Correspondence principle for hidden contributions (Sect. 8(3) sent. 4 of the Corporate In-come Tax Act)

(Limited) separation between company and shareholder

The taxation of corporations and shareholders follows the "separation principle," which, as a "basic principle of tax law governing the separate taxation of individual tax subjects" (Judgment of the Federal Tax Court dated November 2, 2022, file number I R 37/19, margin no. 17), fundamentally discourages any "interaction" between their tax treatment. Tax law does not provide for a "general principle of correspondence" according to which, for example, the tax assessment in the tax assessment notices of different taxpayers would have to be carried out correspondingly. In the opinion of the Federal Fiscal Court, such "unconditional interdependence would be incompatible with the principle of individual taxation" (Judgment of the Federal Tax Court dated March 30, 2017, file number IV R 13/14, margin no. 30). However, the legislature deliberately stipulates such interactions in income tax law in some places. This mutual dependency is particularly prominent, for example, in Sect. 22 No. 1a of the Income Tax Act, which only assumes other income (“sonstige Einkünfte”) "insofar as the requirements for special expenditure deductions for the party obliged to perform or pay under Sect. 10(1a) are met”.

Such dependencies are also specifically stipulated by law for the relationship between corporations and shareholders. On the one hand, this applies to Sect. 8c of the Corporate Income Tax Act, whereby a legally qualified transfer of shares in the corporation by the shareholder leads to the loss of several loss positions at the level of the corporation (Sect. 8c of the Corporate Income Tax Act, Sect. 10a sent. 10 of the Trade Tax Act, Sect. 8a(1) sent. 3 of the Corporate Income Tax Act). 

On the other hand, over the years, the legislature has continued to expand the so-called "correspondence principles". Distributions by corporations are governed by this principle in Sect. 8b(1) sent. 2 ff. of the Corporate Income Tax Act, which corresponds to Sect. 3 No. 40 sent. 1 lit. d sent. 2 et seqq. of the Income Tax Act and Sect. 32d(2) No. 4 of the Income Tax Act. The benefits resulting from a reduction in the tax base or a reduction in the tax rate are only granted to the shareholder to the extent that the distributions in question have not reduced the income of the paying corporation. Insofar as there is a reduction, however, the shareholder is denied the benefit. This is accompanied by the "formal correspondence principle" of Sect. 32a(1) of the Corporate Income Tax Act, which creates the procedural basis for such dependencies.

Substantive correspondence principle for hidden contributions

In the "opposite direction" – i.e., from the shareholder to the company – the correspondence principle is also required for hidden contributions. Hidden contributions do not increase income (Sect. 8(3) sent. 3 of the Corporate Income Tax Act), so any income-related entries must be corrected off-balance sheet. However, income increases to the extent that a hidden contribution has reduced the shareholder's income (Sect. 8(3) sent. 4 of the Corporate Income Tax Act). The provisions of Sect. 6(6) sent. 2 of the Income Tax Act require that a hidden contribution to the shareholder leads to an increase in the acquisition cost of the participation in the corporation by the market value of the asset contributed. Insofar as this legal consequence is not implemented, this situation remains untouched and unaltered. At the level of the receiving corporation, however, the off-balance sheet deduction of the income effects of the hidden contribution is denied. Sect. 32a(2) of the Corporate Income Tax Act also provides procedural "assistance" in this regard. Additional questions arise in "triangular cases" (Sect. 8(3) sent. 5 of the Corporate Income Tax Act; first "Cyprus ruling" of the Federal Fiscal Court, Judgment dated June 13, 2018, file number I R 94/15).

The substantive correspondence principle for hidden contributions was originally introduced to accompany the application of Sect. 8a of the Corporate Income Tax Act (old version) to foreign shareholders (Circular of the Federal Ministry of Finance dated April 15, 2004, margin no. 27). The case law of the Federal Fiscal Court must now currently clarify the details, such as whether foreign shareholders resident in the EU are also to be included in the regulation (rejected in stay of execution proceedings by the Fiscal Court of Saxony, judgement dated October 10, 2025, file number 8 V 1126/25; appeal currently pending at the Federal Fiscal Court, file number I B 39/25).

The Federal Fiscal Court now also had to rule on the regulation of the substance based correspondence principle in the appeal proceedings featuring file number I R 40/23: It also applies to natural persons as shareholders, in this respect in accordance with the lower court (Fiscal Court of Mecklenburg-Pomerania, judgement dated May 16, 2023, file number 1 K 330/18). In addition, the Federal Fiscal Court has now ruled that the failure to tax a fictitious capital gain under Sect. 17(1) sent. 2 of the Income Tax Act at the shareholder level in the case of a hidden contribution of shares in a corporation does not constitute a reduction in income within the meaning of Sect. 8(3) sent. 4 of the Corporate Income Tax Act.

Surprising twist in the substance based correspondence principle in the case of hidden contributions

The exception to the application of the substance based correspondence principle in the case of hidden contributions, particularly of shares within the meaning of Sect. 17 of the Income Tax Act, came as a surprise in this respect. It was relatively clear that natural persons with shares as part of their private assets could also trigger a hidden contribution with the application of the correspondence principle (margin no. 21-23).

However, an exception to Sect. 8(3) sent. 4 of the Corporate Income Tax Act for shares within the meaning of Sect. 17 of the Income Tax Act had not been anticipated: Sect. 17(1) sent. 2 of the Income Tax Act equates the hidden contribution of such shares to a corporation with a sale at fair market value (Sect. 17(2) sent. 2 of the Income Tax Act). This tax consequence had not been implemented in a binding assessment notice on the shareholder level – and, in the opinion of the Federal Fiscal Court, cannot be corrected by Sect. 8(3) sent. 4 of the Corporate Income Tax Act at the expense of the corporation. In this respect, the Federal Fiscal Court 's core argument (margin no. 27) is that there was no reduction in the shareholder's income, but merely a "failure to record a (fictitious) increase in income". This differs, for example, from a hidden profit distribution, where the "reduction in assets or prevented increase in assets" is generally treated in the same way (Sect. 8.5(1) sent. 1 of the Corporate Income Tax Guidelines). In addition (margin number 28), taxation could be made up for later – when the shares are actually sold.