Earn-out as wages: Cologne Fiscal Court takes a position

In its decision of December 4, 2024 (Ref. 12 K 1271/23v), the Cologne Fiscal Court decided that a purchase price component for the sale of shares in a limited liability company (GmbH) linked to future management activities (earn-out) is to be treated as remuneration for tax purposes – not as a capital gain under Art. 17 of the German Income Tax Act (EStG). An appeal is pending before the Federal Fiscal Court under case no. IX R 1/25.

Earn-out on the sale of GmbH shares: Details of the Cologne Fiscal Court decision

In the case in question, a managing partner sold all of his shares in a GmbH. In the purchase agreement, he undertook to remain in office as managing director for a further five years. Part of the agreed purchase price was explicitly linked to his continued service as managing director as part of a so-called “earn-out” arrangement; in the event of his premature departure, the agreement provided for a pro rata repayment.

The seller treated the earn-out as capital gains in his tax return. The tax office, however, considered it to be wages. In its decision, the Cologne Fiscal Court agreed with the tax authorities' assessment.

The key statements of the Cologne Fiscal Court

The Cologne Fiscal Court cited the following reasons for its decision:

• The decisive factor is whether the remuneration is legally and factually linked to the future activities. If a component of the purchase price is only granted if the seller continues to serve as managing director, this indicates that it is wages (Art. 19 EStG). The purchase price component cannot be realized without the continuing service relationship and therefore cannot be considered a capital gain under Art. 17 EStG.
  The agreement requiring a pro rata repayment in the event of early departure shows that the remuneration is consideration for future work and not part of the sale of shares.
• Not every earn-out or retention bonus is considered wages. An overall assessment of all circumstances is decisive, in particular the length of commitment, scope of services, and repayment terms.

Significance of the Fiscal Court’s decision in practice

Whether earn-out components are part of the purchase price and thus fall within the scope of the partial income procedure (Art. 3 No. 40 EStG) in case of a sale of GmbH shares, or whether they constitute remuneration for work performed, is a recurring topic of discussion with the tax authorities. In this context, a number of key findings for the drafting of share purchase agreements can be derived from the present decision:

• If purchase price components are linked to the seller’s future activity, there is a considerable risk for them to qualify as wages. 
• Consideration for shares and remuneration for future activities should be clearly separated in order to minimize tax risks. While the purchase price for the sale of shares is subject to the partial income procedure and is therefore only 60 % taxable, wages are subject to taxation in full.

As the appeal is pending before the Federal Fiscal Court (IX R 1/25), similar disputes with the tax authorities should be kept open until the decision has been rendered.

Benedikt Hoffmann and Daniela Stephan have noted the decision’s specific consequences for founders.

For sellers and buyers, careful contract drafting and documentation are essential in order to avoid tax risks.