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A pension commitment is a common part of the retirement package for a shareholder managing director, especially in medium–sized companies. When buying a business, a buyer will often insist that the pension entitlement is settled and cleared by the previous shareholders before the transaction is completed. When restructuring pension entitlements, you need to be aware of the tax consequences to avoid any unpleasant surprises.
By waiving their pension entitlement, the shareholder managing director declares that they waive this without receiving any compensation.
Example:
At the start of retirement during the 2018 assessment period, person A waives the pension commitment made to him/her by way of a termination agreement with the GmbH (limited liability company) without any compensation and without any business reason. The pension provision at the last balance sheet date was:
In the tax balance sheet, the waiver leads to a reversal of the pension provision liability, which increases earnings, in the amount of EUR 250,000. The waiver imposed by the business situation leads to a so-called hidden contribution to the company by the shareholder managing director amounting to EUR 350,000 that has to be settled off-balance sheet. The waiver thus leads to an expense for the company of: EUR 100,000.
For the shareholder managing director personally, the waiver leads to a fictitious, taxable salary receipt, equalling the total of the hidden investment, and also to subsequent acquisition costs for the company totalling EUR 350,000. The increased acquisition costs affect the capital gain in case of a sale of the shares. However, the partial income procedure, which applies in case of a sale of shares, only leads to a partial compensation of the tax burden from the inflow of the hidden contribution.
Compensation is provided in lieu of a pension commitment when the shareholder managing director waives their pension but receives compensation in lieu thereof.
Example (as with waiver), but A receives compensation in the amount of EUR 350,000:
At the level of the GmbH, the same tax consequences apply as in the case of a waiver. In addition, there is an expense in the amount of the compensation, which qualifies as a hidden profit distribution and has to be corrected off-balance-sheet, so that the P&L effect of this is EUR 0. As a result, there is still a cost of EUR 100,000.
For the shareholder managing director personally, the same tax consequences apply as in the case of a waiver. In addition there is a hidden profit distribution equalling the compensation, which - for the shareholder managing director - is subject to capital gains withholding tax. Therefore the shareholder managing director suffers double taxation.
Example: Transfer of pension commitment incl. assets totalling EUR 350,000 to Company Y. Other values remain unchanged.
As a result of the transfer of the pension commitment including assets, the GmbH suffers a loss of EUR 100,000. This results from the release of the pension provision on the P&L which increases earnings, (EUR 250,000) and the derecognition of assets (EUR 350,000) which increases costs. The loss is spread over the year in which it occurred and the following 14 years, so that the retained earnings of the GmbH have to be increased by 14/15ths of EUR 100,000 and written down off-balance sheet over the following 14 years.
For the shareholder managing director, there are fictitious additional earnings of EUR 350,000 which are subject to tax.
If transferred to an external provider, the shareholder managing director’s pension commitment is transferred, for example, to a pension fund.
Example: For the transfer of the fully acquired pension commitment, the pension fund demands a one-time contribution of EUR 350,000. The company makes an application under Section 4e of the Income Tax Act (EStG). Other values as above.
From the transfer of the pension obligation, the company achieves income totalling EUR 250,000. The company can deduct the excess portion of the reversed pension provision (EUR 100,000) as a business expense, spread equally over the next ten financial years.
A transfer of the pension commitment to the pension fund in accordance with the above application remains tax-free for the shareholder managing director.
As the above examples make clear, resolving the pension commitment is unlikely to remain without tax consequences for either the company granting the pension or for the shareholder managing director. It is therefore advisable to address this topic early on in the transaction process in order to deal adequately with the tax consequences in the context of the overall transaction. In addition, there are further legal and economic aspects that also require attention.
Dr. Susanne Kölbl
Partner
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Dr. Michael S. Braun
Transaction advisory | Mergers & Acquisitions
