Sell shares, remain managing director?

Salary or capital gains in the event of the sale of shares by a shareholder who remains as managing director?

Judgment of the Cologne Fiscal Court of 4 December 2024, file no. 12 K 1271/23 (appeal pending,; German Federal Fiscal Court (Bundesfinanzhof, “BFH”) file no. IX R 1/25)

1. When distinguishing between income from employment and income from the sale of shares in corporations, all the circumstances of the individual case must be taken into account.
2. If the proceeds from the sale are legally and factually linked to the managing director's continued activities, this constitutes remuneration.

In the case of sales of start-ups or family businesses in the legal form of a limited liability company (Gesellschaft mit beschränkter Haftung, “GmbH”), the former shareholder who remains as managing director is often expected to continue to perform management tasks for a certain period, in the interests of retaining and transferring know-how and customer contacts. Insofar as components of the purchase price relate to the future activities of the managing director or, for example, to future operating results within the framework of an earn-out, the question arises as to whether this constitutes fully taxable salary or whether this part of the purchase price is also taxed at only 60% as capital gains (partial income procedure).

The Cologne Fiscal Court ruled on this issue in a case where the shareholder was contracted to continue their management activities following the sale, as set out in the purchase agreement.

1. What did the fiscal court have to decide?

The plaintiff held a 50% stake in A GmbH. He was also the company’s managing director. Together with his co-shareholder, he sold his shares in A GmbH to D.

The purchase agreement contained, among other things, a provision stipulating that part of the purchase price was intended for the plaintiff's continued management activities, which were to be carried out for a period of at least five years. At the same time, the purchase agreement obliged the plaintiff to reimburse the purchase price on a pro rata basis in the event that he prematurely terminated his management activities through his own fault. 

In his income tax return, the plaintiff included the amount in the purchase price for continuing the management activities as part of the sale price, for the purposes of calculating profit within the meaning of Sec. 17 of the Income Tax Act (Einkommensteuergesetz, “EStG”).

The German tax authorities took the view that the part of the purchase price intended for the continuation of management activities constituted consideration for this continuation of the management and was therefore taxable as wages, in accordance with Sec. 19 in conjunction with Sec. 34 para. 1 EStG.

2. What was the fiscal court's legal assessment?

The distinction between the types of income that can be considered is sometimes difficult because there is no legally standardised subsidiarity (hierarchical relationship) between § 17 and § 19 EStG, in other words, no type of income is subordinate to the other. According to the established case law of the BFH (see judgment of 4 October 2016 – IX R 43/15, BFH 255, 442 with further references), the specific causal link is decisive: it must be clarified whether the income is granted 'for' employment within the meaning of Sec. 19 EStG, or for the sale of a participation within the meaning of Sec. 17 EStG.

The Cologne Fiscal Court ruled that the disputed purchase price component was a result of the management's actions and therefore constituted remuneration for (their) work. The fiscal court justified its legal classification on the grounds that receipt of the purchase price was conditional upon the individual continuing in their role as managing director for a minimum period of five years. This condition was also secured by the pro rata repayment if the minimum period was not met. Consequently, the continuation of the managing director relationship was a necessary prerequisite for the granting of the advantage and was clearly prompted by this. This link was not superseded by the transfer of shares.

3. Impact on the structuring practice for share purchases

The decision of the Cologne Fiscal Court is of unmistakable significance for the structuring of share purchases in the fields of private equity and venture capital, as well as in medium-sized businesses. Particularly in transactions in these areas, the shareholders often also work as managing directors or in another employment relationship in the company they have founded.

The contracts in question clearly stated that the managing director's continued involvement would result in a portion of the purchase price being paid to him. Therefore, it is not necessarily to be expected that the Federal Fiscal Court will decide differently in the pending appeal.

The question of how far purchase price components can be linked to future activities without being classified as wages for tax purposes will continue to arise in practice. The Cologne Fiscal Court’s judgement has, at least, provided some helpful guidance on this matter. 

If necessary, comparable cases that have already been finalised should be kept open by filing an appeal and citing the pending appeal proceedings.

We are always available to provide legal advice, whether you are a buyer or a seller. Please feel free to contact us!

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The above information is for informational purposes only and does not constitute legal or tax advice.

Our trainee Christian Müller contributed to the drafting of this article.