German Federal Fiscal Court makes gifting of company shares to deserving employees easier

Background

As is generally known, the gift tax implications of a gift of company shares must be assessed prior to a transaction. If the beneficiary works for the company, it should also not be overlooked that the gift could instead (possibly even additionally) amount to taxable income from employment under section 19 of the German Income Tax Act (Einkommensteuergesetz ‒ EStG) and therefore (also) be subject to income tax. Against this background, the decision of the lower court (Saxony-Anhalt Fiscal Court (Finanzgericht) of 27 April 2022 - 3 K 161/21, RFamU 2022, 530 with a comment by Daragan) has already been widely discussed among legal writers (see, for example, Görg DB 2024, 2049; Gluth ErbStB 2024, 165). There are two main reasons for this:

On the one hand, the Saxony-Anhalt Fiscal Court, in broad agreement with a decision of the Bremen Fiscal Court (RFamU 2022, 327 with a comment by Daragan), has developed classification criteria for assessing whether a transfer of company shares to employees at a reduced price or completely gratuitously (i) stems from the employment relationship (and can therefore lead to taxable income within the meaning of section 19 of the German Income Tax Act ), (ii) is based on a special legal relationship (which can give rise to income from other types of income apart from section 19 of the German Income Tax Act) or (iii) falls outside the scope of income tax (and is therefore at most subject to gift tax). On the other hand, the fundamental question of whether and in which scenarios the same set of facts can simultaneously be subject to both income tax and gift tax came into focus once again (for more details, see Troll/Gebel/Jülicher/Gottschalk/Gebel, 9/2024, ErbStG annex to section 7, para. 417 ff with further references).

It appeared that two fiscal courts had reached comparable conclusions in similar cases, providing a practicable basis for legally sound judgments through their decisions. The tax authorities’ decision to appeal against the judgment of the Saxony-Anhalt Fiscal Court was therefore received with surprise in many quarters. The appeal revived legal uncertainty that was thought to have been resolved.

The Federal Fiscal Court’s (Bundesfinanzhof) appellate decision had been eagerly anticipated, not least because the long-term retention of employees with special professional expertise, industry experience, and possible management experience is a key element of succession planning in many companies. This applies even when there is no familial relationship with deserving employees, such as where (as in the case under discussion) non-family employees are to be given at least a blocking minority free of charge to leverage their expertise and experience in influencing fundamental company decisions. It is evident that negotiations on succession plans are significantly influenced by whether the employees involved can be reliably assured that only a gift tax burden is likely, for example, if the business asset relief pursuant to sections 13a ff of the German Inheritance Tax Act (Erbschaftsteuer- und Schenkungsteuergesetz ‒ ErbStG) is not granted as intended, or whether alternatively (possibly even cumulatively) a potentially higher income tax burden must be anticipated. Although the employees concerned would be given company shares free of charge (or at a reduced price), funds for (additional) tax payments are generally not made available to them.

The decision

The Sixth Senate of the Federal Fiscal Court had to decide whether the transfer of shares in a company by way of gift to the claimant, who had been employed by the company for many years, constituted taxable wages as a pecuniary benefit (as claimed by the tax authorities) or not (as ruled by the lower court). The Sixth Senate upheld the judgment of the Saxony-Anhalt Fiscal Court and dismissed the tax authorities’ appeal as unfounded. The Senate was of the opinion that the Saxony-Anhalt Fiscal Court had correctly decided that the benefit of the transfer of shares in a company by way of gift did not constitute wages for the claimant.

Firstly, the Sixth Senate reaffirmed central elements of its established case law on the income tax treatment of discounted transfers of company shares to employees: the benefit of the price reduction (discount), but not the transferred shares themselves, can be considered wages that are subject to income tax as a pecuniary benefit, even if the shares are not transferred by the employer but by a third party. In contrast, a transfer at market price (i.e. without a discount) does not result in a pecuniary benefit. However, even if a discount is granted, the pecuniary benefit qualifies as taxable wages only if it stems from the employment relationship. It is therefore necessary that the discount is granted as consideration “for” past or future services under the employment contract, rather than stemming from a separate, parallel legal relationship or non-employment-related factors. It is up to the trial courts to determine this distinction primarily by carrying out an overall assessment of all significant circumstances of the individual case, with appellate courts conducting only a restricted review of this assessment.

