On 22 January 2026, the Federal Fiscal Court (BFH) published two almost identical judgments by its Eighth Senate (case number VIII R 13/23 and case number VIII R 11-12/23) on the ongoing taxation of management participation programs in the form of typical silent partnerships, which are welcome from an advisory practice perspective.
In its rulings, the BFH establishes clear principles for the ongoing taxation of typical silent partnerships as management participation programs. This is a clear departure from its previous case law, according to which, income from a management participation could be either income from capital assets or income from employment, depending on the overall circumstances.
The BFH has thus significantly improved legal certainty with regard to the taxation of management participation programs. If the requirements established by the BFH are met by a management participation program, taxation must primarily be carried out in accordance with the rules on capital income, which are favourable for the participants.
In this respect, it is now also clear that the same taxation criteria apply to debt capital investments as to equity investments. In particular, no appropriateness test is to be carried out for the amount of interest.
Key facts at a glance
If ongoing payments to an employee holding shares in an employer company are based on a special legal relationship
- that has been effectively established,
- whose terms have been seriously agreed and implemented, and
- which, in terms of its structure, has its own economic substance alongside the employment relationship,
then taxation of these payments as income from employment is excluded.
If the current income from the shareholding significantly exceeds the nominal amount of the investment, this does not affect its classification as capital income.
Facts
The decisions concerned an investment structure for senior executives as typical silent partners that had already been established in the 1990s. The investments were acquired at nominal value and entitled the holders to a share of the annual surplus or annual deficit in proportion to their percentage share in the company’s capital, including silent partnerships. There was no provision for participation in losses beyond the capital invested; losses were merely offset against future profits. There was no participation in hidden reserves. The participation was to end upon termination of employment relationship.
Over the term of a typical silent partnership, silent partners received a multiple of their investment as income in some cases but also participated substantially in the losses of the respective company.
For many years, employer companies treated these payments as capital income and withheld capital income tax and the solidarity surcharge. Following an external income tax audit of the employer companies, the respective tax offices reclassified the ongoing payments from the silent partnership as income from employment and amended the income tax assessments to the disadvantage of the employees concerned. The employees challenged this decision and were successful before the BFH after the Baden-Württemberg Fiscal Court had initially ruled in favour of the taxpayers and the Saxony Fiscal Court had ruled to the detriment of the taxpayers.
Reasons for the decision
The key issue to be decided in the judgments concerned the distinction between income from employment and capital income. According to the previous rulings of the BFH, the distinction depends on an overall assessment of the facts. This means that even a capital loan relationship could lead to income from employment if the connection between the participation and the employment relationship was too close.
The Sixth Senate had already contradicted this case law in its highly regarded decision of 14 December 2023 (case number VI R 1/21, BStBl. II 2024, 387). According to this ruling, the participation itself cannot constitute a noncash benefit, but only a benefit granted upon acquisition or an excessive price paid upon sale. However, the ruling of the sixth Senate concerned genuine equity shares and related to the classification of the capital gain, not the taxation of ongoing income of the participation. Therefore, the question remained open as to whether this case law also applies to debt capital investments and whether an arm’s length comparison or an appropriateness test must be carried out for the income from such investments. This had been a key argument of the tax authorities, which had regarded high interest rates as an indication that the payments were motivated by the employment relationship.
The Eighth Senate of the BFH has clearly rejected this argument. If a payment is initiated by a special legal relationship
- that has been effectively established,
- whose terms have been seriously agreed and implemented, and
- which, in terms of its structure, has its own economic substance alongside the employment relationship,
then the income from it is always income from capital assets.
The same applies if the shareholding itself was acquired at a reduced price or if an above-market price is paid upon sale. In this respect, the acquisition, holding, and sale of the participation are independently qualifying taxable events that do not influence each other.
Section 20 (1) No. 4 of the German Income Tax Act (EStG) does not provide any guidelines for assessing the appropriateness of remuneration. Only purely discretionary payments or payments that deviate from the contractual agreement are subject to individual assessment.
Conclusion
Income from management capital participations is generally taxable as capital income, provided that the aforementioned conditions are met.
This equally applies to equity and debt capital participations.
The acquisition or sale of the investment may result in a taxable benefit if the investment is purchased at a reduces price or sold at a higher price. This increases the importance of the accurate valuation of the participations in the taxation process.