Wealthy families often pool their assets, or parts thereof, in corporate-style family companies for a variety of reasons, including in a family public limited company. The Federal Fiscal Court (BFH) has now examined the tax appropriateness of directors’ remuneration.
Remuneration of the board of directors in a family-owned public limited company: Distinction from a disguised profit distribution
In family-owned companies organised as public limited companies (Aktiengesellschaft within the meaning of the German Stock Corporation Act (AktG)), the remuneration of the management board plays a central role. It not only influences the motivation and retention of executives, but also has tax and legal implications. The Federal Fiscal Court (BFH, judgement of 24 October 2024 – I R 36/22) recently clarified the tax framework in this regard, stating that the principles governing hidden profit distributions (vGA), as they apply to shareholder-managing directors of limited liability companies (GmbHs), cannot be applied across the board to executive boards of public limited companies (AGs).
Hidden profit distribution – definition and tax implications
A hidden distribution of profits occurs in the event of a reduction in assets or a prevented increase in assets caused by the corporate relationship; it is calculated as the difference in accordance with section 4(1), first sentence, of the Income Tax Act (EstG) in conjunction with section 8(1) of the Corporation Tax Act (KStG), i.e. the taxable profit, and is not based on a regular resolution to distribute profits. In the latter case, however, the subsequent appropriation of profits would in any event not be expected to affect the determination of profit. This is to be assumed where the company grants its shareholder a financial advantage which, had it acted with the diligence expected of a prudent and conscientious director, it would not have granted to a third party outside the company.
A hidden distribution of profits must not reduce taxable income and must be added to taxable profits off-balance-sheet. This represents a frequent risk, particularly during tax audits, as unreasonably high remuneration may be classified as a hidden distribution of profits by tax auditors; salary surveys or advance rulings on payroll tax provide a framework for guidance in this regard.
Caution is advised regarding shareholder-managing directors of a GmbH
In the case of GmbHs, the focus of the audit is primarily on shareholder-managing directors with majority shareholdings. Strict criteria apply here regarding the tax treatment of their remuneration. This must:
- in line with arm’s-length principles (i.e. in line with market conditions),
- clearly agreed in advance and
- of a reasonable amount.
Reasonableness must be assessed on the basis of the arm’s length principle. Remuneration components that are not in line with market conditions – such as overtime pay or bonuses agreed retrospectively – are regularly classified as hidden distributions of profits. Particular care is required in the case of controlling shareholders: the remuneration agreement must be clearly set out and agreed in writing before work commences; a contract concluded retrospectively is invalid for tax purposes – as is generally the case in almost all areas of taxation.
Application to members of the board of directors of a public limited company
Even in the case of a public limited company (AG), executive board remuneration must be in line with market rates, transparent and of an appropriate amount. Excessive payments or unusual benefits may also be classified as hidden distributions of profits in this context. The key difference is that, under company law, it is the responsibility of the supervisory board to determine and monitor the appropriateness of executive board remuneration in an AG. The Federal Fiscal Court (BFH) has now clarified that the criteria applicable to managing directors who are shareholders of a limited liability company (GmbH) cannot be applied without restriction to members of the executive board of a public limited company (AG). Rather, the decisive factor is whether the supervisory board exercises its supervisory function independently and does not act solely in the interests of the executive board member.
An arm’s length comparison may be deemed to have been made if:
- the Supervisory Board is composed of independent members,
- there is no personal relationship with the member of the Executive Board, and
- there are no special circumstances suggesting a conflict of interest.
Conclusion: Legal certainty for family-owned public limited companies
The following also applies to members of the board of directors of a family-owned public limited company: inappropriate or non-market-rate remuneration carries the risk of being classified as a hidden dividend for tax purposes.
The key factor is the structure under company law: in the case of public limited companies (AGs), control is exercised by the independent supervisory board, which reviews the appropriateness of remuneration. Provided that the supervisory board is independent – for example, it does not consist exclusively of family members of the CEO – and the remuneration is in line with standard market practice, bonuses and other forms of remuneration are, in principle, at arm’s length and do not constitute hidden distributions of profits. The ruling provides greater legal certainty for family-owned public limited companies, as it emphasises the importance of a functioning, independent supervisory board and demonstrates that careful drafting of contracts and documentation can have a positive impact on tax assessment. Accordingly, in contractual practice, it should also be possible to agree on levels of executive board remuneration that lie at the upper end of comparable remuneration ranges, provided that the independent supervisory board has previously deemed such levels to be appropriate.
