • at least half of the market price for the use of the flat is covered by an arm's length remuneration of the managing director.

In these cases, the input tax deduction is granted, but the VAT to the market rent must be paid at a rate of 10 % (so-called barter-like turnover), even if the rent is not actually paid.

Other tax aspects

In addition to VAT, other taxes must also be taken into consideration in these arrangements. If input VAT can be deducted for the building investment, it must be considered by the limited liability company. The rent charged increases the taxable profit, VAT must be paid on it and the payment in kind increases the ancillary wage costs (in particular employer's contribution, surcharge on employer's contribution, municipal tax). In the case of the managing director, the value of the use of the flat must be taken into account as income, which leads to an increase in income tax and social security contributions.

Conclusion

In summary, the provision of housing by a company to its managing directors can result in tax advantages. However, several framework conditions must be observed for these arrangements, which should be clarified in advance. Finally, in addition to VAT and income tax criteria, economic and personal aspects must also be taken into consideration. Taking all these factors into account, it is clear that the managing director's flat is a complex issue where good advice is valuable.