Content of tax information March 2025
- Pay attention when including earn-out clauses in Company purchase agreement
- Double holding structure before the sale of shares
- When are shareholder managing directors of German limited liability companies exempt from German social security contributions?
- Be careful with Triangular transactions as far as VAT is concerned
- Withholding Tax on Capital Gains and EU Law
Pay attention when including earn-out clauses in Company purchase agreement
It has become popular to agree on earn-out clauses in company purchase agreements as this creates a win-win situation for the vendor as well as the buyer. An earn-out clause means that the purchase price for a sole proprietorship or a co-entrepreneurial share or a share in a corporation is subsequently increased if the acquirer exceeds a predetermined turnover or profit limit is exceeded.
Court decision
In a decision in 2023 the superior fiscal court in Germany (BFH) has ruled that there is no retroactive increase in capital gains if the purchase price increase is uncertain in terms of reason and amount.
Example:
The purchase price for a partnership share is increased if the gross profit of the acquirer exceeds € 5 million, but by a maximum of € 500,000.
As this is uncertain in terms of reason and amount, there is no retroactive effect.
Why could this be disadvantageous for the seller?
The seller may profit from tax exemptions or tax allowances of the sales price such as those mentioned in sec. 16 or 17 of the Income Tax Act or the quintile rule in section 34. Those usually do not apply to retroactive payments in the future. As a consequence, the seller may have tax disadvantages. However, if the seller is a private individual he or she may be in a lower tax bracket, when receiving the final payment so the individual situation of the parties involved has to be taken into consideration.
Why could this be disadvantageous for the purchaser?
If the purchaser is able to depreciate the acquisition costs or a part of them, he or she will only be able to depreciate the additional payment from the earn-out-clause later.
What could you do to avoid the retroactive effect?
The court decision did not cover the case, if the purchase price increase depends on exceeding a turnover or profit threshold, but the amount of the increase is certain. We therefore assume that in this case the increase is still a retroactive event 175 para. 1 sentence 1 of the Heilmann General Tax code and will therefore be a subsequent increase in the privileged capital gain and avoid the negative tax consequences. However, there is no certainty about that, but it is a chance.
Example:
The above-mentioned example would be to be altered in the following way: The purchase price increases by € 500,000, if the gross profit of the acquirer exceeds € 5 million.
Double holding structure before the sale of shares
It is common practice in Germany to use holding companies in order to save/defer taxes into the future. Section 8b (1) in conjunction with (5) KStG (Corporate Income Tax Act) provides the possibility that dividends one corporation (operative Co.) pays to a shareholder corporation are 95% tax-exempt if the shareholding percentage of this corporation is 10% or more. In this way protection against a liability claim for the profits generated in the operating GmbH can be achieved. If such a dividend is paid to a private individual as the shareholder instead, income taxes of up to 45% may arise on 60% of the profits or alternatively 25% flat rate tax may arise on the full amount.
What if you hold the participation directly as a private individual?
This model can also be used if the private individual shareholder intends to sell shares in a corporation and holds them directly if he uses the following procedure. In the holding model, a holding GmbH is established in a tax-neutral manner by way of a qualified share swap in accordance with section 21 UmwStG prior to the intended sale of shares in a GmbH within the meaning of section 17 EStG.
Lock-up period
It is important to know that there is a lock-up period to be noted. The shares transferred to the holding GmbH are subject to lock-up period in accordance with section 22 para. 2 UmwStG. If these shares are sold by the holding GmbH within the seven-year lock-up period, a retroactive taxation of the hidden reserves in the upstream share swap in the form of contribution gain II is triggered for the transferor in accordance with section 22(2) UmwStG. After the 7 years the 95% tax exemption will be fully granted, and you may defer the distributions to the private individual shareholder until retirement or a time of less income. In this way, you not only profit from the fact that you have to pay the taxes at a later time but also from the fact that your individual tax rate may be lower during retirement than now.
Recommendation:
It is important to plan well in advance (7 years or more) if you hold a major share in a corporation as a private individual and plan to sell that participation without paying the full taxes on the profits immediately at the time of the sale by using the holding model.
When are shareholder managing directors of German limited liability companies exempt from German social security contributions?
Dependent employees are generally subject to compulsory insurance for pension insurance. Dependent employment is characterized by
a) the employee is bound by instructions with regard to time, duration, place and type of work, and
b) integration of the employee into the employer’s business organization.
Not every GmbH shareholder-managing director is automatically exempt from social insurance. The extent of the shareholding and the extent of the resulting influence on the GmbH are the key factors in distinguishing between dependent employment and self-employment. In addition to his/her position as a shareholder, he/she must have the legal power to determine the fate of the GmbH by exerting influence on the shareholders’ meeting. This is generally the case if
– he/she holds at least 50% of the shares in the share capital of the GmbH and if the power to prevent him/her from voting is not revoked by voting rights regulations in the shareholders’ meeting laid down in the articles of association or
– by way of exception, if, as a minority shareholder (managing director), he/she is granted a comprehensive (“genuine” or “qualified”) blocking minority in accordance with the articles of association that covers all of the company’s activities. A “non-genuine” blocking minority limited only to certain resolutions is not suitable to provide the necessary legal power.
The shareholder-managing director is only independent if he/she has the necessary legal power under the articles of association to determine the fate of the company or at least to prevent instructions from the shareholders’ meeting that he/she does not agree with. If, in the case of two 50% shareholders, one is entitled to a special right of “casting vote” under the articles of association, the other is employed and therefore subject to social security contributions.
