Where shares in partnerships are sold, the capital gain is subject to tax (Sections 14, 16 and 18(3) of the Income Tax Act (EStG)). However, the capital gain may be subject to a preferential tax rate under Section 34(1), (3) of the Income Tax Act.
It is not uncommon for so-called earn-out clauses to be agreed in the relevant share purchase agreement. These are variable components of the purchase price, the basis and/or amount of which depend on the achievement of certain future turnover or profit targets. Earn-out clauses are agreed to reconcile the often divergent views of the seller and the buyer regarding a company’s profitability and to share the resulting risk between the parties. Only if the targets are met is the variable component of the purchase price payable in addition to the fixed purchase price.
As it will only become clear well after the conclusion of the sale and purchase agreement whether the condition for the variable purchase price component is met, it is questionable whether the variable purchase price component should be taken into account when determining the capital gain with effect from the date of disposal, and whether a tax assessment that has already been issued should be revoked, or whether the variable purchase price component is to be taxed entirely independently of this as subsequent income in accordance with Sections 16, 24(2) of the Income Tax Act (EStG). This depends on whether the fulfilment of the condition constitutes a retroactive event in accordance with Section 175(1)( 2 of the German Fiscal Code (AO), which would mean that the variable portion of the purchase price would have to be included in the tax assessment at the time of disposal and the reduced tax rate would then also apply to this portion of the purchase price. Similar questions arise in other scenarios as well, for example where additional (share) option rights are agreed.
The Federal Fiscal Court (see, inter alia, the judgement of 9 November 2023 – IV R 9/21, NV) adopts a special approach in the case of such profit- or turnover-dependent variable purchase price components, at least where the basis and amount of the purchase price component are still uncertain at the time of disposal. In such cases, these uncertain purchase price components are not to lead retroactively to an increase in the capital gain, but are to be taxed as current, subsequent income in accordance with Sections 16 and 24(2) of the Income Tax Act (EStG). The Federal Fiscal Court (BFH) has most recently left open the question of whether this also applies where only the occurrence of a payment—the amount of which has already been determined—is dependent on profit or turnover, i.e. where only the reason for the payment is uncertain (judgement of 9 November 2023 – IV R 9/21, NV).
According to the BFH, such uncertain profit- or turnover-dependent purchase price claims constitute purchase price claims subject to a condition precedent (Section 158(1) of the German Civil Code (BGB)), where, at the time of the disposal, it is not yet certain whether a purchase price claim will arise in law in any of the subsequent years, nor how high it will be. Furthermore, the BFH states
“that, in the case of profit- or turnover-dependent purchase price claims, determining the capital gain as at a specific date is at odds with the structure of Sections 16 and 34 of the Income Tax Act (EStG) and with the principle of taxation according to economic capacity […].“
The BFH refers here, somewhat cryptically, to the fact that, according to established case law, the granting of the tax rate reduction depends in particular on whether the income eligible for the relief is recognised for tax purposes within a single assessment period (so-called ‘concentration’). The purpose of the tax rate reduction is, in fact, to provide relief from the increased tax burden resulting from the progressive tax rates that apply due to the concentrated realisation of all hidden reserves in business assets. It is only in respect of this extraordinary income that the scope of application of Section 34 of the Income Tax Act (EStG) is triggered.
The Federal Fiscal Court’s (BFH) legal opinion (above) regarding the realisation date of the variable purchase price components means that this ‘concentration’ of income does not apply in this specific case. There is therefore a risk that the preferential tax rate under Section 34 of the Income Tax Act (EStG) will be entirely lost or granted only in respect of the fixed component of the purchase price. In any event, where the value of the additional benefit amounts to less than 10 per cent of the main benefit, the reduced tax rate should still apply (see, amongst others, the Federal Fiscal Court judgement of 8 April 2014 – IX R 28/13). However, this has so far only been ruled on in relation to compensation payments within the meaning of Section 34(2)(2) of the German Income Tax Act (EStG). Consequently, this only results in a preferential tax rate for the main consideration. The (variable) ancillary payment will not then be eligible for the preferential tax rate again in a subsequent tax assessment period.
It follows that: if the earn-out payment is received in a subsequent tax assessment period, preferential tax treatment under section 34(1), (3) of the German Income Tax Act (EStG) may, at most, be claimed for the fixed component of the purchase price. However, this applies only as long as this fixed component of the purchase price also constitutes the main consideration.
Practical guidance:
Failure to take these principles and risks into account in share purchase agreements may result in unforeseen additional tax liabilities. It is therefore advisable to bear these risks in mind as early as the contract negotiation stage and to actively influence the resulting tax consequences through the drafting of the contract. The appropriate structuring in such cases depends heavily on the individual circumstances. If contracts have already been concluded that could have undesirable tax consequences, it should be examined whether these consequences can be avoided through subsequent restructuring (e.g. by removing the earn-out clause in return for an increase in the fixed purchase price).