Sale of shares - Taxation of earn-out payments
When a company’s shares are sold, it is frequently the case that the contracting parties agree that, under certain circumstances, the purchase price could subsequently go up. As regards these so-called earn-out payments, it is important to note the current opinion of the courts and of the fiscal administration.
In practice, variable purchase price components are often also agreed in addition to a fixed purchase price. These variable portions frequently depend on the Company’s future profits or revenues and can modify the purchase price accordingly. Such flexible arrangements offer the advantage that the final purchase price can take into account the economic development of the company; this is something that might be attractive for both parties, in particular, in relation to the future earnings prospects.
In this respect, in 2023, the Federal Fiscal Court (Bundesfinanzhof, BFH) decided that, when shares are sold, any accruing earn-out payments (thus purchase price components related to profits or revenues) only have to be taxed on the date when they are actually received. Therefore, these payments may not be retroactively included in the capital gain. According to the BFH, given that such arrangements constitute purchase price claims subject to a condition precedent, where the amount of the payment and its occurrence are uncertain, they cannot be included in the calculation of capital gains as at the closing date. As already reported in the 04/2024 issue of our PKF newsletter, this ruling is now generally applicable (see under contribution 4/2024).
In addition, the Schleswig-Holstein Ministry of Finance specified in a decree of 20.8.2024 (reference: VI 3012 - S 2242 – 131) that a distinction nevertheless has to be made between two types of earn-out clauses, namely:
- earn-out clause with non-retroactive effect - in the case of purchase price components related to profits or revenues that are taxed as subsequent income, taxation would take place once this has been realised (on the date when payment is received);
- earn-out clause with retroactive effect - in the case of agreements where the accrual but not the amount is related to profits or revenues, payments would have retroactive effect back to the date of the sale and would therefore have to be taken into account for tax purposes as per the closing date.
Since the BFH has not ruled on the second variant (earn-out clause with retroactive effect), according to the instructions from the Ministry of Finance, the tax offices should continue to assume a retroactive event and, accordingly, bring forward the taxation of these payments to the date of the sale.