In the case of a position as an executive employee, who is not a managing director, a 50% shareholding is not sufficient to avoid the obligation to pay social security contributions because the employee is subject to the instructions of the management and cannot give the management any specific instructions with only 50% of the votes.
In case of doubt, a status determination procedure should always be carried out by the clearing office of the German Federal Pension Insurance (Deutsche Rentenversicherung Bund) in order to avoid social security contributions.
If foreign citizens are shareholder managing directors of German limited liability companies, it has to be checked if there are special exemptions for them in order to avoid that they are paying social security contributions in two countries. Besides lawyers, the authorities provide first information on their website in English.
Be careful with Triangular transactions as far as VAT is concerned
Triangular Transactions: Recent BFH and ECJ Case Law
The taxation of intra-community triangular transactions remains a key problem in VAT law. The following rulings highlight important aspects:
- BFH ruling of July 17, 2024 – XI R 35/22 (XI R 14/20); DStR 2024, p. 2220
- BFH ruling of July 17, 2024 – XI R 34/22 (XI R 38/19); DStR 2024, p. 2225
- ECJ ruling of December 8, 2022 – C-247/21, Luxury Trust Automobil; DStR 2022, p. 2675
Case Study:
Dieter, a business owner from Ulm, operates a machinery trading business. In 2020, Stanislaw from Warsaw purchases a machine from Dieter. Since Dieter does not have the machine in stock, he purchases it from the manufacturer Gaston in Brussels. As agreed, Gaston transports the machine in July 2020 with his own truck to Stanislaw in Warsaw. All three entrepreneurs use their respective VAT identification numbers.
Dieter declares in his VAT return for July 2020:
- An intra-community acquisition from Belgium (§ 1a UStG), deducting the acquisition VAT as input tax (§ 15 (1) sentence 1 no. 3 UStG),
- A tax-exempt intra-community supply to Poland (§ 4 no. 1 letter b UStG).
In the summary report (ZM), he reports the intra-community supply (§ 6a UStG). However, the tax auditor classifies the transaction as a chain transaction. According to the auditor, Dieter must declare an intra-community acquisition at the destination in Poland (§ 3d sentence 1 UStG) and simultaneously in Germany, where his VAT ID is registered (§ 3d sentence 2 UStG), without input VAT deduction, as he has not proven the taxation of the acquisition in Poland (§ 17 (2) no. 4 UStG). Additionally, the transaction does not qualify as an intra-community triangular transaction (§ 25b UStG), as Dieter’s invoice to Stanislaw lacks the mandatory references to a triangular transaction and the ZM does not report it as such.
In 2024, Dieter issues a corrected invoice and a revised ZM, now including the necessary triangular transaction details. However, the tax authorities reject the retroactive effect of the correction and impose interest on the additional VAT payment, arguing that the intra-community acquisition in Germany cannot be annulled retrospectively (§ 25b (3) UStG).
This case demonstrates the VAT challenges in triangular transactions and underscores the importance of correct documentation and reporting.
Our Recommendation:
To avoid such tax pitfalls, businesses involved in intra-community transactions should carefully check their invoicing and VAT reporting obligations. As experienced tax advisors, we can support you in structuring transactions correctly, ensuring compliance with VAT regulations, and avoiding unnecessary tax risks. Please feel free to contact us for personalized advice.
Withholding Tax on Capital Gains and EU Law
The taxation of dividend distributions to foreign shareholders remains a key issue in international tax law, particularly after Brexit. The following case illustrates potential tax consequences for foreign corporate shareholders:
Case Study:
A-Ltd, a UK-based company, has been the sole shareholder of a German GmbH for several years. The GmbH distributes profits to A-Ltd.
Tax Consequences:
- Limited tax liability: Dividend distributions to foreign shareholders are subject to limited tax liability in Germany (§ 49 (1) no. 5 letter a double letter aa EStG).
- Withholding tax: A 25% withholding tax plus a solidarity surcharge applies (§ 43 (1) sentence 1 no. 1 EStG). The tax must be withheld regardless of any potential relief claims (§ 50c (1) EStG).
- Final taxation effect: The withholding tax has a final taxation effect (§ 32 (1) no. 2 KStG), meaning that a corporate tax assessment under § 8b KStG is excluded.
- Potential tax reliefs:
- 44a (9) sentence 1 EStG: A partial refund of 2/5 for every limited tax-liable corporation.
- Article 10 (2) DBA-UK: Reduction of withholding tax to 5% (gross).
- EU Parent-Subsidiary Directive: No longer applicable after Brexit (§ 43b EStG).
Impact of EU Law:
- Discrimination compared to domestic shareholders:
- A-Ltd is subject to a 5% withholding tax on the gross dividend.
- Domestic corporate shareholders effectively pay only around 1.5% due to § 8b (1), (5) KStG.
- If the UK does not grant a full credit for German withholding tax, this creates an additional tax burden.
- Capital movement freedom (Art. 63 TFEU) vs. establishment freedom:
- 8b (1) KStG applies to shareholdings of 10% or more, covering not only controlling interests.
- The freedom of capital movement applies, as it covers third-country investors as well.
- Grandfathering rules under Art. 64 TFEU likely do not apply.
- Potential claim under EU law:
- A-Ltd may be able to claim relief based on EU law principles.
Our Recommendation:
Dividend distributions to foreign corporate shareholders require careful tax planning to avoid excessive withholding tax burdens. As experienced tax advisors, we can assist in analyzing applicable relief options and structuring cross-border investments efficiently. Please feel free to contact us for expert advice.
