In this way, a foundation can serve as a means for an entrepreneur to assume social responsibility, strengthen the image and reputation of his company, preserve a legacy for the long term, ensure control over and the proper use of financial resources, or take advantage of tax benefits. A foundation can generally be operational by running a business itself (business-operating foundation). It can also hold an equity interest in a company as a shareholder (investment-holding foundation). In particular, the legal form of the “Stiftung & Co. KG” is becoming increasingly common in practice, for example, among companies in the food retail sector.
From a tax perspective, the key distinction is whether a foundation pursues economic purposes (private-benefit foundation) or promotes the public good (public-benefit foundation).
In the following, we will explain the legal and tax fundamentals of a charitable foundation—that is, a foundation dedicated to promoting the public good and thus, in a sense, a foundation “in the true sense of the word.”
We will then examine the foundation as an instrument of business succession. In particular, the so-called family foundation is often chosen when an entrepreneur does not see a suitable successor within his or her family but wishes to preserve the business beyond his or her death and ensure that his or her relatives are at least financially secure.
In the following discussion, we will focus on establishing a foundation during the entrepreneur’s lifetime.
1. The Charitable Foundation
Many entrepreneurs are committed to promoting the common good by, for example, supporting initiatives for socially disadvantaged people, for art and culture, for sports, for integration, for nature conservation, or for combating global crises. But why not establish your own foundation and continue your social commitment even beyond death?
There is no doubt that by establishing their own foundation, entrepreneurs create a lasting legacy for themselves and their companies. Above all, the “idea of permanence” inherent in a foundation underscores that the entrepreneur has decided to make a serious and lasting commitment to charitable causes. A company’s image improves among business partners, employees, and the public, and involvement in social and environmental projects can also be attractive from a sustainability perspective in terms of Environmental, Social, and Governance (ESG) criteria.
a) But at what amount does it make sense to establish a foundation?
There is no fixed minimum capital requirement for establishing a legally independent charitable foundation.
However, a prerequisite for the recognition of a foundation with legal capacity is that the permanent and sustainable fulfillment of the foundation’s purpose appears to be assured. The endowment is the foundation’s material basis, which—unless otherwise specified in the bylaws—may not be depleted (“principle of capital preservation”). The foundation generates income from this endowment, which must be used promptly to fulfill its charitable purpose. Whether this is sufficient to fulfill the foundation’s purpose depends on the charitable projects the foundation plans to undertake. During the recognition process, the foundation authority examines whether the pledged assets and, if applicable, any additional expected funds allow for a positive viability prognosis. If an entrepreneur transfers his or her corporate interest to a foundation established by him or her (a holding foundation) and designates this interest as part of the endowment, he or she may, depending on the provisions in the articles of incorporation, stipulate, for example, that the interest must be permanently preserved. The foundation then has the option of receiving tax-free dividend distributions from the equity interest and using these for charitable purposes.
If there is initially insufficient capital to establish an independent foundation, it is also possible to establish a legally dependent foundation (referred to as a “trust foundation” or “fiduciary foundation”). A non-independent foundation is a special-purpose trust fund managed by a trustee. The trustee’s rights and obligations arise from a trust agreement entered into with the founder or from a conditional gift to which the founder attaches the donation. Under certain conditions, a dependent foundation may nevertheless be recognized as a separate entity for tax purposes and classified as a nonprofit organization. It is also possible to “convert” a dependent foundation into an independent foundation.
Alternatively, it is also possible to increase a foundation’s endowment through a so-called additional endowment. Furthermore, a consumable foundation can represent an interesting alternative to a traditional foundation. Its nature is characterized by the fact that the foundation’s assets themselves may be used up to fulfill the foundation’s purpose. By drafting the articles of incorporation accordingly, it is also possible to establish partial consumable foundations (also known as “hybrid foundations”), optional consumable foundations, as well as to convert “normal” foundations into consumable foundations and vice versa.
b) And what are the legal implications?
