The tax consequences in Germany of a management participation plan are not clear. An employee holding an interest in their employer company may either be taxed on the basis of receiving income from their employment or from a capital asset. This results in different tax treatment.

Last year the Fiscal Court of Cologne considered a case where a manager held an interest in a shareholder of their employer and decided that the same principles apply. The decisive factor was whether the payments were caused by and granted under the employment relationship or a different legal relationship between the employee and employer.

The Court ruled that the profit on the sale of an indirect interest held by a manager in the shareholder of his employer should not be considered as employment income. A key factor was that the taxpayer acquired the interest in addition to other employees at a fair market price and bore an actual risk of loss. On the other hand, the Court did not consider it decisive that the participation had only been offered to managers or that the employee had been excluded from the plan upon termination of the employment relationship and was restricted in the sale of the shares.

Unfortunately the Court’s ruling does not eliminate the uncertainty as to the correct tax treatment in Germany of management participation plans. Each case must be looked at carefully taking into account all aspects of the way in which an employee will acquire the shares, including whether there is a separate participation agreement, what price is paid for the shares, whether there is a risk of loss and how the shareholding is dealt with following termination of employment.

An appeal has been filed against the Court’s decision. It remains to be seen which criteria the Federal Fiscal Court will consider decisive in order to determine whether income from a management participation plan is to be treated as employment income or income from a capital asset.