Tax
02. Apr 2025
WP/StB/RA Dr. Rainer Daigfuß

Bonus payments as constructive dividends -  Limited liability company principles only conditionally applicable to a joint stock corporation

Anwältin und Mandant im Gespräch

In a recently decided case, PKF experts were able to convince the Federal Fiscal Court (Bundesfinanzhof, BFH) that a remuneration agreement between a joint stock corporation (Aktiengesellschaft, AG) and an executive board member who was concurrently a minority shareholder in the AG would only in exceptional cases fail to satisfy the arm's-length test. A constructive dividend would be assumed only if the circumstances of the specific case clearly indicated that for the remuneration agreement the supervisory board had unilaterally catered for the interests of the executive board member. In the case of a supervisory board that is staffed with individuals who are not persons related to the executive board member who, as a minority shareholder, holds a participation in the company, this could only be assumed on the basis of special circumstances.

Profit-related and sales-related remuneration as constructive dividends …

In the case in question, an AG, via its supervisory board, concluded a remuneration agreement with executive board member X - who had sole power of representation -, that also provided for sales-related and profit-related bonus payments. Besides X, two members of the three-member supervisory board were minority shareholders, while the third member did not have a shareholding in the AG. No family relationships existed between the executive board member and the supervisory board members. The local tax office and, subsequently, the Nuremberg tax court in its ruling of 19.7.2022 (case reference: 1 K 1489/20) treated the sales-related and profit-related bonus payments to X as constructive dividends. This approach was based on the legal principles developed for this purpose by the BFH for shareholding managing directors of a GmbH [limited liability company] and, in the case of the AG, ultimately resulted in higher corporation tax.

… solely in the case of the one-sided orientation of the supervisory board

This was countered by the BFH, in its ruling of 24.10.2024 (case reference: I R 36/22). In view of the risk of profit extraction, sales-related bonuses, in particular, can admittedly only be recognised under tax law in exceptional cases. However, the Nuremberg tax court failed to take into account that the ruling put forward by it had concerned the remuneration of a shareholding managing director of a GmbH that, because of the differences in the decision-making structures, cannot be transferred to an AG without restrictions. In the case of an AG the situation is unlike that of a GmbH. A supervisory board acts for an AG and when it determines the compensation for the executive board in accordance with Section 87(1) sentence 1 of the German Stock Corporation Act it has to ensure that the compensation is appropriate.

In the case in question, X was not able to control the supervisory board either because he neither held the majority stake that would be necessary for the election of the supervisory board members nor was he related to them. In such a situation, constructive dividends in connection with sales-related or profit-related bonuses then only have to be recognised in exceptional cases where special circumstances have clearly indicated that the supervisory board had unilaterally catered for the interests of the executive board member.

Please note

The BFH referred the matter back to the Nuremberg tax court for a hearing and decision by other means because in court proceedings it is, first and foremost, up to the tax court to make an overall assessment of the considerable evidence for the arm's length test.

Significance for taxation practice

Decisions on the existence of a constructive dividend in an AG are very rare. In the present case, where the AG was represented by PKF Nuremberg, the BFH essentially had to answer the question as to whether or not the agreement concluded between the AG and the minority shareholder was due to the relationship with the company. If yes, the agreement would then have violated the arm's length principle and constructive dividends could then have been deemed to exist. According to the BFH, an agreement with a minority shareholder assigned to the executive board would however not satisfy a substantive arm’s length comparison solely if the supervisory board had unilaterally catered for the interests of the executive board member. 

Independently of the particular case, the BFH clarified that remuneration agreements between an AG and a member of the executive board who is concurrently a minority shareholder normally have to be recognised under tax law. The recognition of a constructive dividend would only be considered in exceptional cases. Furthermore, it is of general relevance to actual practice that the clarification by the BFH that the legal basis for constructive dividends developed by it in connection with shareholding managing directors of a GmbH cannot be transferred to an AG without restrictions. Admittedly, an arm’s length test also has to be carried out in the case of an AG. However, the independence of the supervisory board constitutes very strong evidence against the existence of a one-sided protection of interests and, thus, for the arm's length nature of the remuneration agreement between the AG and a minority shareholding executive board member.

Conclusion

In effect, for practice, it must be noted in this respect that - unlike in the case of minority shareholding managing directors of a GmbH - in the case of minority shareholders, a sales-based bonus would only constitute a constructive dividend in exceptional cases.