I. Basics

The dual function of a shareholder-managing director, who on the one hand acts as a managing director of the GmbH bound by instructions, but on the other hand also controls the management via the shareholders’ meeting itself, can lead to conflicts of interest. In practice, the agreements between the shareholder-managing director and “his” GmbH, which often take the form of employment, loan, rental or purchase agreements, must meet certain requirements in terms of form and content in order to be recognized for tax purposes.
In principle, there is no written form requirement, but in practice contracts should only be concluded in writing in order, on the one hand, to be able to provide the tax office with proof of what was actually intended and, on the other hand, to avoid later legal disputes between the shareholder and the GmbH. In addition, it is not only necessary from a civil law perspective that the shareholder-managing director is exempted from the prohibition of self-dealing (Selbstkontrahierungsverbot) under § 181 German Civil Code (Bürgerliches Gesetzbuch – BGB) in order to be able to conclude effective contracts, such as an employment contract, with the GmbH. This applies in particular to sole shareholder-managing directors, for whose exemption a shareholder resolution and a clause in the articles of association are mandatory.
In terms of content, the agreements must also be made between unrelated third parties in a comparable manner (so-called arm’s length principle (Fremdvergleich dem Grunde nach)). Otherwise, there is a rebuttable presumption that the contractual arrangement is purely socially motivated. In addition, the amount of the agreed remuneration must also be appropriate (arm’s length comparison (Fremdvergleich der Höhe nach)). The appropriateness of agreed salaries, rents or interest on loans is examined by means of an internal or external comparison.
If the managing director is a so-called controlling shareholder, the contractual requirements are additionally tightened in order to avoid subsequent manipulation of results at the GmbH. According to the case law of the BFH, control is generally assumed to exist if the shareholder holds the majority of voting rights or is able to enforce interests of the same kind (gleichgerichtetes Interesse) together with other shareholders. Purely personal relationships between shareholders do not in themselves constitute voting in the same direction (gleichgerichtetes Abstimmungsverhalten). The additional formal requirements are also referred to as the so-called formal arm’s length comparison (formeller Fremdvergleich), according to which the agreement reached

• must be formulated clearly and unambiguously, for example with regard to the time of payment and the amount or basis of assessment of the remuneration (transparency requirement (Transparenzgebot));
• nmay not be concluded retroactively, i.e. only in advance (prohibition of retroactive effect (Rückwirkungsverbot); e.g. no retroactive salary increases) and
• must actually be carried out (e.g. no late or only sporadic salary payment).

If the formal arm’s length criteria are not met, the contractual provisions are not recognized for tax purposes, even if they are deemed appropriate. However, in the case of continuing obligations, such as employment or rental contracts, actual performance can cure a formal deficiency.
If the formal and substantive requirements to which (controlling) shareholder-managing directors and persons closely associated with them are subject are not met, this constitutes a hidden profit distribution (verdeckte Gewinnausschüttung) which must be added back to the GmbH’s profit off the balance sheet and thus results in a higher charge for corporation tax, solidarity surcharge and trade tax. At the level of the shareholder-managing director, the previous income, e.g. from employment or renting and leasing, is reclassified as income from capital assets. Like open profit distributions, hidden profit distributions are no longer subject to the individual tax rate of the shareholder-managing director, but to the flat tax rate of 25 % or the partial income procedure (Teileinkünfteverfahren). As a result, hidden profit distributions generally have a tax-reducing effect in the shareholder-managing director’s income tax assessment.
In addition to the question of whether a clear and arm’s length agreement exists, there have been repeated disputes in the past as to when remuneration accrues to a controlling shareholder-managing director and in which assessment period it is subject to taxation. The BFH has also recently ruled again on the question of the time of accrual and taxation in connection with management bonus payments.

II. Facts of the case

A sole shareholder managing director had concluded a managing director service agreement with her GmbH under which she is entitled to an annual management bonus. Under a supplementary agreement, it was stipulated that the entitlement to payment of the management bonus would not become due upon adoption of the annual financial statements, but only after a separate request by the managing director, taking into account the GmbH’s payment options. Corresponding to the management bonus payment claims, the GmbH formed profit-reducing provisions in its annual financial statements. In subsequent years, the managing director only had her management bonuses paid out on a pro rata basis and consequently only used the partial amounts received as the basis for her income tax returns. The tax office, however, recognized both the partial amounts paid out and the partial amounts not paid out as wages and salaries.

