I. Introduction

The relationship between a shareholder-managing director and “his” corporation is of particular importance under tax law. A shareholder-managing director can exercise considerable influence over the corporation in question. In the course of this, shifts in assets between the shareholder-managing director and the corporation are obvious. There are special tax regulations (e.g. § 8 para. 3 sentence 2 KStG (German Corporation Tax Act) on concealed profit distributions) in order to recognize asset transfers for tax purposes that are based on the company relationship and not on operational transactions.
In addition, the position as shareholder-managing director can also be relevant in other ways, i.e. not only in connection with transactions based on the corporate relationship. This includes, for example, the time at which an (appropriate) bonus entitlement accrues. The BFH recently dealt with this topic in its ruling of 5 June 2024. In the following, the reasons for the ruling are examined and further tax risks in connection with shareholder-managing directors are highlighted.

II. BGH ruling of 5 June 2024

The question in the above ruling was the timing of the receipt of income from bonus claims of a controlling shareholder-managing director. In the case in question, although the shareholder-managing director was entitled to a bonus on the merits, this bonus claim was not reflected in the company’s adopted annual financial statements.
The bonus counts – in the case of the ruling, probably appropriately – as income from employment (§ 19 EStG (German Income Tax Act)) of the managing director. The time of taxation is generally based on when the bonus is received. An inflow is to be assumed when sums of money are paid to the recipient in cash or credited to his account. In the case of so-called controlling shareholder-managing directors, however, the bonus is already received when

• the shareholder-managing director is entitled to a clear and undisputed claim against the corporation and
• the claim is due.

The background to this exception is that the controlling shareholder regularly has the option of having salary claims paid out.
In the case in question, however, there was no maturity date. The bonus entitlement is generally due upon adoption of the annual financial statements, unless otherwise agreed under civil law and at arm’s length. In the case in question, however, the shareholder-managing director’s bonus claim was (incorrectly) not recognized as a liability in the company’s annual financial statements. As the shareholders’ meeting adopted these same annual financial statements, which did not include a bonus liability, the shareholder-managing director’s bonus claim did not fall due. Whether a liability should have been recognized under substantive law is irrelevant. Consequently, according to the criteria above, there was also no inflow. With this opinion, the BFH (Federal Fiscal Court) contradicts the previous opinion of the BMF (Federal Ministry of Finance dated 12 May 2014).
Please note: Even in the case of profit distributions to the controlling shareholder, the time of income recognition is generally not determined by the payment inflow. Rather, the profit distribution is deemed to have been received at the time of the resolution on the appropriation of profits.

III. Tax risks for shareholder-managing directors

1. Hidden profit distribution

In addition to determining the correct time for taxation of shareholder/managing director remuneration, there are tax risks, particularly in the area of hidden profit distribution (§ 8 para. 3 sentence 2 KStG). The consequence of a hidden profit distribution is that it is not tax-deductible at company level and results in capital gains at shareholder level in accordance with § 20 para. 1 no. 1 EStG.
In order to avoid a hidden profit distribution, it must therefore be ensured that relationships between shareholders and the company are at arm’s length (in particular in terms of amount) and – in the case of controlling shareholders – also meet the formal requirements for an arm’s length comparison (see below).
If, for example, the bonus claim in the above ruling had been unreasonably high, this would have constituted a hidden profit distribution. The amount of the bonus would not have stood up to an arm’s length comparison. As a result, the inappropriate portion of the bonus would not have been income from employment (§ 19 EStG), but income from capital assets (§ 20 EStG). At the level of the company, this would result in an off-balance sheet allocation in the amount of the inappropriate portion of the bonus, meaning that it would no longer be tax deductible. A profit adjustment is also made if, for example, the current managing director’s salary is set at an unusually high level or assets of the company are transferred or sold to the shareholder-managing director at a reduced price.
If the remuneration of a shareholder-managing director consists of several remuneration components, each of which is individually at arm’s length, the overall remuneration must also be examined for appropriateness and arm’s length.
In addition to the arm’s length nature of the service relationships between the company and the shareholder, formal requirements must be met for tax recognition of the service relationships in the case of controlling shareholders. An agreement that is effective under civil law, clear, unambiguous and concluded in advance is required. If this is not the case, the entire transaction – regardless of the amount of the remuneration – qualifies as a hidden profit distribution. In particular, the requirement of an agreement concluded in advance often leads to problems in practice (so-called prohibition of retroactivity). For example, if a controlling managing director works for the company as a managing director without an employment contract having been concluded beforehand, the salary payments will result in a hidden profit distribution in full.
Please note: Hidden profit distributions also exist if persons close to the shareholder receive benefits from the company (e.g. excessive salary).

2. Hidden contribution

The counterpart to the hidden profit distribution is the hidden contribution. This occurs when the shareholder provides the corporation with a contributable asset benefit outside of the contributions under company law and this contribution is caused by the corporate relationship.
If, for example, the shareholder-managing director in the above-mentioned case were to waive the already accrued bonus entitlement, this waiver would first lead to an inflow to him (with the corresponding tax consequences) and then to a hidden contribution at the level of the company. The hidden contribution is treated as tax-neutral (§ 8 para. 3 sentence 3 KStG). The shareholder has subsequent acquisition costs for his shares in the same amount. In contrast to the ruling in the case, it is irrelevant for the payment of a hidden contribution whether or not the shareholding liability was recognized as a liability by the corporation.
The hidden contribution of the bonus entitlement (due to the waiver) simulates the receipt of the bonus at the shareholder-managing director level. Consequently, the shareholder-managing director earns income from employment at the time of the hidden contribution (§ 19 EStG). In this case, the so-called dry-income effect can be problematic from the shareholder-managing director’s perspective. This is because there is no actual inflow of liquidity in the amount of the bonus, but the tax burden on this is to be paid as a “real” cash flow.

IV. Consequence

In the case of (controlling) shareholder-managers, the issue of hidden profit distribution regularly arises – in addition to the correct timing of income recognition. In order to avoid the hidden distribution of profits, attention must be paid to the arm’s length nature of the service relationships. Furthermore, the formal requirements must be strictly adhered to in the case of service relationships between the company and controlling shareholders in order to ensure tax recognition. This applies in particular with regard to an agreement concluded in advance.