BFH Ruling of November 9, 2023 – Ref.: IV R 9/21
Earn-out clauses are common in M&A transactions, allowing both buyers and sellers to benefit from variable components of the purchase price. However, the timing of taxation on these variable purchase price components can be contentious. In a recent ruling dated November 9, 2023, the Federal Fiscal Court (Bundesfinanzhof, BFH) clarified that purchase price components dependent on profit or revenue should only be taxed upon receipt as subsequent business income (Ref.: IV R 9/21).
Earn-out clauses are frequently used in M&A transactions within company purchase agreements. This means that the buyer initially pays only a base price for the target company, while additional payments depend on the future development of the company’s revenue and profit. The advantages of earn-out clauses in business acquisitions are clear: the buyer reduces their risk, while the seller can continue to benefit from positive business developments. Earn-out payments can also offer potential tax advantages, according to the law firm MTR Legal Rechtsanwälte, which advises in corporate law and on business transactions.
Taxation of Variable Purchase Price Components
The question of how and when earn-out payments are taxed, however, is often a matter of dispute. It can disadvantage sellers if tax authorities add earn-out payments to the purchase price in the year of sale, even though the cash inflow occurs at a later date. With its ruling on November 9, 2023, the BFH clarified that variable purchase price components are to be taxed in the year when the seller actually receives the payment.
The underlying case concerned the sale of a partnership interest to a limited liability company (GmbH). In addition to paying a fixed purchase price for the business interest, the buyer and seller agreed to an earn-out clause. This clause stipulated that the seller would receive an additional purchase price in the form of a variable payment, based on the gross margin achieved over the following three fiscal years. If a specific gross margin was reached, the seller would receive an additional payment.
On this basis, variable purchase price payments were made to the seller over the three subsequent years.
Taxation in the Year of Sale
The tax office sought to tax these payments as subsequent purchase price payments in the year of sale. The plaintiff’s appeal, claiming that the earn-out payments were installments on the purchase price only realized upon actual receipt of the funds, was rejected by the tax office.
However, the Fiscal Court ruled in favor of the plaintiff, stating that the tax office had incorrectly included the variable purchase price payments in the calculation of the sale profit. In cases of purchase price agreements tied to profit and revenue, the realization of the sale proceeds at the time of receipt is the key consideration, the court concluded. This ruling represents an exception to the principle of date-based profit determination.
Although the tax office appealed against this decision, it failed in the appeal proceedings before the BFH, which upheld the Fiscal Court’s decision.
Exception for Profit- and Revenue-Dependent Purchase Price Claims
The BFH stated that sale profit generally arises at the time of sale, i.e., when economic ownership is transferred. This holds regardless of whether the purchase price is paid immediately, in installments, or only years later. Thus, the sale profit is to be determined based on the date of sale. However, an exception applies to profit- and revenue-dependent purchase price claims, as in this case. Here, the realization of the sale proceeds is key, as the profit is only achieved at the time of receipt, the BFH emphasized.
The BFH justified its position by explaining that such profit- and revenue-dependent purchase price clauses represent conditional claims. At the time of sale, it is uncertain whether this purchase price claim will arise in the subsequent years or what the amount will be. The same applies to earn-out clauses, where both the occurrence and the amount of the variable purchase price components are uncertain, according to the BFH.
When negotiating earn-out clauses in M&A transactions, particular attention should therefore be paid to the tax implications.
As a commercial law firm, MTR Legal Rechtsanwälte has extensive experience in corporate law and is a competent partner in M&A transactions.
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