III. High-Court Principles on the Taxation of Management Bonuses

As a matter of principle, management bonus payments constitute other remuneration and thus wages and salaries (§ 19 para. 1 sentence 1 no. 1 German Income Tax Act (Einkommensteuergesetz – EStG)). As income from employment, management bonuses are classified as surplus income, which is generally taxed upon receipt (§ 11 para. 1 sentence 4 EStG). According to the established case law of the BFH, income is deemed to accrue when the economic power of disposal is obtained. For example, this is always the case with monetary amounts when they are either paid out in cash or credited to the payee’s account. With regard to a controlling shareholder, however, a special rule applies according to which an inflow of income may already exist prior to payment or crediting. In the opinion of the BFH, a controlling shareholder accrues a clear and undisputed claim against “his” GmbH when it becomes due, as the shareholder regularly has it in his power to have amounts owed paid out if the claim is clear, undisputed and due. In this context, it is important that the management bonuses have also had an impact on the GmbH’s income calculation, as in the present case as a result of the recognition of a provision as an expense.
In general, the entitlement to a management bonus is due upon adoption of the annual financial statements. This always applies if no other due date that is valid under civil law and customary for third parties has been agreed in the employment contract. If the managing director is authorized to freely determine the due date, he can economically dispose of the management bonus and its payment as of the adoption of the annual financial statements as long as the GmbH is solvent. Accordingly, the BFH considers the management bonus to have accrued for tax purposes from this point in time – irrespective of any actual payment.
Based on the aforementioned principles, the BFH comes to the conclusion that in the above-described case, no deviating due date was determined in a sufficiently concrete manner and the managing director could have demanded payment of the management bonus by means of a mere request. The agreement that payment can only be demanded if the GmbH is able to make payment does not change this, as no specific agreements were made in this regard either. If, on the other hand, the GmbH had been insolvent, an inflow for tax purposes would already have had to be denied for this reason and without a separate agreement. Due to the lack of a specific due date and the GmbH’s inability to pay, the BFH held that in the present case the management bonus payments became taxable in full upon adoption of the respective annual financial statements.

IV. Special features and pitfalls of profit management bonuses

In addition to the question of when management bonuses accrue to the controlling shareholder-managing director, the overall remuneration of the shareholder-managing director must also be appropriate for tax purposes. The appropriateness of a management bonus is assessed in three steps:

75/25 ratio

The first step is to determine the total shareholder-managing director salary, which is made up of a fixed salary and a variable management bonus. If the management bonus exceeds 25 % of the total remuneration, this indicates an inappropriately high management bonus and thus a hidden profit distribution. However, this presumption can be rebutted if there are operational reasons, for example in the start-up phase, in financial difficulties or in high-risk business areas.

50 % limit

In a second step, the management bonus is compared with the profit according to the commercial balance sheet. If the management bonus exceeds 50 % of the net profit for the year under commercial law, the tax office generally assumes a hidden profit distribution. At this point, it should be noted that the management bonus must be set in relation to the commercial balance sheet profit before income tax and bonus deductions. In addition, it should be noted that the total bonus claims of several shareholder-managing directors may not exceed the 50 % limit.

Advance agreement in the case of the controlling shareholder-managing director

In a third step, the formal arm’s length comparison must be examined in the case of a controlling shareholder-managing director. For this purpose, the bonus agreement must have been concluded in writing before the beginning of the financial year. Otherwise, there is a risk of a hidden profit distribution in the amount of the bonus claims that were earned before the agreement.
Finally, it should be noted that a waiver by the controlling shareholder-managing director of a management bonus already due does not change the taxation subject to wage tax at the level of the shareholder. The waiver additionally leads to a hidden contribution at the GmbH.

V. Consequences for the practice

Case law and administrative practice provide for certain special requirements for the recognition for tax purposes of agreements between a controlling shareholder-managing director and “his” GmbH. Accordingly, a business reason is only given if the agreements are based on clear and unambiguous agreements concluded in advance, which are also effective under civil law and are actually implemented. In practice, therefore, it is urgently recommended that such agreements be set down in writing in order to ensure that what is actually intended can be proven.
Now that the BFH has reaffirmed its previous case law with regard to the inflow of bonus claims for wage tax purposes at the time of adoption of the annual financial statements, it is advisable in practice to conclude a specific and arm’s length agreement on the due date if a management bonus is not to be paid out (in full) and is only to be subject to wage tax in future assessment periods. The decisive factor here is that the controlling shareholder-managing director cannot determine the due date at his own discretion, but that objective conditions trigger the occurrence of the due date.