In a decision dated 3 March 2026 (reference number IX R 1/25) and recently published, the German Federal Fiscal Court (“FFC”) has ruled on the income tax treatment of additional purchase price components for the sale of shares in a corporation. This ruling provides valuable guidance, primarily on structuring additional purchase price payments for management retention arrangements, but it is also relevant for the taxation of earn-outs.
Facts of the case
The shareholder and managing director of a German limited liability company (Gesellschaft mit beschränkter Haftung, “GmbH”) had sold his GmbH shares. In addition to the fixed purchase price, the buyer agreed to pay an additional amount in return for the seller continuing to work for the GmbH as managing director for at least five years (i.e. a retention-based additional purchase price). Based on this agreement, the tax office treated the additional purchase price as employment income (cf. section 19 of the German Income Tax Act (Einkommensteuergesetz, “EStG”)), which is subject to the seller’s personal tax rate (at a maximum income tax rate of approx. 48%, including solidarity surcharge and church tax). However, the seller argued that the additional purchase price should be taxed as a capital gain under section 17 EStG, which is subject to a preferential income tax treatment with a maximum tax rate of approx. 29% (known as the partial income scheme (Teileinkünfteverfahren)).
The FFC’s Ruling
In principle, the FFC confirmed the seller’s view that the additional purchase price is subject to capital gains taxation.
The FFC argued that, as a matter of principle, the entire capital gain from selling corporate shares is subject to the (preferential) taxation under section 17 EStG. According to the FFC’s judgment, this means that any seller’s claim (for payment in cash or in kind) arising from the share purchase agreement must be taken into account when calculating the capital gain, provided that the claim forms part of the overall consideration for the share transfer. Consequently, if an additional payment appears, from an economic perspective, as a separate consideration for a transaction that merely coincides with the share transfer, it cannot be subject to capital gains taxation but must be taxed separately based on the economic substance of the payment (e.g. as employment income).
Further, the FFC confirmed that, contrary to the view taken by the tax office, the quality and stability of a company’s management are, as a rule, integral factors in determining a company’s fair market value (represented in the goodwill). Consequently, the additional purchase price agreed in the present case for the management retention had to be treated as capital gain instead of employment income.
Impact of the judgment
The FFC’s decision provides several important insights. In particular, the following two test questions can be drawn from the judgment to distinguish between a treatment as employment income or as capital gains:
- Does the total purchase price, including any additional purchase price, match to the fair market value of the sold shares? If so, this suggests that the additional payment forms part of the capital gain and is not employment income.
- Would classifying the additional payment as remuneration/wage lead to a significant increase in the managing director’s remuneration compared with the situation prior to the transfer of the shares? If so, this also suggests that the additional payment should be treated as part of the capital gain.
The FFC’s decision is relevant not only for share disposals by individuals, but also for share disposals by corporations involving variable purchase prices. In the latter cases, however, the question is not whether the variable purchase price must be treated as employment income. Instead, the issue is whether the variable purchase price is (a) subject to the participation exemption under section 8b of the German Corporate Income Tax Act (Körperschaftsteuergesetz, KStG), which would make it 95% tax-exempt, or (b) whether it is regular business income, which would be fully taxable at the standard company tax rate, often exceeding 30% (comprising German Corporate Income Tax + solidarity surcharge and German Trade Tax).
As a rule, variable purchase price components such as conventional earn-outs, which are agreed due to uncertainties regarding the fair market value of a target company at the time of the purchase agreement, and which are mostly based on financial indicators such as EBITDA, form part of the overall consideration for the share transfer. Consequently, such earn-outs are subject to capital gains taxation.
However, special attention is required in light of the first test question above if the seller is to receive shares in the buyer (or a company affiliated with the buyer, hereinafter the “Reinvestment Shares”) as part of the variable (benchmark-driven) purchase price (e.g. virtual shares, preferred shares, or ordinary shares). This is because such components may result in the total consideration for the share transfer exceeding the fair market value of the sold shares. This would suggest that this purchase price component constitutes employment income or regular business income, respectively, rather than forming part of the capital gain.
This is particularly important if the value of the Reinvestment Shares is derived also from other shareholdings held by the buyer (e.g. if the buyer is a holding company with multiple shareholdings). This is often the case with venture capital investments in start-ups, where the Reinvestment Shares are also intended to incentivise the continued engagement by the founders. In such cases, it cannot be assumed that the tax authorities will automatically treat the variable purchase price as part of the capital gain.
Consequently, agreements regarding additional or variable purchase price components should be closely reviewed in terms of their economic effect and associated tax risks, particularly with regard to wage/payroll tax. To safeguard the tax treatment of such purchase price components as capital gains rather than wages, it should be considered to obtain a wage tax ruling under section 42e EStG, which is free of charge and binds the tax authorities.
