The decision was based on a case in which the claimant held a life-long right of usufruct over a property she was letting. As part of the sale of the property by the owner, she waived her right of usufruct and received consideration in return.
The dispute with the tax office arose because the latter sought to subject the payment made to the usufructuary to income tax as income from a private disposal transaction pursuant to Section 22(2) in conjunction with Section 23(1), first sentence, No. 2 of the Income Tax Act (EStG). However, given the rental income the usufructuary had received prior to the waiver, the Federal Fiscal Court (BFH) did not accept this basis for the claim and instead relied on Section 24(1)(a) of the Income Tax Act (EStG) in conjunction with Section 21(1), first sentence, No. 1 of the Income Tax Act (EStG), classifying the payment as compensation for lost rental and leasing income ( ).
The BFH hereby reverses a decision of the 10th Senate from 1992, which was also followed by the Federal Ministry of Finance in its Usufruct Circular of 30 September 2013, and according to which the redemption of a conditional or testamentary usufruct in return for a one-off payment was to be regarded as a non-taxable reallocation of assets. A legal transaction that was previously tax-exempt thus becomes taxable.
If one follows the Federal Fiscal Court’s reasoning – namely that the core economic substance of the right of usufruct is the right to generate income and that the usufruct otherwise has no independent value – there is little to object to in the grounds for the judgement. The legal classification under the relevant provisions of the Income Tax Act is flawless. The only cause for unease arises with regard to the outcome of this legal classification, which means that the owner of a let property, whom sells it 10 years after acquisition, is not required to pay tax on any capital gain realised, whilst the usufructuary, regardless of the duration of their legal entitlement, must always be subject to income tax on the consideration received for waiving their rights in future.
However, the 9th Senate has left open the question arising from this case law which is relevant in practice and will be of great interest in the future. The question is whether the new case law also applies if the property was not being let by the usufructuary at the time of the waiver. In any event, the law refers to compensation granted as a substitute for lost or future income, whereby it is the future income in particular that is of interest in this context. Since rental income may cease or be lost at any time – for example, as a result of a notice of termination or the tenant’s insolvency – it could be argued that, for the purposes of taxing the consideration for the waiver, it is irrelevant whether the property was actually let at the time of the waiver. A vacancy brought about by a notice of termination or deliberately accepted with a view to a planned sale of the property could, for its part, be subject to allegations of an abuse of rights, provided it serves solely the purpose of avoiding taxation of the usufructuary.
One thing is certain in this regard: with its ruling, the Federal Fiscal Court (BFH) has opened a new chapter that will occupy legal practice and case law for some time to come.
Conclusion
The amended case law of the Federal Fiscal Court (BFH) necessitates forward-looking consideration when establishing a usufruct in view of a subsequent sale of the property.
Where usufruct rights have already been established, tax avoidance measures should be discussed at an early stage with a view to a sale of the property.
Key points in brief
- Under amended Federal Fiscal Court (BFH) case law, the waiver of a usufruct in return for payment triggers income tax
- The popular gift subject to a right of usufruct will need to be carefully considered in future
- The sale of a property subject to a right of usufruct will require careful preparation in future
