The case: a purchase price component for five more years as managing director
A shareholder-managing director held 50% of a GmbH and received an annual salary of €180,000 plus a Christmas bonus and a bonus payment. When he sold his shares (together with those of a second, equally managing co-shareholder) to an acquiring company, the total purchase price was €4.5 million. This included a separately identified amount of €1.25 million — split equally between the two sellers — paid in consideration of both continuing as managing directors for at least five further years. In the event of early termination, the amount was repayable pro rata, secured by a bank guarantee. At the same time, the newly agreed managing director salary after the sale fell to €140,000 plus a bonus and a small pension supplement.
The claimant reported his half share of €625,000 as part of the tax-privileged capital gain under Section 17 of the German Income Tax Act (EStG). The tax office instead classified the amount as employment income under Section 19 EStG — with significant tax consequences, since wages are taxed in full and without the benefits of the partial-income method.
The disputed question: purchase price or wages?
The Ninth Senate of the Federal Fiscal Court (BFH) had to clarify, for the first time at the highest court level, the standard by which such a “retention payment” — an amount agreed specifically for continuing managing director duties in connection with a share sale — is to be allocated between Section 17 EStG (capital gain) and Section 19 EStG (employment income). According to the headnote, what is decisive is which income category has the closer economic causal connection.
The standard: independent economic significance
The BFH builds on its existing case law on non-compete clauses in business sale agreements (judgment of 20 July 2018, IX R 31/17): additional contractually agreed services in a sale agreement form an unseparated part of the sale price where they lack independent economic significance — that is, where they are merely a calculation factor in forming the overall purchase price. What matters is not what the parties subjectively intended or formally agreed, but the economic substance as evidenced by objective circumstances.
The third headnote is new and particularly significant for practice: the quality and stability of a corporation’s management is, as a matter of ordinary experience, generally a value-influencing factor — and therefore typically an unseparated calculation factor in price formation that merges into the acquired goodwill. This applies regardless of whether the seller continuing as managing director is also a shareholder.
Where the lower court went wrong
The Fiscal Court of Cologne had treated the close legal and factual link between the payment and the continued managing director role as decisive for classifying it as wages. The BFH held this to be an error of logic: that link alone says nothing about why the buyer made the payment. What matters instead is whether the buyer made the payment as consideration for the enterprise value embodied in the transferred shareholding — or as the fruit of future labour. In the case at hand, the buyer’s own managing director had credibly testified that, without the sellers’ continued commitment to the company, the intended know-how transfer would not have been possible and the buyer would not have acquired the shares at all — a strong indication that the payment served to secure enterprise value, not to remunerate labour.
The correct test: comparison with fair market value
The BFH gives the lower court a concrete standard to apply on remand: does the total purchase price allocated to the shareholding correspond to its fair market value? If the purchase price exceeds fair market value, this points towards classifying the excess amount as wages. If, by contrast, the disputed portion is economically absorbed within the fair market value of the shareholding, this points towards allocation to the sale price — because binding the managing director then merely serves to permanently secure for the buyer the profit opportunities embodied in the shareholding.
As a further indicator, the BFH points to a hypothetical control question: would the buyer have made the same payment to an unrelated third party who committed to continuing as managing director? Conversely: would the seller have received the payment even if he had not simultaneously been a shareholder? The BFH also expressly rejects the lower court’s argument that the pro-rata repayment obligation on early termination alone indicates wage character — such a clause can equally be understood as contractual value protection, breach of which gives rise to a fault-based damages claim, as is typical when acquiring shares from a shareholder-managing director.
Practical consequences for deal structuring
For M&A transactions involving shareholder-managing directors as sellers, the judgment provides important guidance for structuring retention and continuity clauses:
First: an isolated look at the contractual link between the purchase price component and the continuation obligation is not sufficient — what matters is the economic embedding within overall price formation. Where possible, it should be documented that, and how, management continuity was factored into the valuation of the shareholding.
Second: a clear comparison between the agreed total purchase price and a traceable fair market valuation of the shareholding creates legal certainty. If the purchase price (including the retention component) stays within the range of fair market value, this clearly favours treatment under Section 17 EStG.
Third: conspicuous salary jumps are a risk factor. In the decided case, reclassifying the amount as wages would have resulted in an approximately 50% salary increase compared with the prior year’s salary — with no discernible reason on the facts. Anyone structuring retention payments should check whether the regular (ongoing) managing director salary remains arm’s length in its own right, independent of the purchase price component.
Fourth: repayment clauses for early termination are unobjectionable in themselves, but should be structured and justified as a value-protection mechanism — not as a penalty for breach of an employment contract.
This article presents a simplified overview of the legal position and does not replace advice in individual cases.