The biggest difference from a business organized under one of the familiar corporate forms is that the foundation—and thus the assets transferred to it—belongs to itself. Thus, there are no shareholders who own the foundation, and even the founder has only limited ability to influence the foundation, unless this right is expressly reserved in the foundation’s articles of incorporation. The foundation’s articles of incorporation and the deed of foundation are the key documents for establishing a foundation. They define the assets transferred to the foundation, the charitable purpose for which the donated assets or their income are to be used, and the internal organization of the foundation. Foundation law has now been uniformly revised at the federal level in the German Civil Code (BGB). The foundation supervisory authority monitors compliance with these regulations. It is also responsible for the recognition process. Even though this may seem very “rigid” at first glance, a wide range of provisions can be established to best implement the founder’s intentions. Typically, the founder (possibly together with others) forms the foundation’s board of directors during his or her lifetime and may reserve the right in the foundation’s bylaws to amend them during his or her lifetime to accommodate changing circumstances.
However, one issue the founder should also address is how the foundation should be structured and operate after the founder’s death.
c) What is the significance of charitable status?
Formal recognition as a nonprofit organization means that the foundation’s income—such as donations, surpluses from asset management, and proceeds from certain permitted economic activities that serve the foundation’s charitable purpose—can be received free of income tax. The tax exemption does not apply to income generated by an economic activity that does not simultaneously serve the charitable purpose (“taxable economic business operations”).
For a foundation to be recognized as a nonprofit, both its articles of incorporation and its actual management must comply with the requirements of tax law governing nonprofit organizations. From a tax perspective, the foundation’s purpose must be directed toward pursuing charitable, benevolent, or religious purposes as defined by the German Tax Code. If a foundation pursues tax-privileged purposes, it must do so selflessly, exclusively, and directly. It must use donations and income promptly for its statutory purposes (“principle of prompt use of funds”). The tax office reviews whether the foundation meets these requirements and, if applicable, issues a corresponding determination notice.
d) And what tax benefits does the founder receive?
The endowment of a charitable foundation is exempt from inheritance and gift taxes. This also applies for real estate transfer tax purposes, provided that the transferred assets include real property.
If the founder additionally allocates funds to the foundation—for example, money via bank transfer—he or she may deduct the donation as a special expense to reduce taxable income up to an amount equal to 20% of his or her total income, or, if the founder is a sole proprietorship or a partnership, up to four per mille of the sum of total sales and wages and salaries paid during the calendar year as special deductions that reduce taxable income (“maximum limit”).
The donor may also make contributions to the foundation’s endowment. In this case, upon application as part of the income tax return (therefore not applicable to corporations), up to a total amount of EUR 1,000,000 may be deducted as special expenses for tax purposes in the year of the contribution and in the following nine assessment periods (up to EUR 2,000,000 for married couples).
If a donor wishes to transfer a specific asset from their business to the charitable foundation free of charge—such as a building or a valuable work of art that is part of the business’s assets—the so-called “book value privilege” may generally be claimed for this purpose. This provision constitutes an exception to the general principle that, in the case of withdrawals from business assets, the difference between the book value and the fair market value of the withdrawn asset is normally taxable as a realization of hidden reserves. A transfer to the foundation is therefore possible on a tax-free basis.
If an entrepreneur has no descendants or other close family members whom he or she wishes to include as successors in the business, and if selling the business to provide financial security for family members is neither desired nor necessary, a charitable foundation can generally also become a shareholder in the company—for example, through a bequest— become a shareholder in a company. In this context, particular attention must be paid to the interplay between corporate, foundation, and inheritance tax laws.
2. The Family Foundation
A family foundation is an independent or fiduciary foundation that generally serves exclusively or primarily to provide for the needs or interests of the members of one or more families. In addition to tax considerations, civil law considerations—such as preserving the family’s assets from fragmentation—are often the decisive factor in practice.
The founder may issue instructions and specify details regarding the management of the assets as well as with respect to specific assets (e.g., a prohibition on sale or sale only under certain narrowly defined conditions). In this respect, the family foundation offers absolute protection against the fragmentation of assets through inheritance, which is not possible, for example, when assets are transferred to a corporation.
Another objective may be to establish a succession plan for a business. If the foundation owns businesses or equity interests in companies, these can be managed by the foundation. Family members may exercise direct influence over the company only to the extent permitted by the founder in the foundation’s articles of incorporation or through the inclusion of family members in the foundation’s governing bodies. It is also conceivable for the foundation’s governing bodies to be composed entirely of external members.
The private-benefit family foundation is subject to the general taxation principles applicable to corporations. In addition, the family foundation’s assets are subject to substitute inheritance tax every 30 years.
