In practice, the taxation of payments made to company sellers often leads to disputes with the tax authorities. The crux of these discussions is whether such payments should be classified as wages or as part of the purchase price.
Purchase price or wages?
In the context of corporate transactions, the seller’s continued involvement is regularly set out in the contract in order to ensure an orderly handover of management and to safeguard the business’s economic continuity. Particularly in the case of acquisitions of owner-managed or innovation-driven companies, the transfer of expertise tied to specific individuals forms an essential part of the transaction structure and is a prerequisite for the long-term success of the acquisition.
Practical guidance: Purchase price subject to conditions
In practice, the seller’s continued involvement is often safeguarded through an incentive-based purchase price structure. To this end, a portion of the purchase price is made subject to a condition precedent or resolutive condition, whereby payment depends on whether the seller actually remains with the company.
Typical contractual arrangements include:
- Conditional payment of a retained portion of the amount after the expiry of a defined period (e.g. three to five years) during which the seller is actively involved in the business; the seller is actively involved in the business;
- Provisions regarding recovery or forfeiture in the event that the seller fails to fulfil their agreed obligations (e.g. termination, insufficient cooperation).
Against this background, the tax-related question arises as to whether these payments should be classified as components of the capital gain in accordance with section 17 of the Income Tax Act (EStG) or as income from employment subject to income tax within the meaning of section 19 of the Income Tax Act (EStG). This classification has significant implications for the treatment under tax and social security law.
Criteria for distinction: proceeds from a sale or wages?
The tax distinction between proceeds from a sale and wages is based on the so-called ‘causal principle’. Wages are deemed to exist where a payment is ultimately caused by the employment relationship – that is, where it is granted in return for the provision of labour. A mere causal or temporal link between the payment and the activity is not sufficient for this. The decisive factor is whether, following an objective assessment of the overall circumstances, the payment constitutes remuneration for a future service. If the payment serves the purpose of securing the seller’s labour for a transitional period, this supports its classification as wages.
Conversely, payments are to be allocated to the capital gain if they are triggered solely by the fact of the sale, irrespective of future activities. The economic purpose of the payment is decisive, and all objective circumstances of the individual case must be examined.
Practical note:
The mere contractual designation as a ‘component of the purchase price’ does not provide any legal certainty. When determining tax treatment, tax authorities and courts base their decisions exclusively on the objective circumstances of the individual case.
Recent case law from the Cologne Finance Court
In its judgement of 4 December 2024 (Case No. 12 K 1271/23), the Cologne Finance Court ruled that part of a purchase price payment is to be classified as wages if it is legally and in fact linked to the continuation of the individual’s employment with the company. In the case in question, it had been agreed that the seller must continue in his role as managing director for at least five years beyond the date of transfer. Otherwise, a portion of the purchase price already received would have to be repaid.
An appeal has been lodged against the judgement. The case is currently pending before the Federal Fiscal Court under case number V R 16/23. The Federal Fiscal Court’s decision is likely to have far-reaching implications for the tax structuring of future company acquisition agreements.
Conclusion
The tax distinction between payment of the purchase price and wages where the seller continues to work remains a matter carrying significant liability risks and of great practical relevance. The pending Federal Fiscal Court (BFH) proceedings are expected to set new benchmarks for the tax classification of such scenarios.
Pending clarification from the highest court, it is advisable to subject existing arrangements to a thorough tax review and to structure new contracts in a risk-based manner. This is the only way to avoid or minimise potential tax and social security liabilities.