In the case under discussion, the Sixth Senate concluded that while the share transfer was related to the claimant’s employment, it did not primarily stem from the employment relationship. The Fiscal Court had correctly based its decision on the fact that the decisive motive for the transfer of the shares was clearly not remuneration for past or future services rendered by the claimant under the employment contract, but rather the implementation of a corporate succession strategy.

The Sixth Senate identified the following key criteria supporting this assessment (with succession planning as the primary objective):

• The contractual agreements with the claimant included an inheritance or gift tax reversion clause. Under this clause, the gifted shares could be reclaimed if the exemption of the transferred business assets from inheritance or gift tax (pursuant to sections 13a ff of the German Inheritance Tax Act) was denied.
• The claimant, who was experienced in managing the company, held, together with other employees who had receives gifts, a blocking minority. This ensured significant influence over the company’s management.
• The integration of skilled employees into the shareholder base indicated that the primary aim was to secure the company’s continuity and development through succession planning. Retaining the professional expertise and experience of (long-standing) employees is typically a critical component of such succession strategies.
• The share transfers were not made dependent on the continuation of the employment relationship. There were no provisions for vesting, cliff or leaver-related conditions typically seen in traditional employee share programmes.
• In the case of the claimant and the other employees who received gifts of shares, there was a clear disproportion between the value of the gifted shares and the employees’ (past and anticipated future gross) salaries.
• Despite variations in their lengths of service and salary levels, the employees receiving gifts received identical share allocations.

Evaluation and practical implications of the decision

The decision of the Sixth Senate contributes to legal certainty and is to be generally welcomed.

In practice, it can be assumed that the decision will improve the framework conditions for implementing entrepreneurial decisions to also grant non-family employees shares in a company free of charge or at a reduced price, beyond remuneration for past or future work performance. This allows companies to retain these employees as shareholders rather than merely as employees. Based on the principles developed by the Saxony-Anhalt Fiscal Court and the Bremen Fiscal Court, and now confirmed by the Sixth Senate of the Federal Fiscal Court, it should generally be possible to create contractual arrangements that securely fall within the scope of gift tax. This includes the possibility of exempting business assets in accordance with sections 13a ff of the German Inheritance Tax Act for the transfer of shares, without triggering income tax consequences. It is advisable to clearly document the motives for offering the discounted or gratuitous benefit.

On the other hand, the Sixth Senate did not have to deal with the question of whether a set of facts can be subject to income tax and gift tax at the same time, as it rejected the classification of the transfer as taxable wages. In our opinion, when company shares are transferred gratuitously, income under section 19 of the German Income Tax Act (wages) and a voluntary gift under section 7(1)(1) of the German Inheritance Tax Act are generally mutually exclusive. This is because income under section 19 of the German Income Tax Act has to stem from the employment relationship, which precludes a voluntary gift within the meaning of section 7(1)(1) of the German Inheritance Tax Act (see, for example, Herrmann/Heuer/Raupach/Lammers, Status 12/2024, German Inheritance Tax Act, section 19, comment 63; Gluth ErbStB 2024, 165 (167)). It remains an open question whether, in cases with other motives, a mixed motivation could lead to a division between income taxable under section 19 of the German Income Tax Act and a voluntary gift within the meaning of section 7(1)(1) of the German Inheritance Tax Act (see Wighardt/Perpetua ZEV 2025, 130 (132 f.)). Accordingly, in the context of employee share transfers during corporate succession, it is important to recognise two competing forms of taxation: firstly, the interplay between gift tax and income tax (tax type competition) and secondly, the distinction between wages and capital income (income type competition). The tax consequences clarified by the Sixth Senate’s decision must be carefully considered and integrated into the legal structuring of such arrangements.

Republished with the kind permission of the RFamU journal. Originally published in German.