I. Previous assessment

Pursuant to sec. 18 para. 1 no. 3 of the German Income Tax Act (Einkommensteuergesetz – EStG), supervisory board members generate income from self-employment. The question of whether they are to be classified as entrepreneurs for VAT purposes is not new. Previously, case law and the tax authorities assumed a self-employed and thus entrepreneurial activity within the meaning of sec. 2 para. 1 German Value Added Tax Act (Umsatzsteuergesetz – UStG) and supervisory board remuneration was then assessed as so-called other services that were taxable and subject to VAT. If the so-called small business regulation (Kleinunternehmerregelung) of sec. 19 UStG was not applicable or if – despite qualifying as a small business – the respective member of the supervisory board voluntarily opted for VAT, invoices with a separate VAT disclosure had to be issued to the company and VAT returns had to be submitted to the tax office. If expenses were incurred in connection with supervisory board activities that were subject to value added tax, an input tax deduction could be claimed if the supervisory board member submitted proper incoming invoices.
The invoiced VAT was deductible on the merits at the level of the Company, as the service was provided by another entrepreneur for the Company’s business. If the Company was entitled to a full input tax deduction on the basis of taxable output transactions, it was entitled to a refund of the corresponding amounts from the tax office in its advance VAT returns.

II. Change in jurisdiction

The aforementioned principles have been in force in this form since 1972. They have recently been modified by the case law of the Federal Fiscal Court (Bundesfinanzhof – BFH). The starting point for this change in case law was a ruling by the European Court of Justice of 13 June 2019 in the IO case (C-420/18). The court had to assess the case of a member of the supervisory board of a Dutch foundation. It rejected its entrepreneurial status and essentially justified its decision on the grounds that the supervisory board member did not act in his own name or on his own account, but merely on behalf of the supervisory board itself as its governing body. Furthermore, the individual member did not bear any responsibility for the decisions of the supervisory board and was not exposed to any economic risks, as the member received a fixed, non-activity-related remuneration in the event of a decision. Even negligent breaches of the duty of care had no effect on the level of remuneration, which would be contrary to the independent exercise of the activity. On this basis, the BFH also decided against the entrepreneurial status of supervisory board members in two decisions (V R 23/19 and V R 62/17) in November 2019, deviating from its previous assessment and arguing similarly to the European Court of Justice.
The rulings were initially not published in the Federal Tax Gazette (Bundessteuerblatt), as they contradicted long-standing VAT practice and administrative guidance. However, in a letter dated 8 July 2021, the Federal Ministry of Finance has now amended the VAT Application Decree (Umsatzsteuer-Anwendungserlasses – UStAE) and accepted the change in case law on the entrepreneurial status of supervisory board members. At the same time, the above-mentioned rulings of the BFH were published in the Federal Tax Gazette. The consequences of this for supervisory board members in the future are outlined below.

III. Future assessment

First of all, it should be noted that supervisory board members can continue to be self-employed and thus entrepreneurial in principle. However, a self-employed activity is no longer assumed if the member of the supervisory board only receives a fixed remuneration and thus does not bear any remuneration risk (A 2.2 para. 3a sentence 1 UStAE). In this case, the remuneration is to be calculated without VAT being shown and the supervisory board member no longer has to fulfill any further VAT obligations. In particular, there is no need to pay the VAT due on the remuneration to the tax office or to declare these sales in a VAT return. On the other hand, due to the lack of entrepreneurial status, the member is no longer entitled to an input tax deduction with regard to the VAT paid for supplies and services received.
The tax authorities define fixed remuneration as a lump-sum expense allowance paid for the duration of membership of the supervisory board (A 2.2 para. 3a sentence 3 UStAE). It is irrelevant whether this is paid in cash or in kind (A 2.2 para. 3a sentence 2 UStAE). On the other hand, attendance fees that are only paid for participation in a supervisory board meeting and expense allowances calculated on the basis of actual expenditure are not fixed remuneration as defined above (A 2.2 para. 3a sentence 4 UStAE). If the supervisory board member only receives such variable amounts, the previous VAT assessment shall apply. This means that the supervisory board member is still an entrepreneur and, unless he or she falls under the small business regulation or has opted for standard taxation, must continue to invoice his or her remuneration with VAT.
If both fixed and variable remuneration components are paid, the supervisory board member is deemed to be an entrepreneur if the variable remuneration component amounts to at least 10% of the total remuneration in the calendar year (A 2.2 para. 3a sentence 5 UStAE). For the purpose of determining the 10% threshold, travel expense reimbursements are not to be taken into account (A 2.2 para. 3a sentence 6 UStAE). If the member of the supervisory board does not bear any remuneration risk, he or she is not self-employed solely because he or she is liable for conduct in breach of duty under the conditions of sec. 116 German Stock Corporation Act (Aktiengesetz – AktG) (A 2.2 para. 3a sentence 10 UStAE).
The aforementioned principles are to be applied in all cases that are still open. However, the tax authorities do not object to supervisory board remuneration generally being treated as subject to VAT until 31 December 2021.

