The case: an earn-out spanning three years
A limited partner sold her interest in a GmbH & Co. KG together with her shares in the general partner GmbH in 2010. Alongside a fixed purchase price, the parties agreed an earn-out clause: for the years 2011 to 2013, the seller was to receive an additional variable amount based on the gross margin achieved each year (net revenue less cost of materials) — scaled between €0 and €533,000 per year, with linear interpolation in between. Over the following years, the seller received roughly €815,800 in total under this clause.
The decisive question: do these later payments form part of the capital gain taxable in the year of sale, 2010 — meaning they could benefit from the tax relief under Sections 16 (4) and 34 of the German Income Tax Act (EStG) (allowance, reduced tax rate) — or must they be taxed as ordinary income only in the years they are actually received, without that relief?
The positions: tax office versus seller
The tax office wanted to retroactively include the earn-out payments in the 2010 capital gain, relying on Section 175 (1) sentence 1 no. 2 of the Fiscal Code (AO), under which events with retroactive tax effect can be reflected in the original assessment. The taxpayer and the Fiscal Court of Rhineland-Palatinate (the lower instance) took a different view: the variable purchase price components were uncertain both as to whether they would arise and as to their amount at the time of sale, and could therefore not be attributed back to that date.
The BFH’s decision: the receipt principle, not the transaction-date principle
The Federal Fiscal Court (BFH) upheld the lower court and dismissed the tax office’s appeal. As a general rule, the sale of a partnership interest is governed by the transaction-date principle: the capital gain arises upon transfer of beneficial ownership, regardless of whether the purchase price is due immediately, deferred, or payable in instalments. Subsequent changes to the purchase price generally relate back to the date of sale — as long as the legal basis for the later payment was already contained in the original sale agreement.
However, a recognised exception applies to profit- or revenue-dependent purchase price claims: because at the time of sale it is uncertain both whether any payment will arise at all and, if so, in what amount, such claims are conditions precedent within the meaning of Section 158 (1) of the German Civil Code (BGB). A capital value cannot be reliably estimated at that point. The BFH expressly confirmed its existing line of case law (including its judgments of 14 May 2002, VIII R 8/01, and 19 December 2018, I R 71/16) and, for the first time, clarified that it applies equally to the sale of partnership interests: such earn-out payments must be taxed only upon actual receipt, as subsequent business income under Section 24 no. 2 in conjunction with Section 2 (1) sentence 1 no. 2 EStG.
No election — and no rate relief
Notably, the BFH expressly rejected the existence of an election right for the taxpayer between immediate, tax-privileged taxation as a capital gain and later taxation as ordinary income. The classification is mandatory. In practice, this means: earn-out payments that are uncertain both as to grounds and amount are taxed in full as ordinary income in the years of receipt — without the allowance under Section 16 (4) EStG and without the reduced rate under Section 34 EStG that would have applied to the capital gain itself. For taxpayers with a high marginal tax rate, this can result in a materially higher overall tax burden than full immediate taxation at the time of sale.
A question deliberately left open
The BFH expressly left open a related question: how should an earn-out clause be treated where only the occurrence is uncertain, but the payment amount itself is already fixed by contract — for example, a clause simply providing that “on reaching metric X, the seller receives an additional flat amount of €Y”? Some commentators take the view that such cases should be attributed back to the date of sale, since — unlike in the case at hand — there is no uncertainty as to amount. Because both grounds and amount were uncertain in the decided case, the Senate did not need to resolve this question — it remains relevant for contract drafting.
Practical consequences for deal structuring
For individual business owners and partners in partnerships, the judgment means: anyone selling their business with a classic earn-out clause that is variable both as to occurrence and amount necessarily loses the rate relief under Sections 16 and 34 EStG for the variable portion of the purchase price. Where contractually feasible, structuring earn-out payments with a fixed amount contingent only on occurrence may be worth considering — though, as shown, the BFH’s position on that constellation remains unsettled and should be carefully assessed in advance.
For sales of shares in a corporation by another corporation, this problem generally does not arise with the same severity: under BFH case law on Section 8b (2) KStG (judgment of 19 December 2018, I R 71/16, BStBl II 2019, 493 — cited as a leading authority in the judgment discussed here), the same receipt-based principles apply there too: variable purchase price components only arise upon actual receipt for corporate sellers as well. However, because the 95% tax exemption under Section 8b (2) KStG attaches to the character of the gain as a capital gain rather than to a specific point in time, the timing shift carries markedly less economic weight there than for individual business owners, who lose the full rate relief under Sections 16 and 34 EStG entirely on delayed receipt. For individual business owners and partnerships, by contrast, the tax treatment of earn-out clauses should be factored into price negotiations and contract drafting from the outset — not only once the first instalment is received and the tax return is due.
This article presents a simplified overview of the legal position and does not replace advice in individual cases.