The BFH dealt in its judgment (IV R 9/21) of 09.11.2023 with the taxation of so-called earn-out payments. In doing so, it endorsed previous case-law. The payment of profit- or turnover-deferred purchase price compensation, which is not fixed either in terms of reason or amount, must therefore be recorded as ex-post operating income according to § 15 (1) in conjunction with § 24 (2) EStG. Below we give you an overview of the consequences of the judgment and the impact on taxation practice.

1st Taxation of Earn-Outs – Introduction

As part of the transaction practice, in addition to a fixed purchase price component, a variable remuneration is often agreed. This is linked to the future development of the company. The regulations on variable purchase price compensation are made via so-called “earn-out clauses” in the purchase contract. Regardless of the basic purchase price payable on the sales date, the variable shares are payable only upon the occurrence of the agreed terms. The obligation to provide services is usually linked to performance-related parameters, such as revenue or profit of the company. However, the agreement can also be tied to real quantities. Examples of this are the successful market launch of a new product or the achievement of a certain number of customers. The period of the agreement (earn-out period) can vary between a few months and several years. All this thus has an indirect impact on the taxation of the earn-out.

New BFH ruling on the taxation of earn-outs

In its judgment (IV R 9/21) of 09.11.2023, the BFH clarified that profit- and turnover-related purchase price compensation for the sale of a share of the co-entrepreneur is taxable as ex-post operating income within the meaning of § 15 (1) in conjunction with § 24 (2) EStG. In this respect, it followed its 2002 decision and confirmed the reasons for its decision. If neither the reason nor the amount of an earn-out is fixed at the time of sale, the payments under taxation are necessarily recorded as ex-post operating income. This is mainly due to the valuation difficulties of the rates. Finally, the present value can only be estimated.

3. Impact of the BFH judgment on the taxation of earn-outs

In the context of company sales, it is therefore possible in principle to adapt the earn-out clauses in the relevant sales contracts in order to achieve the desired taxation. On the one hand, it may be useful to refer the gain on the sale back to the time of the sale in order to benefit from the advantages of §§ 16 (4), 34 (1) and (3) EStG. On the other hand, a distribution of the purchase price for the investment period of the sale may have a progressively mitigating effect.

For the sale of shares in corporations by a corporation, the abovementioned principles are also applicable. However, the advantage granted to § 8b(2) KStG does not in principle have any relevance. In the past, it was questionable whether the tax exemption of the capital gains was also applicable to ex post purchase price rebates under an earn-out agreement or whether the resulting profits were fully taxed. For this case, however, the BFH already decided in 2018 in favor of the applicability of § 8b paragraph 2 KStG.

Taxation of earn-out payments – Conclusion

With regard to the taxation of earn-out payments, the BFH reaffirmed the already existing opinion in the case-law regarding the reason and the amount of still indefinite earn-out payments. However, a treatment of the earn-outs set in terms of amount left this explicitly open. Although the Finance Ministry of Schleswig Holstein reacted and provides clear guidelines in taxation practice, final legal certainty can only be achieved by a decision of the BFH. In order to circumvent the existing risks and to make the best possible use of the tax advantages for company sales, it is therefore advisable in any case to carry out a precise tax assessment so that an optimal arrangement can be made.