IV. Consequences for the practice

As shown above, as a result of the change in case law and administrative opinion, supervisory board members must now examine whether or not they are engaged in business activities due to the nature of the agreed remuneration (fixed or variable). This also applies if the company uses the credit note procedure (sec. 14 para. 2 sentence 2 UStG), as the supervisory board member as the recipient of the credit note can object to the document sent to him in the event of an error in the VAT assessment (sec. 14 para. 2 sentence 3 UStG). Each supervisory board member must be considered individually and the VAT consequences can theoretically differ from year to year.
In the case of companies that provide services subject to VAT and are therefore entitled to deduct input tax, it is generally advisable to structure supervisory board remuneration with VAT, as the supervisory board member can then claim an input tax deduction for his/her own costs. In the case of companies not entitled to deduct input tax (e.g. residential rental companies, banks, insurance companies), it is generally advisable to structure supervisory board remuneration in such a way that no input tax is incurred, i.e. fixed remuneration.
For remuneration relating to periods up to 31 December 2021, members of the supervisory board have the right to choose. Assessments that are not yet final can be changed on the merits in favor of not recognizing supervisory board remuneration for VAT purposes. However, it should be noted that such application of the latest case law in old years is likely to be associated with an invoice correction, as the VAT amounts will otherwise be owed by the member of the supervisory board pursuant to sec. 14c UStG. Whether such a procedure is worthwhile due to the costs incurred must be examined on a case-by-case basis, as we understand that a correction of the VAT is only possible with the consent of the tax office (sec. 14c para. 2 sentences 3 et seq. UStG). It would probably only make sense if the company is not entitled to deduct input tax or is not entitled to deduct input tax in significant parts.
Furthermore, it must be noted that a change in the VAT assessment of supervisory board members may trigger an adjustment pursuant to sec. 15a UStG. Pursuant to this provision, input tax amounts claimed in the past must be repaid to the tax office in full or in part under certain circumstances if the circumstances relevant to the assessment of the input tax deduction change in later years. This also applies if an entrepreneurial activity is discontinued for whatever reason which is the case if the supervisory board member loses his entrepreneurial status.

V. Conclusion

The previous simple rule that supervisory board members not only generate income from self-employment for income tax purposes, but are also self-employed and thus entrepreneurs for VAT purposes, has been overtaken by the most recent case law of the fiscal courts. On the one hand, this is to be regretted, because in many cases the income tax law and the VAT law will now probably diverge. Supervisory board members are required to review their VAT status or have it reviewed by the end of 2021 at the latest. In this context, particular attention should also be paid to the transitional provision and the correction provision of sec. 15a UStG. On the other hand, the reclassification of the entrepreneurial status of supervisory board members can lead to cost relief at the level of the company. If the company is not or not fully entitled to deduct input tax due to the provision of tax-exempt output sales, an additional expense component will no longer apply in the future if the members of the supervisory board are to be classified as non-entrepreneurs.