3 questions to smart minds

Taxation of management shareholdings for advisory boards and consultants

For this 3 questions to Dr. Barbara Koch-Schulte

P+P Pöllath + Part­ners, Munich
Photo: Dr. Barbara Koch-Schulte
5. Febru­ary 2019

Manage­ment invest­ments are part of almost every private equity investor’s invest­ment. Consul­tants and advi­sory board members are often also given the oppor­tu­nity to parti­ci­pate on the same or simi­lar terms as manage­ment. While there are alre­ady a number of court decis­i­ons on the taxa­tion of sala­ried mana­gers with such equity inte­rests, this has not yet been the case for the taxa­tion of advi­sory boards and consul­tants. The Tax Court of Baden-Würt­­te­m­­berg has now deci­ded a first case on June 26, 2017 (- 8 K 4018/14).

For this 3 ques­ti­ons to Dr. Barbara Koch-Schulte, lawyer, tax advi­sor and part­ner at P+P Pöllath + Part­ners, Munich

1. How are manage­ment equity invest­ments gene­rally taxed?

In prin­ci­ple, proceeds from manage­ment equity invest­ments are subject to taxa­tion as capi­tal assets and thus to the redu­ced tax rate of the final with­hol­ding tax and, in the case of equity invest­ments of 1% or more, to the so-called partial income proce­dure. Under certain condi­ti­ons, howe­ver, taxa­tion at the normal income tax rate is also possi­ble if the proceeds are attri­bu­ted to the manager’s employ­ment as income from employ­ment. Compared to taxa­tion as income from capi­tal assets, this is asso­cia­ted with an addi­tio­nal tax burden of approx. 20% (top income tax rate 45% versus final with­hol­ding tax of 25%).

2. And what about advi­sory boards or consul­tants as inves­tors in manage­ment holdings?

The ques­tion has not yet been clari­fied by case law as to whether, and if so under what condi­ti­ons, advi­sory boards or consul­tants as inves­tors in manage­ment holdings must also expect their proceeds to be included in income from self-employ­ment as remu­ne­ra­tion for acti­vi­ties pursu­ant to Section 18 of the German Income Tax Act (EStG). In the prac­tice of tax audits, it is some­ti­mes found that the tax autho­ri­ties do not diffe­ren­tiate between mana­gers and advi­sory boards in these cases.

Diffe­rent condi­ti­ons apply to the quali­fi­ca­tion of income from self-employ­ment than to income from employ­ment. Further­more, income from employ­ment is clas­si­fied as surplus income, while income from self-employ­ment is clas­si­fied as profit income (Section 2 (2) EStG).

3. How should the diffe­ren­tia­tion in manage­ment share­hol­dings for advi­sory boards and consul­tants look like in the future?

In the opinion of the Fede­ral Fiscal Court, not every exch­ange of services with a de facto proxi­mity to the employ­ment rela­ti­onship can auto­ma­ti­cally be assi­gned to income from employ­ment. Rather, it must be exami­ned in each indi­vi­dual case on the basis of all mate­rial circum­s­tances whether the corre­spon­ding exch­ange of services is caused by the employ­ment rela­ti­onship or is to be allo­ca­ted to another type of income or to the non-taxa­ble area on the basis of an inde­pen­dent special legal relationship.

The BFH expressly quali­fies an employee’s equity inte­rest in his employer as such an inde­pen­dent special legal relationship.1 If the employee uses his or her capi­tal to parti­ci­pate in the employer’s company, this is in prin­ci­ple a source of income that is inde­pen­dent of and sepa­rate from the employ­ment relationship.

Advi­sory boards and consul­tants support the private equity inves­tor in the further deve­lo­p­ment of the target company. They have indus­try know-how and often also opera­tio­nal expe­ri­ence as mana­ging direc­tors or board members. As a rule, advi­sory boards and consul­tants do not perform any opera­tio­nal tasks, unless they step in as inte­rim mana­ging direc­tors on an excep­tio­nal basis.

-> You can find Dr. Barbara Koch-Schulte’s detailed author contri­bu­tion on this topic in the new FYB 2019 issue! — You can also down­load the article indi­vi­du­ally in our FYB store.

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